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RESEARCH OBJECTIVES................................................................................................2
5. CONCLUSION..............................................................................................................16
RESEARCH OBJECTIVES
How the world would be right now if there is no liberal trade? It is indeed difficult to
imagine.
Why the free trade works was explained by Adam smith in his book “Wealth of Nations”
long back in 1776 itself. In understanding free trade and how a free trade economy
works, I believe no other economist can explain as clearly as Adam smith. He explains
why free choice and voluntary association is often more well-functioning and orderly
than commands from the top. Voluntary association is what we do together of our own
free will. When people buy and sell to each other and none is subject to force or fraud,
that is voluntary association. It is anything that is going on between consenting adults.
When we visit marketplaces anywhere across the world, they might look like chaos.
However, underneath the surface, it is highly organized. It won’t look like that from
above but by peoples’ own interest and actions. Adam smith’s genius was to see how
prices were emerged in the market, the price of goods, the wages of labour, the costs of
transport could coordinate the activities of millions of independent people, strangers to
one another, without anybody telling them what to do. His key idea was that “self-
interest” could produce an orderly society benefitting everybody. It was as though there
were an “invisible hand1” at work. It is pertinent to understand here what Smith meant by
“self-interest” and “Invisible Hand”.
Self Interest here doesn’t mean greed just taking what we can get. He
was thinking of the day-to-day decisions that we all make to better our lives; the clothes
we wear, the car we drive, even whether we like our fish really fresh. The market tells
producers not only what to produce but how best to produce it through another set of
1
Adam smith, The Wealth Of Nations, Book IV, Chapter III, Part II, p.495, para. c11.
prices; the cost of materials, the wages of labour and so on. When we walk down any free
market area, we can see impersonal forces of the market in operation. For instance, If I
wanted a tomato, I could buy from a particular seller in the vegetable market. But if
everybody suddenly wants to buy tomatoes perhaps because we get new information
about how good they are for our immune system and overall health, there would be too
few tomatoes. So, the suppliers of the vegetable seller in the market would charge him
more. In that case, I have to pay more to get a tomato. If prices increase, farmers will
notice without even having heard about the new health information, they can see with
their own eyes that they would make more money if they produce tomatoes rather than
any other vegetable say cucumber.
And in that case more farmers will move into tomato production and the supply would
be increased. When we buy tomatoes and when someone else is buying fish, we control
the supply on the market. We vote with our pocketbooks and all around the world, people
spring into action to satisfy our demands. Every purchase sends a message. This is how
the market economy works in every sector – from tomatoes to fish to Apple Computers.
This is what is called Adam Smith’s “Invisible Hand”. To make your life better, you
have to better the lives of others. Invisible hands are all around us.
Milton Friedman, another free trade economist says that something that we take for
granted and use every day is a result of a complex interaction between thousands of
people. For example, a smart phone has no. of parts like display, camera, microphones,
chip set, memory, battery and also it has a software and design. Each of these parts is
manufactured by different countries around the world. Thousands of people, on several
continents, cooperated to make these phones so that we could have them. People from
different countries, different cultures, people who had never even met. That is why the
operation of free market is so essential. Not only to promote productive efficiency but
even more, to foster harmony and peace among the peoples of the world.
2.) BACKGROUND OF FREE TRADE THEORY
The case for free trade rests on Ricardo's theory of comparative advantage. In the early
19th century, he argued that England and Portugal could engage in mutually beneficial
exchange of cloth and wine-regardless of the respective industries' prices and
productivities.2 However, his argument assumed a world of flexible exchange rates
responsive to changes in the market for goods, continuous full employment, and costless
factor mobility, meaning that no barriers exist to seeking and finding employment
anywhere in the world. Especially in developing countries with chronic
underemployment and volatile, cyclical capital flows, the last two assumptions are
generally not satisfied. The 20th century "Heckscher-Ohlin Samuelson" (H-O-S) variant
of Ricardo's theory states that countries export products based on inputs they have in
abundance and import products based on inputs that are scarce. Unfortunately, trade
patterns do not confirm this view, as the overwhelming majority of trade occurs among
countries that are similar3.
