Discuss (a) why some economists support free trade policies and (b) the factors that give rise to opposition of such policies?
...nnels.” (www.stls.frb.org) Consider two countries, UK and Japan, producing the same two goods – CD Players and Mobile Phones. With the same factor resources evenly allocated by each country to the production of both goods, i.e. the only production costs are labour costs, the cost required in each country to produce one Mobile Phone or one CD Player is shown below in the table and production possibility frontiers. Figure 1.1 Comparative Advantage Mobile Phones CD Players United Kingdom 1 ½ Japan 1 2 Figure 1.2 This shows that production of CD Players is more costly in the UK than Japan. Due to production cost however, Mobile Phones are cheaper to produce in the UK. Therefore Japan has a comparative advantage in CD player production, the UK therefore has the comparative advantage in the production of mobile phones. The different relative prices provide the basis for both countries to gain from international trade. These gains will arise from both Exchange and Specialisation. If trade is to be lasting then there needs to be a mutual benefit of trade to both countries, if only one benefits than the other will not trade. For that reason if a mutual price cannot be settled than using an outside source will be necessary. For example, if the World Trade Organisation (WTO) were to set the price as shown in the table below. Figure 2.1 Specialisation Mobile Phones CD Players United Kingdom 1 ½ Japan 1 2 WTO 1 1 So now the WTO has set a price 1:1 the United Kingdom can now get more CD Players for every Mobile Phone by an extra half, this will persuade UK to raise Mobile Phone Production to the maximum because it is more valuable. The benefit to Japan is that before to produce one Mobile Phone they had to give up two CD Players, now however, to produce one Mobile Phone they only have to give up one CD Player, i.e. CD Players are now more valuable and the Japanese will now specialise in CD Player production and not producing Mobile Phones. Consequently, due to international free trade, both countries will end up with an increased quantity of goods and greater economic wealth. Both countries will produce at point P and their joint production possibility frontier will be as shown below in figure 2.2. Figure 2.2 Comparative advantage is a dynamic concept and must be expected to change. For example comparative advantage in the production of lower value added products has shifted away from Western European producers to Eastern economies where unit labour costs are cheaper. As countries evolve and develop, different countries and produces start to exploit economies of scale in the production of goods and services. “Nations have become less self-sufficient over time because of increasing specialisation. For example, the tiny colony of Hong Kong has evolved into a global financial centre, specialising in the provision of banking and financial services. Hong Kong is well positioned to specialise in these services because of its industrious, well educated, and multilingual workforce, its communication and technological facilities, and its stable political climate. However, China, Hong Kong’s giant next-door neighbour, is largely a rural economy specialising in agriculture. Hong Kong receives most of its food (and even water) from China in return for financial and banking services.” (Rivoli, ‘International Business’ pp17-18) Tariffs and quotas will have an affect on the production possibility frontiers, but the principle of comparative advantage will still remain. Economists view free trade as advantageous as they alleviate protectionist barriers such as tariffs and quotas. Economists view these barriers to have a negative impact on the global economy. Tariffs, quotas and subsidies are explained below. As shown in the diagram below, tariffs have two basic effects; they reduce the amount of imported products sold (by QsQd to Qs1Qd1 in figure 3), as they are more expensive, therefore lowering demand. They also reduce revenue received by the producers and exporters of the product. For example a UK tariff on textiles from Asia reduces the amount of Asian textiles purchased in the UK and reduces the amount of revenue received by the Asian textile producers. The beneficiaries of tariffs are in this example the UK government, (the increased revenue is the box cdpq in figure 3), and UK producers of textiles. The government would receive the import revenue in the form of taxation, and the domestic producer would be able to successfully compete with the Asian textile producers, as the imposition of a tariff would make imported goods more expensive. “Research from Australia suggests that merely halving current average tariff rates would lead to a global increase in output of US$450 billion per year -- that is an extra $75 per person: not much to you and me, perhaps, but a month's income to someone in Burkina Faso.”(www.bbc.co.uk/news) Figure 3 A quota is “where there is a limit imposed on the quantity of a good that can be imported. The quotas can be imposed by the government, or they can be negotiated with importing countries which agree ‘voluntarily’ to restrict the amount of imports.” (Sloman, J 1991) The prime beneficiary of quotas is the domestic producer of the importing country as quotas restrict the level of competition. Most trade barriers, whether tariffs, quotas, or subsidies, hurt producers in poor countries most. A subsidy is “A grant given which lowers the price of a good, usually designed to encourage production or consumption of a good.”(Rao, C 2001) Subsidy’s reduce the cost of production, and therefore lead to an increase in supply. Subsidy’s lower domestic prices, therefore making imported goods more expensive, and in less demand. An example of a subsidy situation is CAP or the Common Agricultural Policy. The Common Agricultural Policy was established in 1958 and its purpose was to increase agricultural productivity while maintaining fair prices for farmers, and consumers. CAP established an intervention price guaranteeing to buy farmers produce at this price, this succeeded in supply almost outreaching demand as farmers produced as much as possible to gain the high intervention price. An abolition of trade barriers such as tariffs, quotas and subsidies enables people to sell their products to those who are willing to pay the highest price for them. That means the original producer is able to capture a larger proportion of the value of the product. In this sense free trade is fair trade. Often the main exporters that benefit from this are the developing countries of the world. With the ability to produce at much lower costs than western countries, demand is much higher for their product. However, there are also many economists who are against free trade and argue for the restriction of international trade. This is also known as protection. The arguments against free trade are: The national security argument. A country must protect industries that produce defence equipment, and industries that supply the raw materials for defence equipment. Without having in place tariffs and quotas that control the amount of weaponry imported into a country, developing countries would be free to buy large quantities of dangerous materials The infant-industry argument. It is necessary to protect a new industry in order for it to grow into a mature industry that can compete in world markets. Free trade allows foreign industries to dominate the domestic market with much more competitive rates. The existence of tariffs and quotas cuts out some of the competition from the global industries, by restricting the amount of trade they supply to our country. They also allow a new business to grow naturally and establish itself in the international market. We have already discussed the benefits of comparative advantage to a country. The extension of this is dynamic comparative advantage. Which a business develops through the learning-by-doing phenomenon. Simply by producing a product in high quantities, a company becomes more efficient and effective in their production. This leads to dynamic comparative advantage where as a result of specializing in a certain industry, the country becomes the producer with the lowest opportunity cost. So with free trade, new industries are not only subject to higher competition, but because the global industries are have the advantage, they will continue to grow and become even more powerful, taking up more and more of the market share and a new firm will never be able to penetrate this success or develop itself. The dumping argument. Dumping is when a foreign firm sells its exports at a lower price than its production costs. This is often performed by a company wishing to gain a global monopoly. At these low costs the firm can drive any competitive firms out of business as they will be offering the most competitive price and will gain control of the market. Then when other firms have been moved out the company will push prices up, leaving consumers no choice but to pay them as providers of the same good do not exist anymore and ta...