Free trade

Free trade is the untaxed flow of goods and services between countries, and is a name given to economic policies and parties supporting increases in such trade.

Arguments for free trade

In the history of free trade, two types of argument have been advanced in favour of allowing purchases from abroad, and "Free trade" in the broader sense. The first set of arguments are essentially economic, that free trade will make society richer (more prosperous in money terms). These are mostly technical arguments from the discipline of economics, starting especially with Smith's "Wealth of Nations", which overthrew the mercantile orthodoxy. The other set of arguments for free trade could be classified as "moral" arguments, which are pitched at a more high-minded level, some of these are listed below.

Related Topics:
History of free trade - Money - Economics - Smith - Wealth of Nations - Mercantile - Moral - Below

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Economic arguments for free trade

Classical economic analysis indicates that free trade increases the global level of output because free trade permits specialization among countries. Specialization allows nations to devote their scarce resources to the production of the particular goods and services for which that nation has a comparative advantage. The benefits of specialization, coupled with economies of scale, increase the global production possibility frontier. An increase in the global production possibility frontier indicates that the absolute quantity of goods and services produced is highest under free trade. Not only are the absolute quantity of goods and services higher, but the particular combination of goods and services actually produced will yield the highest possible utility to global consumers.

Related Topics:
Classical economic - Output - Specialization - Scarce - Resources - Comparative advantage - Economies of scale - Production possibility frontier - Utility

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Qualitative Arguments

Free trade policies are often associated with general laissez faire economic policies, which can allow for faster growth. Laissez faire policies—the absence of government intervention in trade, entrepreneurship and investment—is often positively correlated with high per capita income. Economic Freedom and Per Capita Income

Related Topics:
Laissez faire - Per capita - Income

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Production possibilities frontiers and indifference curves

Here is the production possibilities frontier for a fictional country, Country A. For simplicity, assume that the country produces only two goods, meat and rice. Because the country has limited resources, the production of an additional unit of rice means some resources must be diverted away from the production of meat. The particular rate of trade-off between meat and rice is not important for this analysis, so it can be ignored.

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Here is the production possibilities frontier for a second fictional country, Country B. Again; the country can produce only the same two goods, meat and rice. Like before, limited resources mean that the production of an additional unit of rice means some resources must be diverted away from the production of meat. The particular rate of trade-off between meat and rice is not important for this analysis, so it can be ignored. The fact that the two countries have different relative rates of trade-off is important. This difference gives rise to a comparative advantage, a key concept in economics. Even if one country has an absolute advantage in the production of all goods, both nations can benefit from trade due to comparative advantage.

Related Topics:
Comparative advantage - Absolute advantage

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The first two images above assume a state of autarky, which means no trade occurs between the two countries. If free trade is possible, the green line is the production possibilities frontier for the entire world. The world PPF is made up by combining the two countries' PPFs. Linear PPFs will always combine to form a shape with an inflection point, as shown at right.

Related Topics:
Autarky - Linear - Inflection point

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Compare the world's production possibilities frontier with each individual nation's. Clearly, the world can produce and consume more when free trade is allowed. To arrive at the world's production possibilities frontier, vector addition must be used. Country A and Country B's meat and rice outputs must be added together for each possible production point.

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An intuitive way of arriving at the world's production possibilities frontier is to first assume that each country tries to specialize by producing only one product. In the graph at right, the first units of meat are produced only by country B (red). Once country B is using all its resources to produce meat, then country A (blue) begins shifting resources away from the production of rice and into the production of meat. On the other axis, assume that the first units of rice are always produced by country A. Additional units of rice can only be obtained if country B shifts some resources into rice production.

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Returning back to country A, here is the same production possibilities graph, now with indifference curves added in. Indifference curves are a measure of preference and utility. Interplay between the country's preferences and production result in the actual combination of goods produced and consumed. Remember, this is the state of Country A under autarky.

Related Topics:
Indifference curve - Preference - Utility

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Here is the same view of Country B's economy. Again, the actual combination of goods produced and consumed is dependent on the country's productive abilities and its citizens' preferences. Thus, it is not surprising that the combination of goods consumed in Country B differs from that in Country A.

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Graphical information of the two countries can be combined in a single graph, as shown here.

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When the two countries' autarkic consumptions are added, the total quantity of each good produced/consumed is less than the world's PPF under free trade. This indicates that by trading, the absolute quantity of goods available for consumption is higher than the quantity available under autarky.

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Basic welfare analysis of free trade

The following pro-Free Trade argument in neo-classical economics looks at the changes of consumer surplus and domestic-producer surplus caused by increased imports when tariffs are removed.

Related Topics:
Free Trade - Neo-classical economics

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With a tariff in place the domestic price of a good is at P1 and the quantity produced in the country is at Q1.

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:Figure 1 illustrates this initial level as goods market equilibrium

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Due to a Tariff, the good's price on the international market is lower than the domestic price.

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:Internationally the price is P2.

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(These prices on the international market have been converted into local currency.)

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:Figure 2 describes the effect on price and domestic production of removing the tariff and allowing free trade. If the tariff is removed the domestic price of the good falls to meet the international one, since rational consumers will buy at the cheaper, foreign rate until competition lowers the domestic price to reach it.

