Free Trade

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Free trade, or trade liberalization, aims to open the national economy to the global economy and encourage trade and investment with the rest of the world. Evidence suggests that countries that are outward oriented grow faster than those that are inward oriented.

Contents

Why should I be aware of this?

  • Free trade theory also argues that it is universally beneficial to move from a closed door economy that doesn't trade very much, to one that trades openly in specialized products.
  • It is in the best interest of all economies to specialize in sectors in which they possess the highest comparative rates of growth of productivity. As the US requires fewer man-years to produce a civilian airplane than China, in a free trade situation both countries would gain if the US concentrated in manufacturing and exporting airplanes to China.

All about free trade

Free trade brings down trade barriers such as tariffs and allows goods and services from everywhere to compete with domestic products and services. Industries receiving protection from foreign competition have little incentive to hold down costs. Free trade injects greater competition into sheltered domestic markets, forcing domestic producers to work to their potential. The speedy drop in international telecom rates as a result of stiff competition to erstwhile monopolies is an example of the effects of free trade.

The first formal world trading system in free trade came with the formation of GATT (General Agreement on Trade and Tariffs) in 1947.GATT was based on the principles of comparative advantage. It enabled trade agreement negotiation on a multilateral platform. The World Trade Organization (WTO) is the successor to this system.

Powerful world economy

Free trade has created a world economy which has become a powerful means for countries to promote economic growth, development, and poverty reduction. Most developing countries have been able to share in this growth, and some have seen dramatic rise in incomes. Developing countries today account for one-third of world trade, as against a quarter in the early 1970s.

Protectionism

Not very long ago India, and before that China, were special targets of protectionist sentiments. China in the late nineties was targeted for its cheap manufacturing exports and undervalued currency, and Japan in the mid-eighties for its sophisticated technological exports.

Though protection has declined over the past three decades, it still remains in certain industrial and developing countries. The only sector where developing countries stand to gain from free trade - agricultural goods - wealthier countries maintain the highest level of "protection" of their own markets. These types of "protectionist" policies are often pursued by many wealthy countries in Europe, as well as the US and Japan to support their own domestic economies, while they force other countries to open up their markets.

In industrial countries average tariff protection in agriculture is nine times higher than in manufacturing. The European Commission is spending billions of euros per year to make sugar profitable for European farmers. Many developing countries have industrial tariffs which are three to four times higher than those of industrial countries. Tariffs on agriculture are even higher than industrial nations.

Another way of protecting one’s own goods is subsidizing domestic businesses by governments giving money and other forms of support to local or domestic businesses, to make sure that they are cheaper over imported products and services. This kind of help often allows inefficient businesses to do well.

Legitimate protectionist measures

WTO has designed certain legitimate protectionist measures (such as patents, copyrights etc) to compensate innovators for research and development costs and to provide temporary monopoly profits. But applications of these measures have grossly compromised on societal well-being in their application. A staggering 40 percent of the population of Botswana, infected with the AIDS epidemic, is unable to procure drugs from India, which produces generics at a fraction of the cost of branded drugs, because of pressures from the patent regime and US political pressure.

Cancún Negotiations

At the Cancún negotiations, the Group of 21 developing countries, led by Brazil, China and India, representing half of the world’s population and two-thirds of its farmers, demanded that if negotiations were to proceed, the proposals should lead to trade that would be fundamentally free and equitable at face value. In particular, they sought the removal of subsidies in the developed world for products in which the developing world enjoyed a comparative advantage (e.g. agriculture); these have grossly undermined the capacity of poorer countries to compete. For example, cotton farmers in West Africa are being crushed by rich-world subsidies, especially the $3 billion per year that America offers its 25,000 cotton farmers to make it the world’s biggest exporter and thereby depressing prices in the global market.

The World Bank had estimated that if the Cancún convention had closed successfully, it would have raised global incomes by more than $500 billion a year by 2015. It is also estimated that 60 percent of that gain would have gone to poor countries and enabled 144 million people to cross the poverty line. About 70 percent of this gain would have come from freer trade among the poor countries themselves.

90 degrees

Developing countries which have opened up their economy have been termed by the World Bank as the "new globalizers," Freeing trade has been seen to frequently benefit the poor in developing countries. Their incomes increase in roughly the same proportion as those of the population as a whole. Skilled workers get raised to the middle class status with creation of new jobs. Since 1990 inequalities among developing countries have been on the decline as a result of trade liberalization.

There is another group known as the dependency theorists who are of the view that rich countries gain more from trade than poor countries. They feel that the system of world trade perpetuates underdevelopment in developing countries. As developed countries export manufactured products, their productivity can increase multi-fold with every technological advance, leading to greater profits and higher wages among workers.

With rise in income demand for primary commodities goes down while there is a rise in demand for manufactured goods such as cars, computers, cell phones etc. This turns to be advantageous for developed countries.

CopperBytes

  • Economic growth in the 19th Century was mainly propelled by countries dropping their restrictions on free trade. The value of goods and currencies was measured by the gold standards which provided a universal currency.
  • The Wall Street crash in 1929 led to a worldwide slump in economic growth. The world reverted to protectionism, trade fell, causing more unemployment and prolonging the downturn.
  • After two world wars, there was an urgent call for revival of world trade as most of Europe and Japan was struggling to feed its people. As the US was least affected by the war there was increased pressure on that country to open up its markets to other countries.
  • In 1948, 23 countries got together to sign the General Agreement on Tariffs and Trade (GATT) in Havana, Cuba, to help promote free trade by persuading countries to abolish import tariffs and other barriers to open markets. The first round of trade negotiations resulted in 45,000 tariff concessions.
  • After five more rounds there was a dramatic drop in tariffs on manufactured goods and a rapid increase in trade, helping to create "economic miracles" in Germany and Japan.
  • In 1995 the World Trade Organization superseded GATT which was given more powers to enforce free trade rules, and a clearer mandate to promote free trade.
  • In 1964-67, the Kennedy Round of talks, named in honor of the late US President, achieved tariff cuts worth $40bn.

References

  • Chinks in the armour
  • What is free trade?
  • A century of free trade
  • Global Trade Liberalization and the Developing Countries
  • The Future Course of Trade Liberalization