Free trade
Encyclopedia
Under a free trade policy, prices emerge from supply and demand
, and are the sole determinant of resource allocation
. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from those which would emerge under deregulation. These governed prices are the result of government intervention in the market through price adjustments or supply restrictions, including protectionist policies. Such government interventions can increase as well as decrease the cost of goods and services to both consumers and producers.
Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade
. Other barriers, however, that may be equally effective in hindering trade include import quotas, taxes, and diverse means of subsidizing domestic industries. Interventions include subsidies, taxes and tariff
s, non-tariff barriers, such as regulatory legislation
and quota
s, and even inter-government managed trade agreements such as the North American Free Trade Agreement
(NAFTA) and Central America Free Trade Agreement (CAFTA) (contrary to their formal titles) and any governmental market intervention resulting in artificial prices.
Most countries in the world are members of the World Trade Organization
(see map), which limits in certain ways but does not eliminate tariffs and other trade barriers. Most countries are also members of regional free trade area
s (see map) which lower trade barriers among participating countries.
Most states conduct trade policies that are to a lesser or greater degree protectionist.One ubiquitous protectionist policy employed by states comes in the form of agricultural subsidies whereby countries attempt to protect their agricultural industries from outside competition by creating artificial low prices for their agricultural goods. Free trade agreements are a key element of customs union
s and free trade area
s.
Notable contemporary trade barrier
s include ongoing tariff
s, import quota
s, sanctions and embargo
es, currency manipulation of the Chinese yuan
with respect to the U.S. dollar, agricultural subsidies in developed countries, and buy American laws.Most countries also prohibit foreign airlines from cabotage
(transporting passengers between two domestic locations), and foreign landing rights are generally restricted, but open skies
agreements have become more common.
in The Wealth of Nations
, in 1776. He wrote,
This statement uses the concept of absolute advantage
to present an argument in opposition to mercantilism
, the dominant view surrounding trade at the time, which held that a country should aim to export more than it imports, and thus amass wealth. Instead, Smith argues, countries could gain from each producing exclusively the good(s) in which they are most suited to, trading between each other as required for the purposes of consumption. In this vein, it is not the value of exports relative to that of imports that is important, but the value of the goods produced by a nation. The concept of absolute advantage however does not address a situation where a country has no advantage in the production of a particular good or type of good.
This theoretical shortcoming was addressed by the theory of comparative advantage
. Generally attributed to David Ricardo
who expanded on it in his 1817 book On the Principles of Political Economy and Taxation
, it makes a case for free trade based not on absolute advantage in production of a good, but on the relative opportunity cost
s of production. A country should specialize in whatever good it can produce at the lowest cost, trading this good to buy other goods it requires for consumption. This allows for countries to benefit from trade even when they do not have an absolute advantage
in any area of production. While their gains from trade might not be equal to those of a country which is more productive in all goods, they will still be better off economically from trade than they would be under a state of autarky
.
had developed in Europe in the 16th century. Two early British economists who were opposed to mercantilism were Adam Smith
and David Ricardo
.
Economists that advocated free trade believed trade was the reason why certain civilizations 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 pursuing a policy of free trade made the free trade/mercantilist dispute the most important question in economics for centuries. Free trade policies have battled with mercantilist
, protectionist
, isolationist
, communist
, populist
, and other policies over the centuries.
Wars have been fought over trade, such as the Peloponnesian War
between Athens and Sparta, the First
and Second Opium War
s between China and Great Britain, and other colonial wars
. All developed countries have used protectionism
due to an interest in raising revenues, protecting infant industries
, special interest pressure, and, prior to the 19th century, a belief in mercantilism
.
Many classical liberals, especially in 19th and early 20th century Britain (e.g. John Stuart Mill
) and in the United States for much of the 20th century (e.g. Cordell Hull
), believed that free trade promoted peace. Woodrow Wilson
included free-trade rhetoric in his "Fourteen Points
" speech of 1918:
The British economist John Maynard Keynes
(1883–1946) grew up with a belief in free trade; this underpinned his criticism of the Treaty of Versailles
in 1919 for the damage it did to the interdependent European economy. After a brief flirtation with protectionism in the early 1930s, he came again to favour free trade so long as it was combined with internationally coordinated domestic economic policies to promote high levels of employment, and international economic institutions that meant that the interests of countries were not pitted against each other. In these circumstances, "the wisdom of Adam Smith" again applied, he said.
In Kicking Away the Ladder, development economist Ha-Joon Chang
reviews the history of free trade policies and economic growth, and notes that many of the now-industrialized countries had significant barriers to trade throughout their history. The United States and Britain, sometimes considered to be the homes of free trade policy, employed protectionism to varying degrees at all times. Britain abolished the Corn Laws
, which restricted import of grain, in 1846 in response to domestic pressures, and it reduced protectionism for manufactures in the mid 19th century, when its technological advantage was at its height, but tariffs on manufactured products had returned to 23% by 1950. The United States maintained weighted average tariffs on manufactured products of approximately 40–50% up until the 1950s, augmented by the natural protectionism of high transportation costs in the 19th century. The most consistent practitioners of free trade have been Switzerland
, the Netherlands
, and to a lesser degree Belgium
. Chang describes the export-oriented industrialization
policies of the Asian Tigers
as "far more sophisticated and fine-tuned than their historical equivalents".
Some degree of protectionism is nevertheless the norm throughout the world. Most developed nations maintain controversial agricultural tariffs. From 1820 to 1980, the average tariffs on manufactures in twelve industrial countries ranged from 11 to 32%. In the developing world, average tariffs on manufactured goods are approximately 34%.
Currently, the World Bank
believes that, at most, rates of 20% can be allowed by developing nations; but Ha-Joon Chang
believes higher levels may be justified because the productivity gap between developing and developed nations is much higher than the productivity gap which industrial countries faced. (A general feature is that the underdeveloped nations of today are not in the same position that the developed nations were in when they had a similar level of technology, because they are weak players in a competitive system; the developed nations have always been strong players, although formerly at an overall lower level. Counter arguments to this point of view are that the developing countries are able to adopt technologies from abroad, whereas developed nations had to create new technologies themselves, and that developing countries have far richer markets to which to export than was the case in the 19th century.) If the main defense of tariffs is to stimulate infant industries, a tariff must be high enough to allow domestic manufactured goods to compete for the tariff to be possibly successful. This theory, known as import substitution industrialization, is largely considered to be ineffective for currently developing nations,. Studies by the World Bank
have determined that export-oriented industrialization
policies correlate with higher economic growth as observed with the Four Asian Tigers. These assessments are based mainly on theory and observational study of correlations, and thus suffer from a number of weaknesses such as small sample size and numerous confounding variables (see the critical review section below).
was regulated by the British mercantile system through the Acts of Trade and Navigation. Until the 1760s, few colonists openly advocated for free trade, in part because regulations were not strictly enforced — New England was famous for smuggling — but also because colonial merchants did not want to compete with foreign goods and shipping. According to historian Oliver Dickerson, a desire for free trade was not one of the causes of the American Revolution
. "The idea that the basic mercantile practices of the eighteenth century were wrong," wrote Dickerson, "was not a part of the thinking of the Revolutionary leaders". Free trade came to what would become the United States as a result of American Revolutionary War
, when the British Parliament
issued the Prohibitory Act
, blockading colonial ports. The Continental Congress
responded by effectively declaring economic independence, opening American ports to foreign trade on April 6, 1776. According to historian John W. Tyler, "Free trade had been forced on the Americans, like it or not."