To explain such realities, economists introduced the idea of a love of variety and,
subsequently, theories of "new" trade, which not only provide greater explanatory power
but also justify policy interventions (i.e., tariffs and subsidies) to support strategically
important, but uncompetitive, industries in developing countries.4 Paul Krugman, Nobel
laureate in economics for 2008, played a crucial role in the development of these models.5
Recent efforts have focused on the heterogeneity of corporate firms to explain why
exporting firms tend to be a lot more productive than firms servicing only the domestic
market.6 Integration of this exciting research into policy models is the next step. Large-
2
D. Ricardo, Principles of Political Economy and Taxation (John Murray, London, 1817).
3
H. G. Grubel, P. J. Lloyd, Econ. J. 35, 646 (1975).
4
A. K. Dixit, J. E. Stiglitz, Am. Econ. Rev. 67, 297 (1977).
5
P. R. Krugman, Ed., Strategic Trade Policy and the New Inter national Economics (The MIT Press,
Cambridge, MA, 1990).
6
A. B. Bernard, J. B. Jensen, S. ]. Redding, P. K. Schott, ;. Econ. Perspect. 21,105 (2007).
scale policy models have focused on configurations that emphasize gains from trade
despite a large and growing chorus of prominent economists arguing that across-the-
board liberalization can be harmful.
For example, Alan Blinder, vice chair of the board of governors of the Federal Reserve
System in the mid-I 990s, has rejected the view that "offshore outsourcing" is business as
usual and suggests it can be a threat to the long-term welfare of developed countries. Still
other models7 derived from Keynesian theories, consider trade to be the result of
differences in growth rates of incomes. Such models often allow for unemployment and
also show fewer gains from trade liberalization than the H-O-S variants.
The fundamental difference between economies of the developed and developing
world is another crucial dimension of trade theory. Suppose that countries specialize in
sectors for which the production factors are relatively abundant, as is recommended by
traditional models. Exports of developing countries tend to be concentrated in primary
products, which offer little added value. However, over time the prices of primary
products will tend to decrease relative to manufactured goods. The role manufacturing
plays for development has been recognized 8. Gains from trade then do not derive from
Ricardian specialization but from expansion of dynamic sectors. From this perspective,
the potential gains from trade liberalization are large, but they will materialize only if
complemented by policies promoting development of industry9.
7
C. W. M. Naastepad, Camb. J. Econ. 30, 403 (2006).
8
J. A. Ocampo, in Beyond Reforms (Stanford Univ. Press, Stanford, CA, 2005), chap. 1.
9
H.-J. Chang, Bad Samaritans, The Myth of Free Trade and the Secret History of Capitalism (Random
House, New York, 2007)
3.) ADVANTAGES OF LIBERAL TRADE
Free trade has delivered unprecedented access to goods and services, with a
revolution in the availability of goods for low income households. Take the cost of
purchasing a television set, for example: between 1980 and 2014, the price of a roughly
comparable TV set fell by 73%, in part as the result of ambitious trade liberalisation
efforts10 – and the smart television sets we buy today are vastly better than those available
in the 1980s. Lower prices are particularly beneficial for poor households, which spend
relatively more on heavily-traded products (for example, staples such as food and
garments).
Not only does Free trade lower prices, it also provides jobs for millions of people
around the world. In a large country like the United States, around 10% of the workforce
is involved in producing goods and services that are exported and consumed abroad,
which amounts to around 14 million American jobs. The share goes up to 20% for
France, almost 30% for Germany, and 47% for a small open economy like Ireland.
Across all countries, the share of jobs that rely on trade is significantly higher when
taking into account “indirect” exports (when a person or company sells a good or service
to another actor in the domestic market that uses it as an input in its exports). In some
10
https://www.oecd.org/trade/understanding-the-global-trading-system/why-open-markets-matter/
countries like China these can out-number jobs in the exporting industries themselves.
These indirect export channels are especially important for smaller firms.
