Free trade

Free trade

From Wikipedia

 

Free trade is a system in which the trade of goods and services between or within countries flows unhindered by government-imposed restrictions. Such government interventions generally increase costs of goods and services to both consumers and producers. Interventions include taxes and tariffs, non-tariff barriers, such as regulatory legislation and quotas, and even inter-government managed trade agreements such as theNorth American Free Trade Agreement (NAFTA) andCentral America Free Trade Agreement (CAFTA) (contrary to their formal titles.) Free trade opposes all such interventions. Trade liberalization entails reductions to these trade barriers in an effort for relatively unimpeded transactions.

One of the strongest arguments for free trade was made by classical economist David Ricardo in his analysis ofcomparative advantage. Comparative advantage explains how trade will benefit both parties (countries, regions, or individuals) if they have different opportunity costs of production.

Free trade can be contrasted with protectionism, which is the economic policy of restricting trade between nations. Trade may be restricted by high tariffs on imported or exported goods, restrictive quotas, a variety of restrictive government regulations designed to discourage imports, and anti-dumping laws designed to protect domestic industries from foreign take-over or competition.

Free trade is a term in economics and government that includes:

  • trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on imports or subsidies for producers)
  • trade in services without taxes or other trade barriers
  • The absence of trade-distorting policies (such as taxes, subsidies, regulations or laws) that give some firms, households or factors of production an advantage over others
  • Free access to markets
  • Free access to market information
  • Inability of firms to distort markets through government-imposed monopoly or oligopoly power
  • The free movement of labor between and within countries
  • The free movement of capital between and within countries
For more detailed arguments in favor of and against free trade, see: Free trade debate.

 

History of free trade

The history of international trade is a focusing on the development of open markets. It is known that various prosperous world civilizations throughout history have engaged in trade. Based on this, theoretical rationalizations as to why a policy of free trade would be beneficial to nations developed over time. These theories were developed in its academic modern sense from the commercial culture of England, and more broadly Europe, over the past five centuries. Before the appearance of Free Trade, and continuing in opposition to it to this day, the policy of mercantilism had developed in Europe in the 1500s. Early economists opposed to mercantilism were David Ricardo and Adam Smith.

Economists that advocated free trade believed trade was the reason why certain civilizations prospered economically. Adam Smith, for example, pointed to increased trading as being the reason for the flourishing of not just Mediterranean cultures such as Egypt, Greece, and Rome, but also of Bengal (East India) and China. The great prosperity of the Netherlands after throwing off Spanish Imperial rule, and declaring Free Trade and Freedom of thought, made the Free Trade/Mercantilist dispute the most important question in economics for centuries. Free trade policies have battled with mercantilist, protectionist, isolationist,communist, and other policies over the centuries.

Wars have been fought over trade, such as the Peloponnesian War between Athens and Sparta, the Opium Wars between China and Great Britain, and other colonial wars. Alldeveloped countries have used protectionism due to an interest in raising revenues,protecting infant industries, special interest pressure, and, prior to the 19th century, a belief inmercantilism. Protectionism still exists throughout the world. In most developed nations, controversial agricultural tariffs are maintained. From 1820 to 1980, the average tariffs on manufactures in twelve industrial countries ranged from 11 to 32%. In the developing world, average tariffs on manufactured goods are approximately 34%.[1]:66

Currently, the World Bank believes that at most rates of 20% can be allowed by developing nations, but Ha-Joon Chang believes higher levels may be justified because the productivity gap between developing and developed nations is much higher than the productivity gap which industrial countries faced. Since the main defense of tariffs is to stimulate infant industries, a tariff must be high enough to allow domestic manufactured goods to compete for the tariff to be possibly successful. This theory, known as import substitution industrialization, is largely considered to be ineffective for currently developing nations,[2]:311 and studies by the World Bank have determined that export-oriented industrialization policies correlate with higher economic growth as observed with the Four Asian Tigers. These assessments are based mainly on theory and observational study of correlations, and thus suffer from a number of weaknesses such as small sample size and numerous confounding variables (see the critical review section below).

 

The US and free trade

The colonies which became the United States generally supported free trade; indeed British restrictions on trade were a major factor in the war for secession. New England was famous for smuggling. However, the 1st U.S. Secretary of the Treasury, Alexander Hamilton, advocated tariffs to help protect infant industries in his “Report on Manufactures.” This was a minority position, however, which the “Jeffersonians” strongly opposed for the most part. Later, in the 19th century, statesmen such as Senator Henry Clay continued Hamilton’s themes within the Whig Party under the name “American System.” The opposition Democratic Party contested several elections throughout the 1830s, 1840s, and 1850s in part over the issue of the tariff and protection of industry. The Democratic Party favored moderate tariffs used for government revenue only, while the Whig’s favored higher protective tariffs to protect favored industries. The economist Henry Charles Carey became a leading proponent of the “American System” of economics. This mercantilist “American System” was opposed by the Democratic Party of Andrew Jackson, Martin Van Buren, James K. Polk, Franklin Pierce, andJames Buchanan.