The 1st U.S. Secretary of the Treasury, Alexander Hamilton
, advocated tariffs to help protect infant industries in his "Report on Manufactures." This was a minority position, though the "Jeffersonians" strongly opposed for the most part. Later, in the 19th century, statesmen such as Senator Henry Clay
continued Hamilton's themes within the Whig Party
under the name "American System
." The opposition Democratic Party
contested several elections throughout the 1830s, 1840s, and 1850s in part over the issue of the tariff and protection of industry. The Democratic Party favored moderate tariffs used for government revenue only, while the Whigs favored higher protective tariffs to protect favored industries. The economist Henry Charles Carey
became a leading proponent of the "American System" of economics. This mercantilist "American System" was opposed by the Democratic Party of Andrew Jackson
, Martin Van Buren
, James K. Polk
, Franklin Pierce
, and James Buchanan
.
The fledgling Republican Party
led by Abraham Lincoln
, who called himself a "Henry Clay tariff Whig", strongly opposed free trade and implemented a 44-percent tariff during the Civil War
- in part to pay for railroad subsidies and for the war effort, and to protect favored industries.
William McKinley
(later to become President of the United States) stated the stance of the Republican Party (which won every election for President from 1868 until 1912, except the two non-consecutive terms of Grover Cleveland
) as thus:
On the other side:
The tariff and support of protection to support the growth of infrastructure and industrialization of the nation became a leading tenet of the Republican Party thereafter until the Eisenhower administration and the onset of the Cold War
, when the Democratic and Republican parties switched positions.
Since the end of World War II
, in part due to industrial supremacy and the onset of the Cold War, the U.S. government 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); although it had rejected an earlier version in the 1950s (International Trade Organization or ITO). Since the 1970s U.S. governments have negotiated numerous managed-trade agreements, such as the North American Free Trade Agreement
(NAFTA) in the 1990s, the Dominican Republic-Central America Free Trade Agreement
(CAFTA) in 2006, and a number of bilateral agreements (such as with Jordan
).
and by analyzing the impact of a tariff
or import quota
. An economic analysis using the law of supply and demand
and the economic effects of a tax
can be used to show the theoretical benefits and disadvantages of free trade.
In this case, the higher price would not cause domestic production to increase from QS1 to QS2, since it has already been assumed in our example that Japan produces the same amount of widgets for price Ptariff as the world economy does for price Pworld. The effect of the tariff would limit imports and create a higher demand for domestically produced widgets but have no effect on consumer prices, since the graph shows that for all quantities to the left of the intersection of the Supply and Demand curves, consumers will buy whatever widgets enter the market. Once the imported + domestic supply of widgets in Japan reaches QS2 then the tariff will no longer be necessary to protect Japan's industry since market forces will cause the domestic and world prices to become equal and the market price will be enough for Japan's widget manufacturers to stay in business.
on some imaginary good. Prior to the tariff, the price of the good in the world market (and hence in the domestic market) is Pworld. The tariff increases the domestic price to Ptariff. The higher price causes domestic production to increase from QS1 to QS2 and causes domestic consumption to decline from QC1 to QC2. 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.
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.
theory, 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
.
In a 2006 survey of American economists (83 responders), "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."
Quoting Harvard economics professor N. Gregory Mankiw
, "Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards." Nonetheless, quoting Prof. Peter Soderbaum of Malardalen University, Sweden, "This neoclassical trade theory focuses on one dimension, i.e., the price at which a commodity can be delivered and is extremely narrow in cutting off a large number of other considerations about impacts on employment in different parts of the world, about environmental impacts and on culture."
Most free traders would agree that although increasing returns to scale might mean that certain industry could settle in a geographical area without any strong economic reason derived from comparative advantage, this is not a reason to argue against free trade because the absolute level of output enjoyed by both "winner" and "loser" will increase with the "winner" gaining more than the "loser" but both gaining more than before in an absolute level.
Despite this, some economists do exist who dispute the benefits of free trade, or question their extent. One long-standing economic critique of free trade is the infant industry argument
. The argument advances that protectionism is frequently required in order to allow the growth of nascent industries, as their competitors will already be employing significant economics of scale by virtue of their size or other factors after a long period of growth. Reliant on this critique is the import substitution industrialization form of protectionism.
, benefits and beneficiaries of free trade are debated by academics, governments and interest groups.
Arguments for protectionism fall into the economic category (trade hurts the economy) or the moral category (the effects of trade might help the economy, but have ill effects in other areas); a general argument against free trade is that it is colonialism
or imperialism
in disguise. The moral category is wide, including concerns of income inequality, environmental degradation
, supporting child labor
and sweatshops, race to the bottom
, wage slavery
, accentuating poverty
in poor countries, harming national defense
, and forcing cultural change.
Free trade is often opposed by domestic industries that would have their profits and market share reduced by lower prices for imported goods. For example, if United States tariffs on imported sugar were reduced, U.S. sugar producers would receive lower prices and profits, while U.S. sugar consumers would spend less for the same amount of sugar because of those same lower prices. The economic theory of David Ricardo holds that consumers would necessarily gain more than producers would lose. Since each of those few domestic sugar producers would lose a lot while each of a great number of consumers would gain only a little, domestic producers are more likely to mobilize against 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.
Socialists frequently oppose free trade on the ground that it allows maximum exploitation
of workers by capital
. For example, 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." Nonetheless, Marx favored free trade solely because he felt that it would hasten the social revolution. To those who oppose socialism, this becomes an argument against free trade.
"Free trade" is opposed by many anti-globalization groups, based on their assertion that free trade agreements generally do not increase the economic freedom
of the poor or the working class, and frequently make them poorer. Where the foreign supplier allows de facto exploitation of labor, domestic free-labor is unfairly forced to compete with the foreign exploited labor, and thus the domestic "working class would gradually be forced down to the level of helotry." To this extent, free trade is seen as nothing more than an end-run around laws that protect individual liberty, such as the Thirteenth Amendment to the United States Constitution (outlawing slavery and indentured servitude). In this regard, protective trade policies are seen, not so much as protecting domestic producers, but rather, as protecting liberty itself. This argument actually comports with the economic analysis of Free Trade to the extent that "slavery and perfect competition equilibria are Pareto optimal." Thus, while admitting that some gain in efficiency might be realized in the short term by implementation of free trade policies, the long-term question of the cost of that efficiency in terms of loss of liberty remains.
It is important to distinguish between arguments against free trade theory, and free trade agreements as applied. Some opponents of NAFTA see the agreement as being materially harmful to the common people, but some of the arguments are actually against the particulars of government-managed trade, rather than against free trade per se. For example, it is argued that it would be wrong to let subsidized corn from the U.S. into Mexico freely under NAFTA at prices well below production cost (dumping
) because of its ruinous effects to Mexican farmers. Of course, such subsidies violate free trade theory, so this argument is not actually against the principle of free trade, but rather its selective implementation.
