Free trade

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Related terms: Free market laissez-faire

In international trade, free trade is an idealized market model, often stated as a political objective, in which trade of goods and services between countries flows unhindered by government-imposed tariff and non-tariff barriers. The Laissez-Faire school holds that no other requirements exist, while students of Microeconomics, sometimes called Welfare Economics, point out that Perfect Competition is also required in order for theory, specifically the General equilibrium theorems, to apply.

Nearly all modern non-Marxist economists support the statement that free trade is a net gain to both trading partners and that the gains from free trade outweigh the losses.^[1] However, the versions of Free Trade that economists have in mind when making this statement are often quite different.

Free Trade is opposed by many groups: some nationalists, Communists, agricultural and manufacturing interests, anti-globalization and some labor campaigners due to a variety of perceived problems.

The term is given to economic policies, as well as political parties that support increases in such trade.

Free trade is a term in economics and government, encompassing some combination of the following, and sometimes other criteria:

• International trade of goods without tariffs (taxes on imports) or other trade barriers (e.g., quotas on imports or subsidies for domestic producers)
• International trade in services without tariffs or other trade barriers
• The absence of trade-distorting policies (such as taxes, subsidies, regulations or laws) that give domestic firms, households or factors of production an advantage over foreign ones
• Free access to markets
• Free access to market information
• Inability of firms to distort markets through monopoly or oligopoly power

Related, but different concepts are:

• The free movement of labour between countries
• The free movement of capital between countries

For more detailed arguments in favor of and against free trade, see: Free trade debate.

Contents 1 History of free trade 1.1 Present day 2 Economics of free trade 2.1 Simple theoretical framework 2.2 Illustrative story 2.3 Trade diversion 3 Opponents of free trade 4 Alternatives to free trade 4.1 Tobin Tax 4.2 Fair trade 4.3 Balanced trade 4.4 International barter 4.5 Increase the credit risk to international loans 4.6 International price floors 4.7 Separating world prices from domestic prices 4.8 Regional trading blocs 5 Miscellaneous 6 See also 7 Footnotes 8 External links

[edit] History of free trade

The history of free trade is a history of international trade focusing on the development of open markets. It is known that various prosperous world cultures 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 cultures 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. For example, in the 1930s, the US adopted the protectionist Hawley-Smoot Tariff Act which economists believe exacerbated the Great Depression. Wars, such as the Pelopponesian War between Athens and Sparta, the Opium Wars between China and Great Britain, and other colonial wars, have been fought over trade. All developed countries have used protectionism, but usually reduced it as they gained more wealth^{[citation needed]}.

Partially in response to problematic state imposed trade restrictions under the Articles of Confederation^[2], the Constitution of the United States explicitly granted the U.S. Congress the authority "to regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes." This Commerce Clause has been interpreted to imply a Dormant Commerce Clause that revokes state authority to legislate on certain aspects of trade and commerce. The clause has been broadly interpreted and applied over the years, creating in effect the world's largest free trade area. Today it is taken for granted that states cannot, for example, levy import tariffs on Oregon lumber.

[edit] Present day

Since World War II, the US 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). The US has negotiated numerous free trade agreements, such as the North American Free Trade Agreement (NAFTA), the Dominican Republic-Central America Free Trade Agreement (CAFTA), and a number of bilateral agreements (such as with Jordan).

[edit] 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.^{[3] [4]} In a 2006 survey of economists, "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."^[5] Quoting Harvard economics professor Gregory Mankiw, "Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards."^[6] 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.

[edit] Simple theoretical framework

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.^[7]

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 P^world. The tariff increases the domestic price to P^tariff. The higher price causes domestic production to increase from Q^S1 to Q^S2 and causes domestic consumption to decline from Q^C1 to Q^C2. 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. ^[8][9]

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. ^[7]

[edit] Illustrative story

This story is a simplistic example that helps explain part of the above theoretical argument. The numbers are entirely made up.

Imagine an orange farmer that produces 20 oranges a year. It costs him $5 to grow each orange and he sells each one for $10. His total profits are therefore $100 (i.e. Revenues of 20 x $10 - Costs of 20 x $5 = $100 profits). The world price for oranges is $4 per orange, but a $7 per orange tariff makes importing oranges uneconomical (the price for imported oranges is $11 because of the tariff).

