Free Trade: Pros and Cons
... the domestic price was higher than the world price, then the consumers would immediately change their supplier to the much cheaper international suppliers and the net effect would be to lower the price of the goods in the domestic market. Price Domestic Supply Price after trade World Price Price before trade Price after trade World Price Domestic demand Domestic quantity Quantity This principle assumes that the country in question is a price taker in that it is a relatively small economy and can therefore export as much of a particular good as it wants without this affecting the world price or can import as much of a good as it wants without this affecting the world price either. Who gains and who loses? When a country follows a free trade policy and becomes an exporter of a good, the domestic producers of the good who benefit as they can take advantage of the higher world price. The domestic consumers become worse off as they now have to pay a higher price for goods that they bought cheaply before free trade. If the country becomes an importer of a good, then it is the domestic consumers who benefit as they import goods at the lower world price. The producers of the good are worse off because they cannot sell the good neither in the domestic market nor in the world market as there are other suppliers supplying the good at a lower price. At the country level, it is assumed that trade raises the economic well being of a country in the sense that the gains of the winners exceed the losses of the losers. Tariffs and Quota’s A tariff is a tax on imported goods. A quota is a restriction on the quantity of a good that can be imported into the country. They therefore only become relevant if the country becomes an importer of goods. The effect of the tariff is to increase the price of the good above the world price with the effect that the domestic producer can now compete in the domestic market with the importers of the good. This will have the effect of reducing the quantity demanded of the imported good and also increases the quantity supplied by domestic producers such that the effect is to bring the equilibrium point to about the same level as it was before free trade. The effect of the quota is that the domestic consumer will not be able to import as much of a good as they want. The supply curve above the world price will be shifted to the right by exactly the same amount as the quota i.e. the price of the goods in the country adjusts to balance supply (domestic and imported) with demand. PROS AND CONS OF FREE TRADE PROS i) Comparative Advantage This is the idea that when each country specializes in the production of goods and services in which it has a comparative advantage, then everyone benefits as they produce and sell what they do most efficiently. The current hot political issue as regards this advantage is that of global outsourcing. Companies in the west are deciding to outsource some functions to China, India and other low cost countries with comparative skills and western governments are under pressure to intervene to stop other companies from doing so as well. Proponents of free trade would argue that governments should intervene as little as possible in the process. ii) Competition This follows on from the first advantage in that lower costs resulting from specialization and economies of scale are passed down to consumers in the form of lower prices. Competition from the larger international market would foster lower prices overall due to the efficiency in production. iii) Variety Free trade increases the number and variety of products available to customers. Through imports, a country is able to enjoy consumption of goods that may either be too expensive or impossible to produce within its own borders. iv) Tariffs and Quotas Tariffs and non-tariff barriers to trade such as quotas result in higher prices for the consumer. If a country removes this due to its free trade policy, the effect would be lower prices for consumers and therefore a benefit. v) Interdependence It is often argued that free trade leads to interdependence and the benefit of this is that conflicts would be too costly. The of the creation of the European Union is often given as an example of this. After fighting numerous wars in close succession it was felt that a closer economic integration would prove a powerful disincentive to start conflict. It might be argued that the fact there has been no major war in western Europe since the inception of the EEC is proof of this but that is a moot point. vi) Transfer of knowledge and capital Free trade would normally facilitate the transfer of knowledge, technology and most importantly capital from the more developed countries to the less developed ones. An example of this again can be seen in the current outsourcing trend where the companies that choose to go to India or China normally invest in those countries as well. vii) Standardization With the transfer of knowledge and capital, comes the idea of global provision of services and products. The spread of global brands and the ancillary benefits of a standard quality of product across the globe means that people around the world would enjoy the same quality products with these being of a higher quality in most countries. An example of this can be seen in the banking industry where a global bank such as HSBC or Barclays decide to invest in Africa or Asia with an intention of providing a similar service as they do in their other branches in Europe or the US. The result is that you have a better banking industry in those countries as the local banks try to match the service. viii) Democratization Some commentators argue that free trade promotes democracy as it fosters a culture of transparency and discipline. CONS i) Threats to domestic jobs Economists would argue that free trade also creates jobs and growth. It is clear that free trade does cause structural unemployment. These dislocations in the employment market of a country may occur even though the country may probably gain more than it loses by adopting free trade policy. However the individuals and industries directly affected may not have the luxury of seeing the bigger picture and may therefore lobby their governments to adopt a more protectionist policy. ii) Infant Industries Many developing nations argue that they need to protect their infant industries so that they can get them off the ground in the first place. While this may be a valid argument, in fact most developed countries built their industrial competencies by protecting these industries when they were at an infant stage, it is often felt that most countries will be slow or reluctant to remove these protections once the industry is strong enough to survive on its own. iii) Risk of Specialization The Principle of Comparative Advantage could make an economy, particularly a smaller one, too dependent on a few resources and products such that if demand for these product fell or the country lost its comparative advantage over others, there would be economic catastrophe iv) E...