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At the lower price fewer domestic manufacturers would wish to make the good, thus the quantity produced domestically falls to Q2A. However, at the new lower price far more consumers would be able to buy the good, and thus quantity of the good purchased would increase to Q2B, with the difference between Q2A and Q2B being imported.

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Since less of the good is being made in the country producer surplus will shrink. Companies will either be forced to reduce production, or some of them will have to close.

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If we assume that the total domestic consumption was supplied by domestic producers while the Tariff was in place, the drop in domestic production is Q2A - Q1.

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:Figure 3 shows the amount producer surplus will decrease under the assumption of no imports with a high initial tariff.

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In fact, this isolationist tariff is the worst-case scenario for domestic producer surplus loss. Typically, some of the domestic consumption would have been imported, even with tariffs in place, and therefore some of the surplus loss to producers would fall on imports. Although the domestic society would also be hurt by reduced tariff revenue, some of the net loss to producers would still occur overseas. Smuggling and the positive slope of the foreign supply curve mean that any surplus gained from imports pre-tariff-repeal by foreign producers would be greater than the tariff paid. Therefore, the resulting drop in domestic producer surplus depicted is greater than the fall that would actually occur, assuming some imports.

Related Topics:
Isolationist - Import - Smuggling

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Therefore, the yellow area is the maximum domestic producer surplus loss.

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:Figure 4: Benefit to the consumer from price deflation

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The lower price will increase consumer surplus. More consumers would be able to own the good in question and their standard of living will increase. Everyone who buys the good domestically is now better off.

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: The green area gives the surplus-gain to consumers

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:Figure 5: Comparing producer surplus and consumer surplus.

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The increase in consumer surplus will be larger than the decrease in producer surplus.

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Taking the yellow producer surplus-loss from the green consumer surplus-gain gives the red net-surplus-gain across society caused by removing the tariff.

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This Utilitarian argument claims that society should maximize total utility, and that removing tariffs will lead to the net utility increase highlighted in red. However, different constituencies suffer (domestic producers) from those who benefit (domestic consumers) in tariff repeal. Some people reject the utilitarian calculation on the basis that utility changes cannot be compared between groups. It has also been argued, on less theoretical grounds, that a change which is not Pareto optimal, and hurts some groups (such as producers) should be rejected a priori. To overcome this objection the outline argument can be modified to include transfer payments from consumers to producers to make everyone better off as trade barriers fall.3.

Related Topics:
Utilitarian - Utility - Pareto optimal - 3

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It has often been observed that the changes in surplus between consumer and producer do not directly correlate into political action. Since producers are smaller in number and more organized than consumers they form a more effective lobby against the lowering of tariffs than consumers do. {{ref|Murray}}

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This graphical argument assumes full employment; that the workers who lose jobs because of the decrease in the amount produced will find jobs in other industries that can better compete internationally. It also assumes that trading regions are world price-takers; that no matter how much is imported, the world price remains constant (this is reasonable for regions that are sufficiently small).

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Reciprocal free trade is in exporter's interests

An early lobbying effort on behalf of free trade was made by the businessmen of the Anti-Corn Law League. Some of these gentlemen owned textile factories, and believed that repeal of the Corn Law import-ban would allow 1830s Britain to sell cotton clothing to wheat-exporting nations.

Related Topics:
Anti-Corn Law League - Textile - Factories - Corn Law - 1830s - Britain - Cotton

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Although this argument is rooted in Mercantilism and producer self-interest it amounts to a voice in favour of free trade. See also: Reciprocal Trade Agreements Act.

Related Topics:
Mercantilism - Reciprocal Trade Agreements Act

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In 1950 Jacob Viner showed that a trading block mutually lowering tarrifs would produce gains not merely on the demand side but also on the supply side. This was called trade creation, the benefits to the supply side as a whole accrue as resources are reallocated towards firms producing at the highest comparative advantage (among the partners) in each country.

Related Topics:
1950 - Jacob Viner - Supply - Trade creation

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Moral arguments in favor of free trade

The 18th and 19th century intellectuals who backed free trade rarely did so under the rubric of increasing material wealth. In many cases this was given as the least important reason for free trade. Rather, they argued that international society would be improved by increased commerce. Some of these, and later, sociopolitical arguments are listed here.

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Increased commerce means reduced war

The argument for free trade that commonly underlies neoliberal foreign policies can be made from the perspective of national security - it is seen by some policy analysts that countries that trade with each other are less likely to go to war due to the enormous cost of suddenly disrupting their trade abroad, particularly since they would be dependent on the world economy as a result of specialization and comparative advantage.

Related Topics:
Neoliberal - Comparative advantage

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Qualitative analysis suggests that free trade encourages economic interdependence between countries, reducing the likelihood of war. However, the belief that free trade would reduce war was hypothetical rather than empirical (at least until the 1950s). Twenty-two years after Ricardo advanced his theories of comparative advantage they were used as justification by the British to start the Opium wars. Also, it is hard to know when the occurrence of free trade has prevented the outbreak of war, but easy to know when it hasn't; critics of free trade sometimes cite the First World War as an instance where developed, industrialized countries with reasonably extensive trade links abruptly broke off those trade links and entered into a particularly destructive war. It is an open question whether the First World War, its causes, and the economic environment that preceded it are sufficiently similar to the modern globalized economy to draw parallels between 1914 and 2005.