Free trade also plays a role in raising incomes and improving overall working
conditions. Exporters in the United States, for example, on average pay wages that are
6% higher than non-exporters. And whether the measure is injuries on the job, child
labour, informality, or effects on female labor, open economies significantly out-perform
closed ones, and labour rights are generally better respected.
Free trade also helps businesses become more productive and innovative. Trade
openness also benefits firms, by giving producers access to bigger markets, allowing
them to increase the scale of their production, and encouraging market competition and
innovation. Firms that export tend to be more productive than those that do not.
Free trade also allows new technologies to move more freely around the world,
benefitting more companies and more people. Smaller businesses in particular stand to
gain from spill-overs of technology and managerial know-how, as well as opportunities
to scale up and enhance productivity. The more a country trades, the more technology
and ideas spread; workers get more done, and higher productivity can lead to better
wages.
Free trade can lead to structural changes, which requires adjustment assistance. A
powerful driver of structural change, trade helps to reallocate resources to the sectors and
areas where they can be most efficient. This is one of the key gains from trade, but also
one of its costs. Not all of the gains from trade are immediate, and not every worker
benefits. Losses can be sharp and concentrated on individuals, often those with the least
capacity to adjust on their own. So as well as ensuring people are able to take advantage
of opportunities from trade and technology, governments must also find ways to help
those facing hard adjustment.
Free trade helps through comparative advantage. This explains that by specialising in
goods where countries have a lower opportunity cost, there can be an increase in
economic welfare for all countries. Free trade enables countries to specialise in those
goods where they have a comparative advantage.
Free trade reduces tariff barriers which leads to trade creation. Trade creation occurs
when consumption switches from high-cost producers to low-cost producers. This is done
by increased exports. As well as benefits for consumers importing goods, firms exporting
goods where the UK has a comparative advantage will also see a significant improvement
in economic welfare. Lower tariffs on UK exports will enable a higher quantity of
exports boosting UK jobs and economic growth.
Free trade increases economies of scale. If countries can specialise in certain goods
they can benefit from economies of scale and lower average costs; this is especially true
in industries with high fixed costs or that require high levels of investment. The benefits
of economies of scale will ultimately lead to lower prices for consumers and greater
efficiency for exporting firms.
Free trade leads to increased competition and an engine of growth. With more trade,
domestic firms will face more competition from abroad. Therefore, there will be more
incentives to cut costs and increase efficiency. It may prevent domestic monopolies from
charging too high prices.11 World trade has increased by an average of 7% since 1945,
causing this to be one of the significant contributors to economic growth.
Free trade helps in making use of surplus raw materials and encourages efficiency.
Middle Eastern countries such as Qatar are very rich in reserves of oil, but without trade,
there would be not much benefit in having so much oil. Japan, on the other hand, has very
few raw materials; without trade, it would have low GDP. If an economy protects its
domestic industry by increasing tariffs industries may not have any incentives to cut
costs.
Free trade contributes to economic prosperity in many ways. One of the greatest benefits
11
Steven Magiera and Michael Herlihy, 'Comparing World Price Changes from Trade Liberalization
Models'.
of trade is that international differences in prices allow countries to utilize their
comparative advantage, because trade gives a country access to goods and services at
relatively low prices, while simultaneously allowing domestic producers to find
profitable export markets in which to sell goods that can be produced at lower prices at
home than abroad.12 Trade allows a nation to achieve higher overall consumption of
goods and services than would be possible if no trade occurred. Trade also benefits
consumers by increasing the number and variety of goods available domestically. Trade
raises the productivity of domestic firms in multiple ways: Trade shifts production toward
goods in which the country has a comparative advantage, so that over time, capital and
labor will become concentrated in relatively more productive sectors, raising national
income; trade connects domestic producers to new technology and a greater variety of
inputs, and it exposes them to more competition; and firms that gain access to new
markets can increase average productivity as unit costs fall, thus benefiting from what
economists call economies of scale in production. Because trade allows the most
productive firms and sectors to increase their share of U.S. production, trade makes
possible increases in productivity, profitability, and wages that raise national standards of
living.
