Free trade

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Related terms: Free market laissez-faire International trade

Free trade is a market model in which the trade of goods and services between or within countries flows unhindered by government-imposed restrictions. These restrictions may increase costs to goods and services, producers, businesses, and customers, and may include taxes and tariffs, as well as other non-tariff barriers, such as regulatory legislation and quotas. Trade liberalization entails reductions to these trade barriers in an effort for relatively unimpeded transactions

One of the strongest arguments for free trade was made by classical economist David Ricardo in his analysis of comparative advantage. Comparative advantage explains how trade will benefit both parties (countries, regions, or individuals) if they have different opportunity costs of production.

Free trade can be contrasted with protectionism, which is the economic policy of restricting trade between nations. Trade may be restricted by high tariffs on imported or exported goods, restrictive quotas, a variety of restrictive government regulations designed to discourage imports, and anti-dumping laws designed to protect domestic industries from foreign take-over or competition.

Free trade is a term in economics and government that includes:

• trade of goods without taxes (including tariffs) or other trade barriers (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 taxes, subsidies, regulations or laws) that give some firms, households or factors of production an advantage over others
• Free access to markets
• Free access to market information
• Inability of firms to distort markets through government-imposed monopoly or oligopoly power
• The free movement of labor between and within countries
• The free movement of capital between and within countries

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

Contents 1 History of free trade 1.1 American opposition to free trade 1.2 Present day (U.S. based) 2 Economics of free trade 2.1 Trade diversion 3 Opponents of free trade 4 Alternatives to free trade 4.1 Fair Trade 4.2 Tobin Tax 4.3 Protectionism 4.4 Balanced trade 4.5 International barter 4.6 Increase the credit risk to international loans 4.7 International price floors 4.8 Separating world prices from domestic prices 4.9 Regional trading blocs 5 Miscellaneous 6 See also 7 References 8 External links

[edit] History of free trade

The history of international free trade is a history of international trade focusing on the development of open markets. It is known that various prosperous world civilizations throughout history have engaged in trade. Based on this, theoretical rationalizations as to why a policy of free trade would be beneficial to nations developed over time. These theories were developed in its academic modern sense from the commercial culture of England, and more broadly Europe, over the past five centuries. Before the appearance of Free Trade, and continuing in opposition to it to this day, the policy of mercantilism had developed in Europe in the 1500s. Early economists opposed to mercantilism were David Ricardo and Adam Smith.

Economists that advocated free trade believed trade was the reason why certain civilisations prospered economically. Adam Smith, for example, pointed to increased trading as being the reason for the flourishing of not just Mediterranean cultures such as Egypt, Greece, and Rome, but also of Bengal (East India) and China. The great prosperity of the Netherlands after throwing off Spanish Imperial rule, and declaring Free Trade and Freedom of thought, made the Free Trade/Mercantilist dispute the most important question in economics for centuries. Free trade policies have battled with mercantilist, protectionist, isolationist, communist, and other policies over the centuries.

Wars have been fought over trade, such as the Peloponnesian War between Athens and Sparta, the Opium Wars between China and Great Britain, and other colonial wars. All developed countries have used protectionism at some time, due to special interest pressure or, prior to the 19th century, a belief in mercantilism, but usually reduced it as they gained more wealth^[1].

[edit] American opposition to free trade

Beginning with 1st U.S. Secretary of the Treasury Alexander Hamilton's "Report on Manufactures", in which he advocated tariffs to help protect infant industries, including bounties (subsidies) derived in part from those tariffs, the United States was the leading nation opposed to "free trade" theory. Throughout the 19th century, leading statesmen of the U.S. including 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 1830's, 1840s, and 1850's in part over the issue of the tariff and protection of industry. The Democratic Party favored moderate tariffs and the Whig's favored higher protective tariffs which won the elections of 1840 and 1848 respectively. The leading economist in the United States at this time Henry Charles Carey became the leading proponent of the "American System" of economics. This system developed in opposition to the 'free trade' system which Carey referred to as the "British System," popularized and proposed by Adam Smith and advocated by the British Empire. Smith's book, "Harmony of Interests," outlined his economic philosophy, and combined together with German-American economist Friedrich List,(who also opposed the free trade system) to popularize the tariff and government taxation around Europe. The fledgling Republican Party led by Abraham Lincoln who called himself a "Henry Clay tariff Whig" strongly opposed free trade when formed and implemented at 44 percent tariff during the Civil War in part to pay for the building of the Union-Pacific Railroad, the war effort, and to protect American industry.^[2] President William McKinley stated the United States' stance under the Republican Party (which won every election for President until 1912, except the two non-consecutive terms of Grover Cleveland) 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."^[3]

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.

In the 1930s, the US adopted the protectionist Hawley-Smoot Tariff Act which raised rates to all time highs beyond the Lincoln levels, which some economists believe exacerbated the Great Depression while others disagree. In response the Democratic Party under Franklin D. Roosevelt resorted to Hamilton's earlier formula of Reciprocity with moderate tariffs coupled with subsidy to industry which went unbroken until the 1970s when the Free Trade era began for the United States after the Kennedy Round of trade talks in the late sixties were complete.