Related Topics:
War - 1950s - Ricardo - Comparative advantage - Opium wars - First World War - 1914 - 2005

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The fact that some wars have been fought between trading-partners does not disprove the notion that increased trade lowers the willingness to go to war, simply that however much it does so, other considerations sometimes overwhelm the economic. McDonald's is in the vanguard of global free trade, permitted to spread its brand of consumerism by the free trade in capital (its product is mostly sourced locally). Famously, only a single, short, war has been fought between any of the 122 countries having franchises. This fact might not be due to the ties of trade, but could still be attributed to the homogenizing effects of free trade, as identical consumers the world over see less reason to wage war on one another.

Related Topics:
McDonald's - Consumerism - Capital - Single, short, war

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The process of free trade, especially in post intdustrial economies, effectivly eliminates the existance of unequal resource distribution. Japan imports much of its food source, and in return exports mainly the produce of its extensive and high-tech workforce. Continuing the example, Japan would not likely be able to sustain the population it does today without one of three possibilities, an unbelieveable increase in technology to allow for better use of land resources, international trade, or seizeing arable land from another state. Trade also allows for better quality produce and competitiveness between nations, effectivly raising the living standards of those nations. It would be illogical to many in such a case to jeopardise those living standards for a war. Finally, increased trade leads to increased bilateral communication between nations and as such, wars not focused on resources or land already cured by trade, including idealogical arguments become less evident.

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After the second world war many liberals said that the war's ultimate cause had been the restrictive trade practices of Nazi Germany and the British Empire. They thought that free trade would increase the likelihood of a lasting peace. Cordell Hull, the U.S. secretary of state until 1944, believed this, and argued that as trade barriers dovetail with war, so free trade does with peace. The post war consensus expressed at Bretton Woods was that government coordination was necessary to prevent trade wars and competitive devaluations, to ensure free trade and peace.

Related Topics:
Second world war - Nazi Germany - British Empire - Cordell Hull - Believed this - Trade barrier - Expressed at Bretton Woods

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Protectionism sullies the cause of patriotism

Adam Smith thought that protectionism against free trade was a scam on the public on behalf of producers, carried out for nationalism. Even if overall economic interests had not been harmed by tariffs, he was opposed to them on the grounds that patriotism shouldn't be perverted by scoundrels to enrich themselves.

Related Topics:
Adam Smith - Nationalism - Patriotism

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Tariffs are internally divisive

See Nullification crisis.

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Free trade is a right

The libertarian position argues that any trade restraint is immoral a priori, since restricting the rights of sovereign consumers to purchase foreign goods is outside the competence of legitimate government. This is in the tradition of the anti-Corn Law radicals, like Richard Cobden, who concluded their 1838 parliamentary petition with an appeal to "negative liberty":

Related Topics:
Libertarian - A priori - Sovereign consumers - Richard Cobden - 1838 - Negative liberty

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: "Holding one of the principles of eternal justice to be inalienable right of every man freely to exchange the result of his labour for the productions of other people, and maintaining the practice of protecting one part of the community at the expense of all other classes to be unsound and unjustifiable, your petitioners earnestly implore your honourable House to repeal all laws relating to the importation of foreign corn and other foreign articles of subsistence, and to carry out to the fullest extent, both as affects agriculture and manufactures, the true and peaceful principles of Free Trade, by removing all existing obstacles to the unrestricted employment of industry and capital." {{ref|Cobden1838}}

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Free trade reduces poverty

Conflating the "moral" and "economic" arguments are those campaigners who say that increased trade is the best way to relieve extreme poverty throughout the world. Opposing free trade, they argue, is tantamount to supporting economic injustice. (For instance, "The Economist" magazine sometimes runs controversial cover stories making this impassioned argument for free trade.)

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The thrust of this point is that economic and moral issues cannot properly be separated, and that any other particular socioeconomic problems can be combated most effectively through rising living standards.

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Bjørn Lomborg's Copenhagen Consensus on international development challenges ranked trade liberalization as third on the list of development priorities; the experts judged that modest costs could yield large benefits for developing nations. (They ranked freer trade as a "Very Good" opportunity for fighting misery along with cheap measures against HIV infection, micronutrient distribution, and anti-malarial programs.) The conference was of the opinion that reducing subsidies and tariffs would improve the wellbeing of the global poor being more than any agricultural, political, or environmental program. They considered that the free trade in labour would also be a significant (although less important) move against poverty, especially if skilled worker migration were permitted. The approach and conclusions of the "consensus" have been widely criticized, especially trade liberalization's high ranking.

Related Topics:
Bjørn Lomborg - Copenhagen Consensus - International development - Trade liberalization - Costs - Developing nation - HIV - Micronutrient - Malaria - Subsidies - Tariff - Environment - Skilled worker - Widely criticized

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