Now imagine that the tariff is removed. First, the farmer is wiped out of business because the world price ($4) is below the farmer's production costs ($5). His $100 profit is gone.

On the other hand, consumers are made more than $100 better off. Previously, consumers had purchased 20 oranges at $10 each, for a total of $200. After the tariff is removed, 20 oranges can be purchased for $80, but even this underestimates how much better off consumers are because consumers will buy more than 20 oranges now that oranges cost $4 instead of $10.

More complicated and precise stories/examples can be constructed, but the general point remains that the monetary gains from free trade are larger than the monetary losses.

[edit] Trade diversion

According to 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.^[7]

[edit] 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 (see Dumping (pricing policy) .) 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. However, domestic sugar producers have large financial incentives to politically oppose the lifting of tariffs. 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.

Free trade is also opposed by many anti-globalization groups, based on the observation 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 ^[10] that letting subsidized corn from the US into Mexico freely under NAFTA at prices well below production cost (dumping) is ruinous to Mexican farmers. This claim is of course disputed by the U.S. corn lobby.

Many free-trade economists now acknowledge that they underestimated or concealed the harm that free trade does to workers and the middle class. Alan S. Blinder, of Princeton University, former Federal Reserve Board vice chairman and advisor to Democratic presidential candidates, argued, with most economists, that free trade enriches the U.S. and its trading partners, despite harm to some workers. Now he says new communication technology will put 30-40 million American jobs at risk in 10-20 years. Blinder still believes in free trade, David Ricardo, and comparative advantage, but wants more for displaced workers, and a better education system. Blinder opposed steel, aluminum and farming export subsidies and protection, and helped Clinton sell NAFTA, although he disagreed that it would create jobs in 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^[11], 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 created a list of "Highly offshorable" jobs that could be lost in the next 20 years, for example, 1,815,340. bookkeeping, accounting and auditing clerks. ^[12]

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."

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's National System of Political Economy in his bibliographic references.)

[edit] Alternatives to free trade

[edit] Tobin Tax

Main article: Tobin tax

A Tobin tax is the suggested tax on all trade of currency across borders. This is intended to put a penalty on short-term speculation in currencies. This policy is an alternative to the free flow of capital across borders. This policy has little or nothing to do with the free flow of goods and services.

[edit] Fair trade

Main article: Fair trade

The fair trade movement, also known as the trade justice movement, promotes international labor, environment and social standards for the production of traded goods and services. The movement focuses in particular on exports from the Third and Second Worlds to the First World.

[edit] Balanced trade

Main article: Balanced trade

Balanced trade is an alternative economic model to free trade. Under balanced trade, nations are required to provide a fairly even reciprocal trade pattern. They cannot run large trade deficits. If deficits appear, the surplus nation must find a way to balance out trade or risk sanctions, fees, or quotas. Critics say this may discourage innovation as one country may reduce its efforts to produce products needed by the other.

Many economists would call balanced trade a modern day form of mercantilism. Though it is has intuitive appeal, there is absolutely no economic reason why a trade deficit is automatically bad. For example, if a country is running a trade deficit, this automatically implies it is running an investment surplus.^{[citation needed]} If this investment increases the capital stock, sparks new innovation, and increases productivity, there is absolutely no reason why a trade deficit would cause a problem. Empirically this also appears to be true as a number of countries, such as the U.S., have run large trade deficits for years with no discernible adverse impact.

[edit] International barter

Some nations have prohibited trade under monetary terms of trade. For example, Hjalmar Schacht arranged barter for Nazi Germany to bypass the free market which he thought was rigged by Anglo-American capitalists.^[13] The former Soviet Union occasionally arranged bilateral barter within its sphere of influence. See Comprehensive Program for Socialist Economic Integration or Comecon. Arab League nations have also occasionally replaced monetary trade with barter.

[edit] Increase the credit risk to international loans

George Soros and others argue that some of the most destructive free trade, such as developing world agricultural monoculture, is driven by export-oriented production targets set by the International Monetary Fund (IMF) and the governments it supports. He suggests that the volume of this trade would be lower if the lending banks were liable for credit default instead of receiving IMF bail-outs. If banks were responsible for default, the levels of lending would be lower and lead to more sustainable export programs due to the discipline of the free market, he believes.