Latin America performed poorly since tariff cuts in 1980s and 1990s, compared to protectionist China and Southeast Asia. According to Samuelson
, it is wrong to assume a necessary surplus of winnings over losings. The paper, "Will inventions A or B lower or raise the new market-clearing real wage rates that sustain high-to-full employment" condemned "economists' over-simple complacency about globalization" and said that workers don't always win. Some economists try to emphasize that trade barriers should exist to help poor nations build domestic industries and give rich nations time to retrain workers.
and the school of mercantilism
. In the 19th century these criticized British calls for free trade as cover for British Empire
, notably in the works of American Henry Clay
, architect of the American System and by German American
economist Friedrich List
.
More recently, Ecuador
ian 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, written in part by Correa's current Energy Minister Alberto Acosta. Citing as his source the book Kicking Away the Ladder, written by 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." According to Correa, 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.
, fair trade
, protectionism
and Tobin tax
.
Trade organizations:
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
, and are the sole determinant of resource allocation
Resource allocation
Resource allocation is used to assign the available resources in an economic way. It is part of resource management. In project management, resource allocation is the scheduling of activities and the resources required by those activities while taking into consideration both the resource...
. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from those which would emerge under deregulation. These governed prices are the result of government intervention in the market through price adjustments or supply restrictions, including protectionist policies. Such government interventions can increase as well as decrease the cost of goods and services to both consumers and producers.
Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
. Other barriers, however, that may be equally effective in hindering trade include import quotas, taxes, and diverse means of subsidizing domestic industries. Interventions include subsidies, taxes and tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s, non-tariff barriers, such as regulatory legislation
Legislation
Legislation is law which has been promulgated by a legislature or other governing body, or the process of making it...
and quota
Import quota
An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time....
s, and even inter-government managed trade agreements such as the North American Free Trade Agreement
North American Free Trade Agreement
The North American Free Trade Agreement or NAFTA is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement...
(NAFTA) and Central America Free Trade Agreement (CAFTA) (contrary to their formal titles) and any governmental market intervention resulting in artificial prices.
Features of free trade
Free trade implies the following features:- Trade of goods without taxes (including tariffTariffA tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s) or other trade barrierTrade barrierTrade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...
s (e.g., quotas on imports or subsidies for producers) - Trade in services without taxes or other trade barriers
- The absence of "trade-distorting" policies (such as taxTaxTo tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es, subsidiesSubsidyA subsidy is an assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry to prevent the decline of that industry or an increase in the prices of its products or simply to encourage it to hire more labor A subsidy (also...
, regulationRegulationRegulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...
s, or lawLawLaw is a system of rules and guidelines which are enforced through social institutions to govern behavior, wherever possible. It shapes politics, economics and society in numerous ways and serves as a social mediator of relations between people. Contract law regulates everything from buying a bus...
s) that give some firms, households, or factors of productionFactors of productionIn economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
an advantage over others - Free access to marketMarketA market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
s - Free access to market information
- Inability of firms to distort markets through government-imposed monopolyMonopolyA monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
or oligopolyOligopolyAn oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
power - The free movement of labor between and within countries
- The free movement of capitalCapital (economics)In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
between and within countries
Current status
Most countries in the world are members of the World Trade Organization
World Trade Organization
The World Trade Organization is an organization that intends to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade , which commenced in 1948...
(see map), which limits in certain ways but does not eliminate tariffs and other trade barriers. Most countries are also members of regional free trade area
Free trade area
A free trade area is a trade bloc whose member countries have signed a free trade agreement , which eliminates tariffs, import quotas, and preferences on most goods and services traded between them. If people are also free to move between the countries, in addition to FTA, it would also be...
s (see map) which lower trade barriers among participating countries.
Most states conduct trade policies that are to a lesser or greater degree protectionist.One ubiquitous protectionist policy employed by states comes in the form of agricultural subsidies whereby countries attempt to protect their agricultural industries from outside competition by creating artificial low prices for their agricultural goods. Free trade agreements are a key element of customs union
Customs union
A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff. The participant countries set up common external trade policy, but in some cases they use different import quotas...
s and free trade area
Free trade area
A free trade area is a trade bloc whose member countries have signed a free trade agreement , which eliminates tariffs, import quotas, and preferences on most goods and services traded between them. If people are also free to move between the countries, in addition to FTA, it would also be...
s.
Notable contemporary trade barrier
Trade barrier
Trade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...
s include ongoing tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s, import quota
Import quota
An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time....
s, sanctions and embargo
Embargo
An embargo is the partial or complete prohibition of commerce and trade with a particular country, in order to isolate it. Embargoes are considered strong diplomatic measures imposed in an effort, by the imposing country, to elicit a given national-interest result from the country on which it is...
es, currency manipulation of the Chinese yuan
Chinese yuan
The yuan is the base unit of a number of modern Chinese currencies. The yuan is the primary unit of account of the Renminbi.A yuán is also known colloquially as a kuài . One yuán is divided into 10 jiǎo or colloquially máo...
with respect to the U.S. dollar, agricultural subsidies in developed countries, and buy American laws.Most countries also prohibit foreign airlines from cabotage
Cabotage
Cabotage is the transport of goods or passengers between two points in the same country by a vessel or an aircraft registered in another country. Originally starting with shipping, cabotage now also covers aviation, railways and road transport...
(transporting passengers between two domestic locations), and foreign landing rights are generally restricted, but open skies
Open skies
Open skies is an international policy concept which calls for the liberalization of rules and regulations on international aviation industry most specially commercial aviation - opening a free market for the airline industry...
agreements have become more common.
In literature
The value of free trade was first observed and documented by Adam SmithAdam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
in The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...
, in 1776. He wrote,
- "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.. . . If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage."
This statement uses the concept of absolute advantage
Absolute advantage
In economics, principle of absolute advantage refers to the ability of a party to produce more of a good or service than competitors, using the same amount of resources...
to present an argument in opposition to mercantilism
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
, the dominant view surrounding trade at the time, which held that a country should aim to export more than it imports, and thus amass wealth. Instead, Smith argues, countries could gain from each producing exclusively the good(s) in which they are most suited to, trading between each other as required for the purposes of consumption. In this vein, it is not the value of exports relative to that of imports that is important, but the value of the goods produced by a nation. The concept of absolute advantage however does not address a situation where a country has no advantage in the production of a particular good or type of good.
This theoretical shortcoming was addressed by the theory of comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
. Generally attributed to David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
who expanded on it in his 1817 book On the Principles of Political Economy and Taxation
On the Principles of Political Economy and Taxation
On the Principles of Political Economy and Taxation is a book by David Ricardo on economics. The book concludes that land rent grows as population increases...
, it makes a case for free trade based not on absolute advantage in production of a good, but on the relative opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
s of production. A country should specialize in whatever good it can produce at the lowest cost, trading this good to buy other goods it requires for consumption. This allows for countries to benefit from trade even when they do not have an absolute advantage
Absolute advantage
In economics, principle of absolute advantage refers to the ability of a party to produce more of a good or service than competitors, using the same amount of resources...
in any area of production. While their gains from trade might not be equal to those of a country which is more productive in all goods, they will still be better off economically from trade than they would be under a state of autarky
Autarky
Autarky is the quality of being self-sufficient. Usually the term is applied to political states or their economic policies. Autarky exists whenever an entity can survive or continue its activities without external assistance. Autarky is not necessarily economic. For example, a military autarky...