The fledgling Republican Party led by Abraham Lincoln, who called himself a “Henry Clay tariff Whig,” strongly opposed free trade and implemented at 44 percent tariff during the Civil War in part to pay for railroad subsidies, the war effort, and to protect favored industries.[3]President William McKinley stated the United States’ stance under the Republican Party (which won every election for President until 1912, except the two non-consecutive terms of Grover Cleveland) as thus:

“Under free trade the trader is the master and the producer the slave. Protection is but the law of nature, the law of self-preservation, of self-development, of securing the highest and best destiny of the race of man. [It is said] that protection is immoral…. Why, if protection builds up and elevates 63,000,000 [the U.S. population] of people, the influence of those 63,000,000 of people elevates the rest of the world. We cannot take a step in the pathway of progress without benefitting mankind everywhere. Well, they say, ‘Buy where you can buy the cheapest’…. Of course, that applies to labor as to everything else. Let me give you a maxim that is a thousand times better than that, and it is the protection maxim: ‘Buy where you can pay the easiest.’ And that spot of earth is where labor wins its highest rewards.”[4]

On the other side:

The growing Free Trade Movement sought an end to the tariffs and corruption in state and federal governments by every means available to them, leading to several outcomes. The first and most important was the rise of the Democratic Party with Grover Cleveland at its helm. The next most important were the rise of the “Mugwumps” within the Republican party. For many Jeffersonian radicals, neither went far enough or sufficiently effective in their efforts and looked for alternatives. The first major movement of the radical Jeffersonians evolved from the insights of a young journalist and firebrand, Henry George. – Kenneth R. Gregg, George Mason University History News Network

The tariff and support of protection to support the growth of infrastructure and industrialization of the nation became a leading tenet of the Republican Party thereafter until the Eisenhower administration and the onset of the Cold War, when the Democratic and Republican parties switched positions.

In the 1930s, the US adopted the protectionist Hawley-Smoot Tariff Act which raised rates to all time highs beyond the Lincoln levels, which many economists believe exacerbated theGreat Depression. Europe, which had less protectionism at the time, had largely come out of the depression while the US remained mired in the depression. Franklin D. Roosevelt resorted to Hamilton’s earlier formula of tariff Reciprocity coupled with subsidy to industry which went unbroken until the 1970s when protectionism was reduced after the Kennedy Round of trade talks in the late sixties.

In 2006 American Economic Association conducted a poll which revealed that 87,5 percent of its members with Ph.D. agreed that “the U.S. should eliminate remaining tariffs and other barriers to trade.”[5]

 

Present day (U.S. based)

Since the end of World War II, in part due to industrial supremacy and the onset of the Cold War, the U.S. government has become one of the most consistent proponents of reduced tariff barriers and free trade, having helped establish the General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO); although it had rejected an earlier version in the 1950s (International Trade Organization or ITO). Since the 1970s U.S. government has negotiated numerous managed trade agreements, such as the North American Free Trade Agreement (NAFTA) in the 1990s, the Dominican Republic-Central America Free Trade Agreement (CAFTA) in 2006, and a number of bilateral agreements (such as with Jordan).

 

Economics of free trade

The literature analysing the economics of free trade is extremely rich with extensive work having been done on the theoretical and empirical effects. Though it creates winners and losers, the broad consensus among members of the economics profession in the U.S. is that free trade is a large and unambiguous net gain for society.[6] [7] In a 2006 survey of American economists (83 responders), “87.5% agree that the U.S. should eliminate remaining tariffs and other barriers to trade” and “90.1% disagree with the suggestion that the U.S. should restrict employers from outsourcing work to foreign countries.”[8] Quoting Harvard economics professor N. Gregory Mankiw, “Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards.”[9] Nonetheless, quoting Prof. Peter Soderbaum of Malardalen University, Sweden, “This neoclassical trade theory focuses on one dimension, i.e., the price at which a commodity can be delivered and is extremely narrow in cutting off a large number of other considerations about impacts on employment in different parts of the world, about environmental impacts and on culture.” [10] Two simple ways to understand the benefits of free trade are through David Ricardo’s theory of comparative advantage and by analyzing the impact of a tariff or import quota.

The pink regions are the net loss to society caused by the existence of the tariff.

The pink regions are the net loss to society caused by the existence of the tariff.