12
https://georgewbush-whitehouse.archives.gov/cea/ERP_2009_Ch4.pdf
4.) CHALLENGES OF LIBERAL TRADE
14
J.H.Jackson, World Trading System, op. cit. p. 288.
Impact on domestic political sovereignty
All international treaties, whether relating to nuclear disarmament, human rights, the
environment, the law of the sea, or trade, constrain domestic political sovereignty through
the assumption of external obligations. But unless anarchy in international relations is
preferred as an alternative, in most cases we accept that the benefits of the reciprocal
obligations involved outweigh the costs associated with any loss of political sovereignty.
In the trade context, the additional argument is sometimes made that increased economic
interdependence constrains political sovereignty in unacceptable ways in that countries—
especially smaller countries with major trading relationships with larger countries, such
as Canada and the USA—will be concerned that adopting independent foreign policies,
for example, may antagonize the larger trading partner and lead to forms of economic
‘blackmail’ designed to induce policy conformity.
This risk cannot be altogether gainsaid. However, trade treaties that structure
relations by reference to durable, well-defined substantive norms and objective dispute
resolution procedures reduce the risks of larger countries exploiting raw economic power
to bully smaller countries, by subjecting power relations to some form of legal ordering.
In addition, smaller countries typically stand to gain disproportionately from trade
liberalization. This is due to the simple fact that liberalization will provide access to a
larger set of potential new trading relationships than in the case of the larger country
gaining enhanced access to the smaller country’s market. Nevertheless, sweeping claims
for international harmonization of many domestic policies in the name of trade or
investment liberalization do legitimately engage concerns over excessive constraints on
political sovereignty and democratic accountability by privileging competitive markets
over competitive politics.15
15
Article 11(1), Subsidies Code
very well lose. This insight was belatedly invoked in 2005 to generate support for "aid for
trade" as a sop to induce developing countries to accept further trade liberalization.
Bhagwati has argued that aid for trade needs to be ramped up to maintain global support
for further liberalization.16
First, governments need to be compensated for loss of tariff revenue, which can
account for up to half of total tax revenue in the poorest countries. Second, producers,
workers, and others have to be compensated for loss of "uncompetitive" production
capacities in agriculture, industry, and even services. Third, funds are needed to help
develop new internationally competitive capacities and capabilities. Such recognition of
the need to compensate for the loss of revenue and economic capacities, as well as the
high and uncertain costs of developing alternative economic capacities, underscores the
limitations of traditional trade theory. The Reality of Trade Negotiations By 1994, the
WTO replaced the General Agreement on Tariffs and Trade (GATT), which gave the
WTO enhanced powers and significantly broadened scope. The WTO trade agenda now
includes services and gives greater attention to agriculture. The broadening of the scope
of multilateral negotiations has made it even harder for developing countries to be
represented by expert negotiators.
16
J. Bhagwati, Financial Times, 26 September 2005.
The Latest Doha Round In July 2008, negotiations for a Doha Round trade deal
collapsed again, this time over provisions to allow developing countries to protect the
livelihoods of subsistence farmers. Premature trade liberalization undermines the policy
space necessary for investment and technology policies for development. Further
agricultural trade liberalization will undermine food security in most developing
countries, many of which have been transformed from net food exporters into net food
importers.17 Contrary to the claims of advocates of agricultural trade liberalization,
eliminating agricultural and export subsidies in the organisation for Economic Co-
operation and Development would, at least temporarily, increase food prices in food-
importing countries! The supposed gains from agricultural trade liberalization are likely
to bring greater benefits to a few rich agriculture-exporting countries, rather than to most
of the developing world, let alone the bulk of the poor. The current multilateral
negotiations, the Doha Development Agenda, were conceived in the spirit of promoting
global cooperation and under the banner of helping developing countries do just that-
develop. A return to these principles is of utmost importance for successful conclusion of
the round.