.
History of free trade
Before the appearance of Free Trade doctrine, and continuing in opposition to it to this day, the policy of mercantilismMercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
had developed in Europe in the 16th century. Two early British economists who were opposed to mercantilism were Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
and David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...
.
Economists that advocated free trade believed trade was the reason why certain civilizations 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 pursuing a policy of free trade made the free trade/mercantilist dispute the most important question in economics for centuries. Free trade policies have battled with mercantilist
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
, protectionist
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...
, isolationist
Isolationism
Isolationism is the policy or doctrine of isolating one's country from the affairs of other nations by declining to enter into alliances, foreign economic commitments, international agreements, etc., seeking to devote the entire efforts of one's country to its own advancement and remain at peace by...
, communist
Communism
Communism is a social, political and economic ideology that aims at the establishment of a classless, moneyless, revolutionary and stateless socialist society structured upon common ownership of the means of production...
, populist
Populism
Populism can be defined as an ideology, political philosophy, or type of discourse. Generally, a common theme compares "the people" against "the elite", and urges social and political system changes. It can also be defined as a rhetorical style employed by members of various political or social...
, and other policies over the centuries.
Wars have been fought over trade, such as the Peloponnesian War
Peloponnesian War
The Peloponnesian War, 431 to 404 BC, was an ancient Greek war fought by Athens and its empire against the Peloponnesian League led by Sparta. Historians have traditionally divided the war into three phases...
between Athens and Sparta, the First
First Opium War
The First Anglo-Chinese War , known popularly as the First Opium War or simply the Opium War, was fought between the United Kingdom and the Qing Dynasty of China over their conflicting viewpoints on diplomatic relations, trade, and the administration of justice...
and Second Opium War
Second Opium War
The Second Opium War, the Second Anglo-Chinese War, the Second China War, the Arrow War, or the Anglo-French expedition to China, was a war pitting the British Empire and the Second French Empire against the Qing Dynasty of China, lasting from 1856 to 1860...
s between China and Great Britain, and other colonial wars
Colonial war
Colonial war is a blanket term relating to the various conflicts that arose as the result of overseas territories being settled by foreignpowers creating a colony...
. All developed countries have used protectionism
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...
due to an interest in raising revenues, protecting infant industries
Infant industry argument
The Infant industry argument is an economic rationale for trade protectionism. The core of the argument is that nascent industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar...
, special interest pressure, and, prior to the 19th century, a belief in mercantilism
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
.
Many classical liberals, especially in 19th and early 20th century Britain (e.g. John Stuart Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...
) and in the United States for much of the 20th century (e.g. Cordell Hull
Cordell Hull
Cordell Hull was an American politician from the U.S. state of Tennessee. He is best known as the longest-serving Secretary of State, holding the position for 11 years in the administration of President Franklin Delano Roosevelt during much of World War II...
), believed that free trade promoted peace. Woodrow Wilson
Woodrow Wilson
Thomas Woodrow Wilson was the 28th President of the United States, from 1913 to 1921. A leader of the Progressive Movement, he served as President of Princeton University from 1902 to 1910, and then as the Governor of New Jersey from 1911 to 1913...
included free-trade rhetoric in his "Fourteen Points
Fourteen Points
The Fourteen Points was a speech given by United States President Woodrow Wilson to a joint session of Congress on January 8, 1918. The address was intended to assure the country that the Great War was being fought for a moral cause and for postwar peace in Europe...
" speech of 1918:
The program of the world's peace, therefore, is our program; and that program, the only possible program, all we see it, is this: [...]
3. The removal, so far as possible, of all economic barriers and the establishment of equality of trade conditions among all the nations consenting to the peace and associating themselves for its maintenance.
The British economist John Maynard Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
(1883–1946) grew up with a belief in free trade; this underpinned his criticism of the Treaty of Versailles
Treaty of Versailles
The Treaty of Versailles was one of the peace treaties at the end of World War I. It ended the state of war between Germany and the Allied Powers. It was signed on 28 June 1919, exactly five years after the assassination of Archduke Franz Ferdinand. The other Central Powers on the German side of...
in 1919 for the damage it did to the interdependent European economy. After a brief flirtation with protectionism in the early 1930s, he came again to favour free trade so long as it was combined with internationally coordinated domestic economic policies to promote high levels of employment, and international economic institutions that meant that the interests of countries were not pitted against each other. In these circumstances, "the wisdom of Adam Smith" again applied, he said.
In Kicking Away the Ladder, development economist Ha-Joon Chang
Ha-Joon Chang
Ha-Joon Chang is one of the leading heterodox economists and institutional economists specialising in development economics...
reviews the history of free trade policies and economic growth, and notes that many of the now-industrialized countries had significant barriers to trade throughout their history. The United States and Britain, sometimes considered to be the homes of free trade policy, employed protectionism to varying degrees at all times. Britain abolished the Corn Laws
Corn Laws
The Corn Laws were trade barriers designed to protect cereal producers in the United Kingdom of Great Britain and Ireland against competition from less expensive foreign imports between 1815 and 1846. The barriers were introduced by the Importation Act 1815 and repealed by the Importation Act 1846...
, which restricted import of grain, in 1846 in response to domestic pressures, and it reduced protectionism for manufactures in the mid 19th century, when its technological advantage was at its height, but tariffs on manufactured products had returned to 23% by 1950. The United States maintained weighted average tariffs on manufactured products of approximately 40–50% up until the 1950s, augmented by the natural protectionism of high transportation costs in the 19th century. The most consistent practitioners of free trade have been Switzerland
Switzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
, the Netherlands
Netherlands
The Netherlands is a constituent country of the Kingdom of the Netherlands, located mainly in North-West Europe and with several islands in the Caribbean. Mainland Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany to the east, and shares maritime borders...
, and to a lesser degree Belgium
Belgium
Belgium , officially the Kingdom of Belgium, is a federal state in Western Europe. It is a founding member of the European Union and hosts the EU's headquarters, and those of several other major international organisations such as NATO.Belgium is also a member of, or affiliated to, many...
. Chang describes the export-oriented industrialization
Export-oriented industrialization
Export-oriented Industrialization sometimes called export substitution industrialization or export led industrialization is a trade and economic policy aiming to speed up the industrialization process of a country by exporting goods for which the nation has a comparative advantage...
policies of the Asian Tigers
Asian Tigers
The Asian Tigers is a Pakistani militant group, first publicised when they claimed credit for the kidnapping of former Pakistani intelligence officers Khalid Khawaja, Colonel Imam, British journalist Asad Qureshi and Qureshi's driver Rustam Khan in March 2010. Khawaja was killed in April 2010....
as "far more sophisticated and fine-tuned than their historical equivalents".
Some degree of protectionism is nevertheless the norm throughout the world. Most developed nations maintain controversial agricultural tariffs. From 1820 to 1980, the average tariffs on manufactures in twelve industrial countries ranged from 11 to 32%. In the developing world, average tariffs on manufactured goods are approximately 34%.