[edit] International price floors

Some argue that free trade is responsible for the decline in international commodity prices. One reason for these low prices is the over-production of subsidized commodities in the developed world. Rather than removing the production subsidy for farmers in the rich world some suggest extending them to farmers in the developing world. For instance, producers in Poland lobbied to be included in the Common Agriculture Policy. The reason that rich-country farmers need subsidies to thrive is the comparative advantage of cheap land and labour enjoyed by their poor-country competitors.

[edit] Separating world prices from domestic prices

Foreign trade of Communist Czechoslovakia was conducted at "free trade" import prices, with the Ministry of Foreign Trade selling the goods on, into the internal market, at pre-determined prices for each good. In this way, Czechoslovakian consumers were insulated from shifts in world prices whilst having some access to foreign products.

It is difficult for governments to sustain different internal prices over the long term. If the internal price is set below world prices, smugglers try to profit from the differential by illegally exporting the product to nations where they can sell it at a higher price. To the extent smugglers succeed, the domestic government is indirectly subsidizing foreign consumers. This problem has been vividly illustrated in nations where fuel prices are subsidized below world prices; domestic shortages frequently occur as a significant portion of the good is illegally smuggled out of the country. Rationing and black markets are stimulated by artificially low prices; in Iraq the famously long petrol pump queues for petrol at 50 dinars/litre can be bypassed by buying on the black market at 250 dinars/litre. Unofficial markets are a common problem wherever the "official" price is below (or above) the free trade price.^[14]

Despite the difficulties of maintaining fixed commodity prices, many Governments that attempt it claim that doing so "immunizes" their economies against destabilizing price shocks. It is sometimes argued that the social and economic benefits alone, outweigh the disadvantages (of import-price stability).

On the other hand, international prices tell the costs of producing certain products and the benefits of consuming them. By separating the prices this flow of information is halted and therefore the local decisions are decoupled from the global needs and possibilities, thus hindering the producers in the country to produce the products where they have a comparative advantage and the consumers to consume the products that can elsewhere be produced so cheaply that they would like to consume them at those prices instead of consuming some other kind of products or less products (or services).

[edit] Regional trading blocs

James Goldsmith advocated free trade within regional trading blocs, but not between blocs (such as European Community countries). If countries within the "customs union" had similar living standards and norms of social and environmental policy they would not race to the bottom. He also proposed protectionism in the goods market, whilst allowing free trade in technology and capital.

[edit] 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 perceived 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.

[edit] See also

Concepts/topics

• Fair trade
• Free trade area
• Free trade debate
• Free trade zone
• International trade
• Trade barrier
• Trade war
• Dumping (pricing policy)
• Trade war over genetically modified food
• Offshore outsourcing
• Offshoring
• Borderless Selling
• Balanced trade
• Trade bloc
• Globalization and health
• Mercantilism

Trade organizations

• General Agreement on Tariffs and Trade (GATT)
• World Trade Organization (WTO)

Other lists

• List of free trade agreements
• List of trade blocs
• list of international trade topics

Criticism

• Lou Dobbs
• Anti-Globalism

[edit] Footnotes

[edit] External links

• Freetrade.org
• In Defence of Globalization, Free Trade and Free Market
• Stop Calling It “Free Trade!”
• BBC News - The argument for free trade
• Guardian Unlimited - Food & Trade - Hunger in a world of plenty
• Free Trade as Ideology, by Edward Luttwak, August 1, 2001
• Why developing countries should liberalise trade
• Freedom to Work, to Earn, & to Buy by Harry Browne
• News Articles Critical Of The Free Trade Aspect Of The North American Union from Age Of Tyranny News

view	Topics in Trade
Definitions	Balance of payments · Current account (Balance of trade) · Capital account · Foreign exchange reserves · Comparative advantage · Absolute advantage · Import substitution · International trade
Organizations & Policies	World Trade Organization · International Monetary Fund · World Bank · International Trade Centre · Trade bloc · Free trade zone · Trade barrier · Import quota · Tariff
Schools of Thought	Free trade · Balanced trade · Mercantilism · Protectionism
Related Issues	Globalization · Outsourcing · Trade justice and fair trade