A simple economic analysis using the law of supply and demand and the economic effects of a tax can be used to show the theoretical benefits of free trade.[11]

The chart at the right analyzes the effect of the imposition of an import tariff on some imaginary good. Prior to the tariff, the price of the good in the world market (and hence in the domestic market) is Pworld. The tariff increases the domestic price to Ptariff. The higher price causes domestic production to increase from QS1 to QS2 and causes domestic consumption to decline from QC1 to QC2. This has three main effects on societal welfare. Consumers are made worse off because the consumer surplus (green region) becomes smaller. Producers are better off because the producer surplus (yellow region) is made larger. The government also has additional tax revenue (blue region). However, the loss to consumers is greater than the gains by producers and the government. The magnitude of this societal loss is shown by the two pink triangles. Removing the tariff and having free trade would be a net gain for society. [12][13]

An almost identical analysis of this tariff from the perspective of a net producing country yields parallel results. From that country’s perspective, the tariff leaves producers worse off and consumers better off, but the net loss to producers is larger than the benefit to consumers (there is no tax revenue in this case because the country being analyzed is not collecting the tariff). Under similar analysis, export tariffs, import quotas, and export quotas all yield nearly identical results. Sometimes consumers are better off and producers worse off, and sometimes consumers are worse off and producers are better off, but the imposition of trade restrictions causes a net loss to society because the losses from trade restrictions are larger than the gains from trade restrictions. Free trade creates winners and losers, but theory and empirical evidence show that the size of the winnings from free trade are larger than the losses. [11]

 

[edit]Trade diversion

According to mainstream economic theory, global free trade is a net benefit to society, but the selective application of free trade agreements to some countries and tariffs on others can sometimes lead to economic inefficiency through the process of trade diversion. It is economically efficient for a good to be produced by the country which is the lowest cost producer, but this will not always take place if a high cost producer has a free trade agreement while the low cost producer faces a high tariff. Applying free trade to the high cost producer (and not the low cost producer as well) can lead to trade diversion and a net economic loss. This is why many economists place such high importance on negotiations for global tariff reductions, such as the Doha Round.[11]

 

Critical review

In an assessment of the literature on the theory and empirical research relating to the benefits of free trade, Sonali Deraniyagala and Ben Fine found that much of the work was flawed, and concluded that the extent to which free trade benefits economic development is unknown.[14]Theoretical arguments are largely dependent upon specific empirical assumptions which may or may not hold true. In the empirical literature, many studies suggest the relationship is ambiguous, and the data and econometrics underlying a set of empirical papers showing positive results have been critiqued. The best of these papers use a simplified model, and the worst involve the regression of an index of economic performance on an index of openness to trade, with a mix of these two approaches common. In some cases, Deraniyagala and Fine claim, these indexes of openness actually reflect trade volume rather than policy orientation. They also observe that it is difficult to disentangle the effects of reverse causality and numerous exogenous variables.

In Kicking Away the Ladder, Ha-Joon Chang reviews the history of free trade policies and economic growth, and notes that many of the now-industrialized countries had significant barriers to trade throughout their history. Protectionism under the auspices of the infant industry argument (related to import substitution industrialization), was first pursued byAlexander Hamilton in the 1790s in opposition to the admonition of Adam Smith, who advised that the United States focus on agriculture, where it had a comparative advantage. In the 1840s Friedrich List, known as the father of the infant industry argument,[1]:3 advocated the infant industry argument for Germany. Chang’s research shows that the United States and Britain, sometimes considered to be be the homes of free trade policy, were aggressive protectionists. Britain did end its protectionism when it achieved technological superiority in the late 1850s with the repeal of the Corn Laws, but tariffs on manufactured products had returned to 23% by 1950. The United States maintained weighted average tariffs on manufactured products of approximately 40-50% up until the 1950s, augmented by the natural protectionism of high transportation costs in the 1800s.[1]:17 The most consistent practitioners of free trade have been Switzerland, the Netherlands, and to a lesser degreeBelgium.[1]:59

Chang describes the export-oriented industrialization policies of the Asian Tigers as “far more sophisticated and fine-tuned than their historical equivalents”.[1]:50

 

Opponents of free trade

Free trade is often opposed by domestic industries that would have their profits and market share reduced by lower prices for imported goods.[15][16] For example, if United States tariffs on imported sugar were reduced, US sugar producers would receive lower prices and profits, while US sugar consumers would spend less for the same amount of sugar because of those same lower prices. Economics says that consumers would necessarily gain more than producers would lose.[17][18] Since each of those few domestic sugar producers would lose a lot as an individual while each of a much greater number of consumers would gain only a little, domestic producers are more likely to mobilize against the lifting of tariffs.[16] More generally, producers often favor domestic subsidies and tariffs on imports in their home countries, while objecting to subsidies and tariffs in their export markets.