Currently, the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
believes that, at most, rates of 20% can be allowed by developing nations; but Ha-Joon Chang
Ha-Joon Chang
Ha-Joon Chang is one of the leading heterodox economists and institutional economists specialising in development economics...
believes higher levels may be justified because the productivity gap between developing and developed nations is much higher than the productivity gap which industrial countries faced. (A general feature is that the underdeveloped nations of today are not in the same position that the developed nations were in when they had a similar level of technology, because they are weak players in a competitive system; the developed nations have always been strong players, although formerly at an overall lower level. Counter arguments to this point of view are that the developing countries are able to adopt technologies from abroad, whereas developed nations had to create new technologies themselves, and that developing countries have far richer markets to which to export than was the case in the 19th century.) If the main defense of tariffs is to stimulate infant industries, a tariff must be high enough to allow domestic manufactured goods to compete for the tariff to be possibly successful. This theory, known as import substitution industrialization, is largely considered to be ineffective for currently developing nations,. Studies by the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
have determined that export-oriented industrialization
Export-oriented industrialization
Export-oriented Industrialization sometimes called export substitution industrialization or export led industrialization is a trade and economic policy aiming to speed up the industrialization process of a country by exporting goods for which the nation has a comparative advantage...
policies correlate with higher economic growth as observed with the Four Asian Tigers. These assessments are based mainly on theory and observational study of correlations, and thus suffer from a number of weaknesses such as small sample size and numerous confounding variables (see the critical review section below).
The United States and free trade
Trade in colonial AmericaBritish America
For American people of British descent, see British American.British America is the anachronistic term used to refer to the territories under the control of the Crown or Parliament in present day North America , Central America, the Caribbean, and Guyana...
was regulated by the British mercantile system through the Acts of Trade and Navigation. Until the 1760s, few colonists openly advocated for free trade, in part because regulations were not strictly enforced — New England was famous for smuggling — but also because colonial merchants did not want to compete with foreign goods and shipping. According to historian Oliver Dickerson, a desire for free trade was not one of the causes of the American Revolution
American Revolution
The American Revolution was the political upheaval during the last half of the 18th century in which thirteen colonies in North America joined together to break free from the British Empire, combining to become the United States of America...
. "The idea that the basic mercantile practices of the eighteenth century were wrong," wrote Dickerson, "was not a part of the thinking of the Revolutionary leaders". Free trade came to what would become the United States as a result of American Revolutionary War
American Revolutionary War
The American Revolutionary War , the American War of Independence, or simply the Revolutionary War, began as a war between the Kingdom of Great Britain and thirteen British colonies in North America, and ended in a global war between several European great powers.The war was the result of the...
, when the British Parliament
Parliament of Great Britain
The Parliament of Great Britain was formed in 1707 following the ratification of the Acts of Union by both the Parliament of England and Parliament of Scotland...
issued the Prohibitory Act
Prohibitory Act
The Prohibitory Act 1775 was passed as a measure of retaliation by Great Britain against the general rebellion then going on in her American colonies, which became known as the American Revolutionary War...
, blockading colonial ports. The Continental Congress
Second Continental Congress
The Second Continental Congress was a convention of delegates from the Thirteen Colonies that started meeting on May 10, 1775, in Philadelphia, Pennsylvania, soon after warfare in the American Revolutionary War had begun. It succeeded the First Continental Congress, which met briefly during 1774,...
responded by effectively declaring economic independence, opening American ports to foreign trade on April 6, 1776. According to historian John W. Tyler, "Free trade had been forced on the Americans, like it or not."
The 1st U.S. Secretary of the Treasury, Alexander Hamilton
Alexander Hamilton
Alexander Hamilton was a Founding Father, soldier, economist, political philosopher, one of America's first constitutional lawyers and the first United States Secretary of the Treasury...
, advocated tariffs to help protect infant industries in his "Report on Manufactures." This was a minority position, though the "Jeffersonians" strongly opposed for the most part. Later, in the 19th century, statesmen such as Senator Henry Clay
Henry Clay
Henry Clay, Sr. , was a lawyer, politician and skilled orator who represented Kentucky separately in both the Senate and in the House of Representatives...
continued Hamilton's themes within the Whig Party
Whig Party (United States)
The Whig Party was a political party of the United States during the era of Jacksonian democracy. Considered integral to the Second Party System and operating from the early 1830s to the mid-1850s, the party was formed in opposition to the policies of President Andrew Jackson and his Democratic...
under the name "American System
American System (economic plan)
The American System, originally called "The American Way", was a mercantilist economic plan that played a prominent role in American policy during the first half of the 19th century...
." The opposition Democratic Party
Democratic Party (United States)
The Democratic Party is one of two major contemporary political parties in the United States, along with the Republican Party. The party's socially liberal and progressive platform is largely considered center-left in the U.S. political spectrum. The party has the lengthiest record of continuous...
contested several elections throughout the 1830s, 1840s, and 1850s in part over the issue of the tariff and protection of industry. The Democratic Party favored moderate tariffs used for government revenue only, while the Whigs favored higher protective tariffs to protect favored industries. The economist Henry Charles Carey
Henry Charles Carey
Henry Charles Carey , a leading 19th century economist of the American School of capitalism. He is now best known for the book The Harmony of Interests, to compare and contrast what he called the "British System" of laissez faire free trade capitalism with the "American System" of developmental...
became a leading proponent of the "American System" of economics. This mercantilist "American System" was opposed by the Democratic Party of Andrew Jackson
Andrew Jackson
Andrew Jackson was the seventh President of the United States . Based in frontier Tennessee, Jackson was a politician and army general who defeated the Creek Indians at the Battle of Horseshoe Bend , and the British at the Battle of New Orleans...
, Martin Van Buren
Martin Van Buren
Martin Van Buren was the eighth President of the United States . Before his presidency, he was the eighth Vice President and the tenth Secretary of State, under Andrew Jackson ....
, James K. Polk
James K. Polk
James Knox Polk was the 11th President of the United States . Polk was born in Mecklenburg County, North Carolina. He later lived in and represented Tennessee. A Democrat, Polk served as the 17th Speaker of the House of Representatives and the 12th Governor of Tennessee...
, Franklin Pierce
Franklin Pierce
Franklin Pierce was the 14th President of the United States and is the only President from New Hampshire. Pierce was a Democrat and a "doughface" who served in the U.S. House of Representatives and the Senate. Pierce took part in the Mexican-American War and became a brigadier general in the Army...
, and James Buchanan
James Buchanan
James Buchanan, Jr. was the 15th President of the United States . He is the only president from Pennsylvania, the only president who remained a lifelong bachelor and the last to be born in the 18th century....
.
The fledgling Republican Party
Republican Party (United States)
The Republican Party is one of the two major contemporary political parties in the United States, along with the Democratic Party. Founded by anti-slavery expansion activists in 1854, it is often called the GOP . The party's platform generally reflects American conservatism in the U.S...
led by Abraham Lincoln
Abraham Lincoln
Abraham Lincoln was the 16th President of the United States, serving from March 1861 until his assassination in April 1865. He successfully led his country through a great constitutional, military and moral crisis – the American Civil War – preserving the Union, while ending slavery, and...
, who called himself a "Henry Clay tariff Whig", strongly opposed free trade and implemented a 44-percent tariff during the Civil War
American Civil War
The American Civil War was a civil war fought in the United States of America. In response to the election of Abraham Lincoln as President of the United States, 11 southern slave states declared their secession from the United States and formed the Confederate States of America ; the other 25...
- in part to pay for railroad subsidies and for the war effort, and to protect favored industries.