17
Jaime Quizon, Bruce Gardner, and Lois Quinn, 'Consequences of Agricultural Trade Liberalization for
Developing Countries'
5. CONCLUSION
In the face of these concerns, governments can feel pressure to implement protectionist
policies and measures – including tariffs, quotas and various forms of subsidies – as a
way of 'saving' domestic jobs and enterprises. However, protection penalises those it aims
to protect: jobs retained solely by protection are unlikely to be sustainable, nor to
generate other jobs; protecting specific jobs or firms is a costly way of helping relatively
few people, with costs (increasing over time) for jobs in other sectors, and for low
income households facing higher prices. A better approach is a combination of domestic
and international policies to foster inclusive growth and share the gains from trade.
Trade liberalization would lead to moderate increases in world prices and trade volumes
for most agricultural commodities. The size of the increase is more or less in proportion
to the protection which government policies provide from international competition.
Earlier in the decade, livestock and dairy products, and sugar were subject to the greatest
policy distortions. Recently, distortions have increased substantially for cereals. Relaxing
these distortions would have a world price effect comparable to that for livestock, dairy
and sugar. The long-term trend in world prices is downward despite short-term
fluctuations due to weather conditions and other factors. Technological change continues
to expand supply faster than the increase in world demand. The rise in prices from trade
liberalization would help to offset the downward trend but would not prevent it.
The price changes brought about by liberalization would be small relative to the normal
variability in world markets. Taxpayers and consumers would gain substantially from
trade liberalization through lower government expenditures and lower food prices. If no
measures are taken to compensate producers they would lose in many countries,
including the United States. Producers in less-distorting countries (e.g., New Zealand),
would gain from liberalization. Unilateral liberalization would lead to larger benefits than
multilateral liberalization for most countries but would impose substantial costs on
producers. Multilateral liberalization is less disruptive domestically. There is a major
incentive for countries to cooperate in reforming domestic agricultural policies in order to
minimize domestic adjustments from freer trade. Freer trade would have different
regional effects within countries.
The quantitative impact of this effect is uncertain, especially if full liberalization is not
achieved. Most agricultural programs combine stabilization with producer support. If
support were reduced but policy institutions remained roughly the same, domestic
stability would continue to be achieved at the cost of world instability. Whether
developing countries would gain or lose from trade liberalization depends on whether
they are agricultural exporters or importers. Liberalization may improve the trade balance
for importers at higher prices they can produce more and import less - but not necessarily
their net income. The gains from liberalization would be greater if all agricultural
commodities are liberalized, and if developing countries also participate in the reform of
domestic policies. Centrally planned countries would probably experience a slight
income loss if industrial countries liberalize.
Trade liberalization would generally result in net gains to the countries who liberalize.
Taxpayers and consumers could afford to compensate producers and others in the
agricultural sector for their losses and still be better off. Society's long-term gains would
be sufficient to pay for the short-run adjustment costs of liberalization borne by particular
groups of individuals. Nations could also afford to support the incomes of their
agricultural producers if their support programs allowed the benefits from freer trade to
be realized. The challenge is to find alternatives to current policies that will achieve this.
Economic advantage implies that the economy is not a zero-sum game. In other words,
we are not fighting over ever-smaller pieces of the pie. The pie is constantly growing
larger, as people and businesses become more productive. And the world is getting
wealthier all the time. In the last 100 years, with relatively free markets, we have created
more wealth than in the 1 lakh years before. And as a result, we have reduced the extreme
poverty around the world; more than people ever dreamed was possible.
People with huge of money can afford to be early adopters, they can pay ridiculous
amounts for the first versions of cell phones and personal computers and that’s a good
thing for the rest. Because they create bigger markets, so the companies get revenue and
that they can streamline production and create lower-cost versions, and that all of us can
buy one. Historically, this seems to be the case. Free markets regularly turn luxuries in to
consumer goods. This may seem hard to believe. The average rate of air conditioners,
dish washers, refrigerators is higher among the poor American households today than
they were all American households in the early 1970s.
“When people are free, they are able to use their own resources most effectively and we
have a great deal of productivity, a great deal of opportunity. The major beneficiaries
are always the small man. The man who has power, who is at the top of a society, he’s
going to do well whatever kind of a society we have. It’s the society which gives a small
man the opportunity to go his way, which is going to benefit him the most.”
- MILTON FRIEDMAN