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A Closer Look at the Pros and Cons of Free Trade

written by: •edited by: Linda Richter•updated: 8/8/2011

Free trade brings advantages to the international community by enabling countries to specialize in certain goods and services and increase their productivity. Free trade also brings problems for domestic industries by increasing competition and increasing business risk.

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    Advantages of Free Trade

    Free trade is the term given to trade between nations that takes place without the imposition of barriers in the form of tariffs, quotas or other measures by governments or international organizations. Free trade is generally considered by economists to be beneficial to international trade by encouraging competition, innovation, efficient production and consumer choice. There are some arguments against international trade that often lead to political pressure to impose barriers to trade with the aim of protecting domestic industries and the jobs of workers in those industries.

    International trade also means that consumers in a particular country have a wider choice of goods, as they find imported as well as domestic goods on display in the shops. Domestic businesses may also have a chance to reduce costs by buying imported raw materials from abroad or importing new technology. Both individuals and businesses may have access to imported products that do not exist on the domestic market and would not be available without international trade.

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    The theory of comparative advantage first put forward by David Ricardo in the first part of the nineteenth century demonstrated that countries may boost their production by specializing in those industries for which their opportunity cost is lower than for their competitors. By engaging in international trade, countries may then export those goods or services that they are most efficient in producing and import the items which other countries may produce more efficiently.

    By concentrating on certain industries, it may be possible for countries and the firms operating in their territory to build up economies of scale that lower their costs and boost productivity. Generally, larger organizations may compete more efficiently on the international market by keeping control over their costs of production and managing their supply chain to reduce transport and inventory costs. International trade increases competition as domestic industries must compete with foreign firms in the same industry as well as other firms in their own country. This compels domestic industries to look for ways to keep costs down by operating more efficiently. This gives them an incentive to innovate and look for improved products, processes and marketing methods. This constant search for new ideas and technology enables them to compete on the international market.

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    Disadvantages of Free Trade

    International trade also involves some risks for a country because the international market conditions are out of the control of any government and are often unpredictable and liable to fluctuation. As the terms of trade change, a particular industry in a country can fall into decline, resulting in factory closures and unemployment. The labor market is not fully flexible, and workers may have difficulty retraining for other industries or moving to other locations to find work. Structural unemployment may therefore cause problems for a country’s economy.

    Free Trade A country may become too dependent on the export of a particular commodity; this leaves the economy vulnerable to fluctuations in the price of that commodity. This is often the case with former colonies that were compelled to cultivate a limited number of crops such as cereals or mine for a particular metal. The price of agricultural products or minerals on the global market fluctuates greatly with changes in international supply and demand which are outside the control of the producer countries.

    The distribution of income between countries may be more uneven as a result of international trade, because some countries will be able to take advantage of natural resources, skilled workforce or economies of scale to sell their goods and services internationally on favorable terms. Within each particular country, international trade may increase the gap between rich and poor because those who benefit most from international trade may be the rich elites who own the main assets of the country.

    For individual firms trading internationally, the business risks are increased. They are exposed to the risk of falls in demand as a result of changes in taste or fashion and problems resulting from the introduction of new technology or more efficient processes by their international competitors. Credit risks can be high and the cost of borrowing may increase unexpectedly, making such firms uncompetitive.

    Countries often need to become part of a larger trading bloc to obtain favorable terms of trade internationally, but such economic benefits may come at the cost of a loss of sovereignty, as important decisions affecting the national economy are made by the international trading bloc rather than by its individual members. The inflow of international goods into a country may cause other problems such as an erosion of the national culture.

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    Arguments for Protectionism

    Protectionism Protectionism is still common in the modern world, though it is sometimes disguised in the form of other measures such as health and safety. Countries sometimes argue that tariff barriers are necessary to protect their infant or pioneer industries that have not yet grown large enough to benefit from economies of scale and compete on the international scene. Tariff barriers increase the costs of imports, making them uncompetitive. The danger of such protection of domestic industries is that they have no incentive to innovate and become more efficient, remaining uncompetitive and in need of protection indefinitely.

    Governments may alternatively argue that tariff or quota barriers are necessary to protect domestic employment. They may be reluctant to allow declining industries to disappear because the resulting unemployment problem among former workers in those industries may be difficult to deal with. However, one might argue that in this case subsidies or other government support might be preferable to setting up tariff barriers, as these might enable the industries to innovate and become competitive again. This also preserves choice for the domestic consumers who would still have access to imported goods at a reasonable price.

    Other arguments put forward for protectionism include the need to keep strategic industries such as defense or space technology under national control. Another argument put forward is that tariff barriers discourage the dumping of foreign goods on the domestic market at low prices. Generally, however, it may be said that there are alternative ways of achieving these goals.

References

  • "Economics" by Alain Anderton, 5th edition, Pearson Education 2009

    "Economics - course companion" by Jocelyn Blink and Ian Dorton, Oxford University Press, 2007

    Image credits: click on morguefile:  industry and factory