William McKinley
William McKinley
William McKinley, Jr. was the 25th President of the United States . He is best known for winning fiercely fought elections, while supporting the gold standard and high tariffs; he succeeded in forging a Republican coalition that for the most part dominated national politics until the 1930s...
(later to become President of the United States) stated the stance of the Republican Party (which won every election for President from 1868 until 1912, except the two non-consecutive terms of Grover Cleveland
Grover Cleveland
Stephen Grover Cleveland was the 22nd and 24th president of the United States. Cleveland is the only president to serve two non-consecutive terms and therefore is the only individual to be counted twice in the numbering of the presidents...
) as thus:
"Under free trade the trader is the master and the producer the slave. Protection is but the law of nature, the law of self-preservation, of self-development, of securing the highest and best destiny of the race of man. [It is said] that protection is immoral…. Why, if protection builds up and elevates 63,000,000 [the U.S. population] of people, the influence of those 63,000,000 of people elevates the rest of the world. We cannot take a step in the pathway of progress without benefitting mankind everywhere. Well, they say, ‘Buy where you can buy the cheapest'…. Of course, that applies to labor as to everything else. Let me give you a maxim that is a thousand times better than that, and it is the protection maxim: ‘Buy where you can pay the easiest.' And that spot of earth is where labor wins its highest rewards."
On the other side:
The growing Free Trade Movement sought an end to the tariffs and corruption in state and federal governments by every means available to them, leading to several outcomes. The first and most important was the rise of the Democratic Party with Grover Cleveland at its helm. The next most important were the rise of the "MugwumpMugwumpThe Mugwumps were Republican political activists who bolted from the United States Republican Party by supporting Democratic candidate Grover Cleveland in the United States presidential election of 1884. They switched parties because they rejected the financial corruption associated with Republican...
s" within the Republican party. For many Jeffersonian radicals, neither went far enough or sufficiently effective in their efforts and looked for alternatives.
The first major movement of the radical Jeffersonians evolved from the insights of a young journalist and firebrand, Henry GeorgeHenry GeorgeHenry George was an American writer, politician and political economist, who was the most influential proponent of the land value tax, also known as the "single tax" on land...
. – Kenneth R. Gregg, George Mason UniversityGeorge Mason UniversityGeorge Mason University is a public university based in unincorporated Fairfax County, Virginia, United States, south of and adjacent to the city of Fairfax. Additional campuses are located nearby in Arlington County, Prince William County, and Loudoun County...
History News Network
The tariff and support of protection to support the growth of infrastructure and industrialization of the nation became a leading tenet of the Republican Party thereafter until the Eisenhower administration and the onset of the Cold War
Cold War
The Cold War was the continuing state from roughly 1946 to 1991 of political conflict, military tension, proxy wars, and economic competition between the Communist World—primarily the Soviet Union and its satellite states and allies—and the powers of the Western world, primarily the United States...
, when the Democratic and Republican parties switched positions.
Since the end of World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
, in part due to industrial supremacy and the onset of the Cold War, the U.S. government 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
General Agreement on Tariffs and Trade
The General Agreement on Tariffs and Trade was negotiated during the UN Conference on Trade and Employment and was the outcome of the failure of negotiating governments to create the International Trade Organization . GATT was signed in 1947 and lasted until 1993, when it was replaced by the World...
(GATT) and later the World Trade Organization
World Trade Organization
The World Trade Organization is an organization that intends to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade , which commenced in 1948...
(WTO); although it had rejected an earlier version in the 1950s (International Trade Organization or ITO). Since the 1970s U.S. governments have negotiated numerous managed-trade agreements, such as the North American Free Trade Agreement
North American Free Trade Agreement
The North American Free Trade Agreement or NAFTA is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement...
(NAFTA) in the 1990s, the Dominican Republic-Central America Free Trade Agreement
Dominican Republic-Central America Free Trade Agreement
The Dominican Republic – Central America Free Trade Agreement, commonly called DR-CAFTA, is a free trade agreement . Originally, the agreement encompassed the United States and the Central American countries of Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua, and was called CAFTA...
(CAFTA) in 2006, and a number of bilateral agreements (such as with Jordan
Jordan
Jordan , officially the Hashemite Kingdom of Jordan , Al-Mamlaka al-Urduniyya al-Hashemiyya) is a kingdom on the East Bank of the River Jordan. The country borders Saudi Arabia to the east and south-east, Iraq to the north-east, Syria to the north and the West Bank and Israel to the west, sharing...
).
Economic models
Two simple ways to understand the proposed benefits of free trade are through David Ricardo's theory of comparative advantageComparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
and by analyzing the impact of a tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
or import quota
Import quota
An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time....
. An economic analysis using the law of supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
and the economic effects of a tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
can be used to show the theoretical benefits and disadvantages of free trade.
Advantages of tariffs
This graph demonstrates the benefits of tariffs to a domestic industry. Assume that Japan wants to protect a domestic industry that is only able to produce and sell widgets at the price Ptariff. Since there are other countries that are exporting the same widgets at a price of Pworld, Japan's industry is threatened to go out of business should widgets be imported into their country without a tariff. This graph also shows that as long as Ptariff does not fall above the intersection of the Supply and Demand lines, then an equilibrium can be reached in which there are no shortages of supply or excesses of demand, and so Japan's society can enjoy widgets to the same degree as any other country.In this case, the higher price would not cause domestic production to increase from QS1 to QS2, since it has already been assumed in our example that Japan produces the same amount of widgets for price Ptariff as the world economy does for price Pworld. The effect of the tariff would limit imports and create a higher demand for domestically produced widgets but have no effect on consumer prices, since the graph shows that for all quantities to the left of the intersection of the Supply and Demand curves, consumers will buy whatever widgets enter the market. Once the imported + domestic supply of widgets in Japan reaches QS2 then the tariff will no longer be necessary to protect Japan's industry since market forces will cause the domestic and world prices to become equal and the market price will be enough for Japan's widget manufacturers to stay in business.
Disadvantages of tariffs
The chart at the right analyzes the effect of the imposition of an import tariffTariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
on some imaginary good. Prior to the tariff, the price of the good in the world market (and hence in the domestic market) is Pworld. The tariff increases the domestic price to Ptariff. The higher price causes domestic production to increase from QS1 to QS2 and causes domestic consumption to decline from QC1 to QC2. 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.
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.
Trade diversion
According to mainstream economicMainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...
theory, the selective application of free trade agreements to some countries and tariffs on others can sometimes lead to economic inefficiency
Efficiency (economics)
In economics, the term economic efficiency refers to the use of resources so as to maximize the production of goods and services. An economic system is said to be more efficient than another if it can provide more goods and services for society without using more resources...
through the process of trade diversion
Trade diversion
Trade diversion is an economic term related to international economics in which trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade agreement or a customs union.-Occurrence:...
. 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
Doha round
The Doha Development Round or Doha Development Agenda is the current trade-negotiation round of the World Trade Organization which commenced in November 2001. Its objective is to lower trade barriers around the world, which will help facilitate the increase of global trade...
.