Some socialists oppose free trade as a consequence of their exploitation theory and opposition to employment (“wage slavery”). For example, Karl Marx wrote in The Communist Manifesto, “The bourgeoisie… has set up that single, unconscionable freedom — Free Trade. In one word, for exploitation, veiled by religious and political illusions, it has substituted naked, shameless, direct, brutal exploitation.”

Others oppose government managed trade, erroneously calling it free trade. Thus, “free trade” is opposed by many anti-globalization groups, based on their assertion that so-called Free Trade agreements generally do not increase the economic freedom of the poor, and frequently make them poorer. See perfect competition for the basis for this view of how Free Trade should work. For example, it is argued [19] that letting subsidized corn from the US into Mexico freely under NAFTA at prices well below production cost (dumping) is ruinous to Mexican farmers. Of course, such subsidies violate free trade, so this argument might better be seen as against subsides and for free trade, properly understood.

Some free trade economists have recently begun to express their own doubts concerning the concept and practice of free trade. Alan S. Blinder, for example, a professor of economics at Princeton University, and former Federal Reserve Board vice chairman and advisor to Democratic presidential candidates, had previously argued, along with most economists, that free trade enriches the U.S. and its trading partners. However, he now says new communication technology will put 30-40 million American jobs at risk in 10-20 years. Blinder has not completely rejected free trade or Ricardo’s ideas about comparative advantage, but he advocates greater protection for displaced workers and an improved education system. Blinder opposed steel, aluminum and farming export subsidies and protection, and pushed for the passage of NAFTA, though he did not agree that it would create jobs in the US. Trade changes types of jobs, not the number, he said. Technology allowed Indians in call centers to do the work of Americans at lower wages. “Tens of millions of additional American workers will start to experience an element of job insecurity that has heretofore been reserved for manufacturing workers,” said Blinder. Democrats and Republicans are becoming skeptical. The debate is, “Should government encourage forces of globalization or try to restrain them?” Latin America performed poorly since tariff cuts in 1980s and 1990s, compared to protectionist China and Southeast Asia. Paul Samuelson, in his 2004 essay[20], condemned “economists’ over-simple complacencies about globalization” and said that workers don’t always win. Lawrence Summers, advocate for trade expansion as Clinton Treasury Secretary, said retraining is “pretty thin gruel” to the middle class. Ralph Gomory, former IBM chief scientist, says the rise of China and India could make the U.S. lose important industries. Harvard economist Dani Rodrik says trade barriers should help poor nations build domestic industries and give rich nations time to retrain workers. But Jagdish N. Bhagwati says jobs will grow in medicine, law and accounting. Blinder has created a list of “highly offshorable” jobs that could be lost in the next 20 years, which claims that 1,815,340 bookkeeping, accounting and auditing jobs could be lost. [21]

Ecuadorian President Rafael Correa has denounced the “sophistry of free trade”, in an introduction he wrote for a book titled The Hidden Face of Free Trade Accords. One of the authors of that book is today Correa’s Energy Minister, Alberto Acosta. Citing as his source the book, Kicking Away the Ladder, [2] written by a Korean economist based at Cambridge University, Ha-Joon Chang, Correa identified the difference between an “American system” opposed to “a British System” of free trade. The latter, he says, was explicitly viewed by the Americans as “part of the British imperialist system.” Correa wrote that Chang showed that it was Treasury Secretary Alexander Hamilton, and not Friedrich List who was the first to present a systematic argument defending industrial protectionism. (Correa includes List’sNational System of Political Economy in his bibliographic references.)

Following alternatives for free trade are proposed: balanced trade, fair trade, protectionismand Tobin tax.

 

Miscellaneous

The relative costs, benefits and beneficiaries of free trade are debated by academics, governments and interest groups. While the academic debate is essentially settled in favor of free trade, a number of arguments for and against in the ongoing public debate can be seen in the free trade debate article.

Depending on the specific context, use of the term free trade can signify one or more of the above conditions. However, it is fundamental that only governments can restrict trade: they have the legal monopoly over the use of physical force to influence trade in a geographical area.

The term free trade has become very politically based, and it is not uncommon for so-called “free trade agreements” to impose additional trade restrictions. Such restrictions on trade are often due to domestic political pressure by powerful corporate, environmental or labor interest groups seeking special protections of their interests.

Free trade agreements are a key element of customs unions and free trade areas. The details and differences of these agreements are covered in their respective articles.

See also

Concepts/topics

Trade organizations

Other lists

Criticism

Conservative opposition to free trade


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