Opinion of advocacy groups
The Freedom to Trade coalition argues that:
"Protectionism creates poverty, not prosperity. Protectionism doesn't even "protect" domestic jobs or industries; it destroys them, by harming export industries and industries that rely on imports to make their goods. Raising local prices of steel by "protecting" local steel companies just raises the cost of producing cars and the many other goods made with steel. Protectionism is a fool's game."
Opinion of economists
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.In a 2006 survey of American economists (83 responders), "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."
Quoting Harvard economics professor N. Gregory Mankiw
N. Gregory Mankiw
Nicholas Gregory "Greg" Mankiw is an American macroeconomist and Professor of Economics at Harvard University. Mankiw is known in academia for his work on New Keynesian economics....
, "Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards." Nonetheless, quoting Prof. Peter Soderbaum of Malardalen University, Sweden, "This neoclassical trade theory focuses on one dimension, i.e., the price at which a commodity can be delivered and is extremely narrow in cutting off a large number of other considerations about impacts on employment in different parts of the world, about environmental impacts and on culture."
Most free traders would agree that although increasing returns to scale might mean that certain industry could settle in a geographical area without any strong economic reason derived from comparative advantage, this is not a reason to argue against free trade because the absolute level of output enjoyed by both "winner" and "loser" will increase with the "winner" gaining more than the "loser" but both gaining more than before in an absolute level.
Despite this, some economists do exist who dispute the benefits of free trade, or question their extent. One long-standing economic critique of free trade is the infant industry argument
Infant industry argument
The Infant industry argument is an economic rationale for trade protectionism. The core of the argument is that nascent industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar...
. The argument advances that protectionism is frequently required in order to allow the growth of nascent industries, as their competitors will already be employing significant economics of scale by virtue of their size or other factors after a long period of growth. Reliant on this critique is the import substitution industrialization form of protectionism.
Opposition
The relative costsSocial cost
Social cost, in economics, is generally defined in opposition to "private cost". In economics, theorists model individual decision-making as measurement of costs and benefits...
, benefits and beneficiaries of free trade are debated by academics, governments and interest groups.
Arguments for protectionism fall into the economic category (trade hurts the economy) or the moral category (the effects of trade might help the economy, but have ill effects in other areas); a general argument against free trade is that it is colonialism
Colonialism
Colonialism is the establishment, maintenance, acquisition and expansion of colonies in one territory by people from another territory. It is a process whereby the metropole claims sovereignty over the colony and the social structure, government, and economics of the colony are changed by...
or imperialism
Imperialism
Imperialism, as defined by Dictionary of Human Geography, is "the creation and/or maintenance of an unequal economic, cultural, and territorial relationships, usually between states and often in the form of an empire, based on domination and subordination." The imperialism of the last 500 years,...
in disguise. The moral category is wide, including concerns of income inequality, environmental degradation
Environmental degradation
Environmental degradation is the deterioration of the environment through depletion of resources such as air, water and soil; the destruction of ecosystems and the extinction of wildlife...
, supporting child labor
Child labor
Child labour refers to the employment of children at regular and sustained labour. This practice is considered exploitative by many international organizations and is illegal in many countries...
and sweatshops, race to the bottom
Race to the bottom
A race to the bottom is a socio-economic concept that is argued to occur between countries as an outcome of regulatory competition, progressive taxation policies and social welfare spending...
, wage slavery
Wage slavery
Wage slavery refers to a situation where a person's livelihood depends on wages, especially when the dependence is total and immediate. It is a negatively connoted term used to draw an analogy between slavery and wage labor, and to highlight similarities between owning and employing a person...
, accentuating poverty
Poverty
Poverty is the lack of a certain amount of material possessions or money. Absolute poverty or destitution is inability to afford basic human needs, which commonly includes clean and fresh water, nutrition, health care, education, clothing and shelter. About 1.7 billion people are estimated to live...
in poor countries, harming national defense
Defense (military)
Defense has several uses in the sphere of military application.Personal defense implies measures taken by individual soldiers in protecting themselves whether by use of protective materials such as armor, or field construction of trenches or a bunker, or by using weapons that prevent the enemy...
, and forcing cultural change.
Free trade is often opposed by domestic industries that would have their profits and market share reduced by lower prices for imported goods. For example, if United States tariffs on imported sugar were reduced, U.S. sugar producers would receive lower prices and profits, while U.S. sugar consumers would spend less for the same amount of sugar because of those same lower prices. The economic theory of David Ricardo holds that consumers would necessarily gain more than producers would lose. Since each of those few domestic sugar producers would lose a lot while each of a great number of consumers would gain only a little, domestic producers are more likely to mobilize against 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.
Socialists frequently oppose free trade on the ground that it allows maximum exploitation
Exploitation
This article discusses the term exploitation in the meaning of using something in an unjust or cruel manner.- As unjust benefit :In political economy, economics, and sociology, exploitation involves a persistent social relationship in which certain persons are being mistreated or unfairly used for...
of workers by capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
. For example, Karl Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...
wrote in The Communist Manifesto
The Communist Manifesto
The Communist Manifesto, originally titled Manifesto of the Communist Party is a short 1848 publication written by the German Marxist political theorists Karl Marx and Friedrich Engels. It has since been recognized as one of the world's most influential political manuscripts. Commissioned by the...
, "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." Nonetheless, Marx favored free trade solely because he felt that it would hasten the social revolution. To those who oppose socialism, this becomes an argument against free trade.
"Free trade" is opposed by many anti-globalization groups, based on their assertion that free trade agreements generally do not increase the economic freedom
Economic freedom
Economic freedom is a term used in economic and policy debates. As with freedom generally, there are various definitions, but no universally accepted concept of economic freedom...
of the poor or the working class, and frequently make them poorer. Where the foreign supplier allows de facto exploitation of labor, domestic free-labor is unfairly forced to compete with the foreign exploited labor, and thus the domestic "working class would gradually be forced down to the level of helotry." To this extent, free trade is seen as nothing more than an end-run around laws that protect individual liberty, such as the Thirteenth Amendment to the United States Constitution (outlawing slavery and indentured servitude). In this regard, protective trade policies are seen, not so much as protecting domestic producers, but rather, as protecting liberty itself. This argument actually comports with the economic analysis of Free Trade to the extent that "slavery and perfect competition equilibria are Pareto optimal." Thus, while admitting that some gain in efficiency might be realized in the short term by implementation of free trade policies, the long-term question of the cost of that efficiency in terms of loss of liberty remains.
It is important to distinguish between arguments against free trade theory, and free trade agreements as applied. Some opponents of NAFTA see the agreement as being materially harmful to the common people, but some of the arguments are actually against the particulars of government-managed trade, rather than against free trade per se. For example, it is argued that it would be wrong to let subsidized corn from the U.S. into Mexico freely under NAFTA at prices well below production cost (dumping
Dumping (pricing policy)
In economics, "dumping" is any kind of predatory pricing, especially in the context of international trade. It occurs when manufacturers export a product to another country at a price either below the price charged in its home market, or in quantities that cannot be explained through normal market...
) because of its ruinous effects to Mexican farmers. Of course, such subsidies violate free trade theory, so this argument is not actually against the principle of free trade, but rather its selective implementation.
Latin America performed poorly since tariff cuts in 1980s and 1990s, compared to protectionist China and Southeast Asia. According to Samuelson
Paul Samuelson
Paul Anthony Samuelson was an American economist, and the first American to win the Nobel Memorial Prize in Economic Sciences. The Swedish Royal Academies stated, when awarding the prize, that he "has done more than any other contemporary economist to raise the level of scientific analysis in...
, it is wrong to assume a necessary surplus of winnings over losings. The paper, "Will inventions A or B lower or raise the new market-clearing real wage rates that sustain high-to-full employment" condemned "economists' over-simple complacency about globalization" and said that workers don't always win. Some economists try to emphasize that trade barriers should exist to help poor nations build domestic industries and give rich nations time to retrain workers.
Colonialism
It has long been argued that free trade is a form of colonialism or imperialism, a position taken by various proponents of economic nationalismEconomic nationalism
Economic nationalism is a term used to describe policies which emphasize domestic control of the economy, labor and capital formation, even if this requires the imposition of tariffs and other restrictions on the movement of labor, goods and capital. It opposes globalization in many cases, or at...
and the school of mercantilism
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
. In the 19th century these criticized British calls for free trade as cover for British Empire
British Empire
The British Empire comprised the dominions, colonies, protectorates, mandates and other territories ruled or administered by the United Kingdom. It originated with the overseas colonies and trading posts established by England in the late 16th and early 17th centuries. At its height, it was the...
, notably in the works of American Henry Clay
Henry Clay
Henry Clay, Sr. , was a lawyer, politician and skilled orator who represented Kentucky separately in both the Senate and in the House of Representatives...
, architect of the American System and by German American
German American
German Americans are citizens of the United States of German ancestry and comprise about 51 million people, or 17% of the U.S. population, the country's largest self-reported ancestral group...
economist Friedrich List
Friedrich List
Georg Friedrich List was a leading 19th century German economist who developed the "National System" or what some would call today the National System of Innovation...
.
More recently, Ecuador
Ecuador
Ecuador , officially the Republic of Ecuador is a representative democratic republic in South America, bordered by Colombia on the north, Peru on the east and south, and by the Pacific Ocean to the west. It is one of only two countries in South America, along with Chile, that do not have a border...
ian President Rafael Correa
Rafael Correa
Rafael Vicente Correa Delgado born is the President of the Republic of Ecuador and was the president pro tempore of the Union of South American Nations. An economist educated in Ecuador, Belgium and the United States, he was elected President in late 2006 and took office in January 2007...
has denounced the "sophistry of free trade" in an introduction he wrote for a book titled The Hidden Face of Free Trade Accords, written in part by Correa's current Energy Minister Alberto Acosta. Citing as his source the book Kicking Away the Ladder, written by Ha-Joon Chang
Ha-Joon Chang
Ha-Joon Chang is one of the leading heterodox economists and institutional economists specialising in development economics...
, 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." According to Correa, Chang showed that it was Treasury Secretary Alexander Hamilton
Alexander Hamilton
Alexander Hamilton was a Founding Father, soldier, economist, political philosopher, one of America's first constitutional lawyers and the first United States Secretary of the Treasury...
, and not Friedrich List
Friedrich List
Georg Friedrich List was a leading 19th century German economist who developed the "National System" or what some would call today the National System of Innovation...
, who was the first to present a systematic argument defending industrial protectionism.
Alternatives
The following alternatives for free trade are proposed: balanced tradeBalanced 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....
, fair trade
Fair trade
Fair trade is an organized social movement and market-based approach that aims to help producers in developing countries make better trading conditions and promote sustainability. The movement advocates the payment of a higher price to producers as well as higher social and environmental standards...
, protectionism
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...
and Tobin tax
Tobin tax
A Tobin tax, suggested by Nobel Laureate economist James Tobin, was originally defined as a tax on all spot conversions of one currency into another...
.
See also
Concepts/topics:- ProtectionismProtectionismProtectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...
- Free trade areaFree trade areaA free trade area is a trade bloc whose member countries have signed a free trade agreement , which eliminates tariffs, import quotas, and preferences on most goods and services traded between them. If people are also free to move between the countries, in addition to FTA, it would also be...
- Free trade debateFree trade debateFree trade is one of the most debated topics in economics of the 19th, 20th, and 21st century. Arguments over free trade can be divided into economic, moral, and socio-political arguments. The academic debate among economists is currently settled in favor of free trade, with a consensus having...
- Free trade zoneFree trade zoneA free trade zone or export processing zone , also called foreign-trade zone, formerly free port is an area within which goods may be landed, handled, manufactured or reconfigured, and reexported without the intervention of the customs authorities...
- Fair tradeFair tradeFair trade is an organized social movement and market-based approach that aims to help producers in developing countries make better trading conditions and promote sustainability. The movement advocates the payment of a higher price to producers as well as higher social and environmental standards...
- International tradeInternational tradeInternational trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
- Trade barrierTrade barrierTrade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following:* Tariffs* Non-tariff barriers to trade** Import licenses** Export licenses** Import quotas** Subsidies...
- Trade warTrade warA trade war refers to two or more states raising or creating tariffs or other trade barriers on each other in retaliation for other trade barriers...
- Dumping (pricing policy)Dumping (pricing policy)In economics, "dumping" is any kind of predatory pricing, especially in the context of international trade. It occurs when manufacturers export a product to another country at a price either below the price charged in its home market, or in quantities that cannot be explained through normal market...
- Trade war over genetically modified food
- Offshore outsourcingOffshore outsourcingOffshore outsourcing is the practice of hiring an external organization to perform some business functions in a country other than the one where the products or services are actually developed or manufactured. It can be contrasted with offshoring, in which the functions are performed in a foreign...
- OffshoringOffshoringOffshoring describes the relocation by a company of a business process from one country to another—typically an operational process, such as manufacturing, or supporting processes, such as accounting. Even state governments employ offshoring...
- Borderless SellingBorderless SellingBorderless selling is the process of selling services to clients outside the country of origin of services through modern methods which eliminate the actions specifically designed to hinder international trade...
- Balanced tradeBalanced tradeBalanced 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....
- Trade blocTrade blocA trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, are reduced or eliminated among the participating states.-Description:...
- MercantilismMercantilismMercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...
- Laissez-faireLaissez-faireIn economics, laissez-faire describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies....
- Economic globalizationEconomic globalizationEconomic globalization refers to increasing economic interdependence of national economies across the world through a rapid increase in cross-border movement of goods, service, technology and capital...
Trade organizations:
- General Agreement on Tariffs and TradeGeneral Agreement on Tariffs and TradeThe General Agreement on Tariffs and Trade was negotiated during the UN Conference on Trade and Employment and was the outcome of the failure of negotiating governments to create the International Trade Organization . GATT was signed in 1947 and lasted until 1993, when it was replaced by the World...
(GATT) - World Trade OrganizationWorld Trade OrganizationThe World Trade Organization is an organization that intends to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade , which commenced in 1948...
(WTO) - North American Free Trade AgreementNorth American Free Trade AgreementThe North American Free Trade Agreement or NAFTA is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement...
- Free Trade Area of the AmericasFree Trade Area of the AmericasThe Free Trade Area of the Americas , , ) was a proposed agreement to eliminate or reduce the trade barriers among all countries in the Americas but Cuba. In the last round of negotiations, trade ministers from 34 countries met in Miami, United States, in November 2003 to discuss the proposal...
(FTAA) - European Union