[edit] Present day (U.S. based)

Since the end of WWII, 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. government has 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).

[edit] Economics of free trade

The literature analysing the economics of free trade is extremely rich with extensive work having been done on the theoretical and empirical effects. Though it creates winners and losers, the broad consensus among members of the economics profession in the U.S. is that free trade is a large and unambiguous net gain for society.^{[4] [5]} 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."^[6] 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."^[7] 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." ^[8] Two simple ways to understand the benefits of free trade are through David Ricardo's theory of comparative advantage and by analyzing the impact of a tariff or import quota.

A simple economic analysis using the law of supply and demand and the economic effects of a tax can be used to show the theoretical benefits of free trade.^[9]

The chart at the right analyzes the effect of the imposition of an import tariff on some imaginary good. Prior to the tariff, the price of the good in the world market (and hence in the domestic market) is P^world. The tariff increases the domestic price to P^tariff. The higher price causes domestic production to increase from Q^S1 to Q^S2 and causes domestic consumption to decline from Q^C1 to Q^C2. This has three main effects on societal welfare. Consumers are made worse off because the consumer surplus (green region) becomes smaller. Producers are better off because the producer surplus (yellow region) is made larger. The government also has additional tax revenue (blue region). However, the loss to consumers is greater than the gains by producers and the government. The magnitude of this societal loss is shown by the two pink triangles. Removing the tariff and having free trade would be a net gain for society. ^[10][11]

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. ^[9]

[edit] Trade diversion

According to mainstream economic theory, global free trade is a net benefit to society, but the selective application of free trade agreements to some countries and tariffs on others can sometimes lead to economic inefficiency through the process of trade diversion. It is economically efficient for a good to be produced by the country which is the lowest cost producer, but this will not always take place if a high cost producer has a free trade agreement while the low cost producer faces a high tariff. Applying free trade to the high cost producer (and not the low cost producer as well) can lead to trade diversion and a net economic loss. This is why many economists place such high importance on negotiations for global tariff reductions, such as the Doha Round.^[9]

[edit] Opponents of free trade

Free trade is often opposed by domestic industries that would have their profits and market share reduced by lower prices for imported goods.^[12][13] For example, if United States tariffs on imported sugar were reduced, US sugar producers would receive lower prices and profits, while US sugar consumers would spend less for the same amount of sugar because of those same lower prices. Economics says that consumers would necessarily gain more than producers would lose.^[14][15] Since each of those few domestic sugar producers would lose a lot as an individual while each of a much greater number of consumers would gain only a little, domestic producers are more likely to mobilize against the lifting of tarrifs.^[13] 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.

Some socialists oppose free trade as a consequence of their exploitation theory and opposition to employment ("wage slavery"). E.g. 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."

Others oppose government managed trade, erroneously calling it free trade. Thus, "free trade" is opposed by many anti-globalization groups, based on their assertion that so-called Free Trade agreements generally do not increase the economic freedom of the poor, and frequently make them poorer. See perfect competition for the basis for this view of how Free Trade should work. For example, it is argued ^[16] that letting subsidized corn from the US into Mexico freely under NAFTA at prices well below production cost (dumping) is ruinous to Mexican farmers. Of course, such subsidies violate free trade, so this argument might better be seen as against subsides and for free trade, properly understood.

Some free trade economists have recently begun to express their own doubts concerning the concept and practice of free trade. Alan S. Blinder, for example, a professor of economics at Princeton University, and former Federal Reserve Board vice chairman and advisor to Democratic presidential candidates, had previously argued, along with most economists, that free trade enriches the U.S. and its trading partners. However, he now says new communication technology will put 30-40 million American jobs at risk in 10-20 years. Blinder has not completely rejected free trade or Ricardo's ideas about comparative advantage, but he advocates greater protection for displaced workers and an improved education system. Blinder opposed steel, aluminum and farming export subsidies and protection, and pushed for the passage of NAFTA, though he did not agree that it would create jobs in the US. Trade changes types of jobs, not the number, he said. Technology allowed Indians in call centers to do the work of Americans at lower wages. "Tens of millions of additional American workers will start to experience an element of job insecurity that has heretofore been reserved for manufacturing workers," said Blinder. Democrats and Republicans are becoming skeptical. The debate is, "Should government encourage forces of globalization or try to restrain them?" Latin America performed poorly since tariff cuts in 1980s and 1990s, compared to protectionist China and Southeast Asia. Paul Samuelson, in his 2004 essay^[17], condemned "economists' over-simple complacencies about globalization" and said that workers don't always win. Lawrence Summers, advocate for trade expansion as Clinton Treasury Secretary, said retraining is "pretty thin gruel" to the middle class. Ralph Gomory, former IBM chief scientist, says the rise of China and India could make the U.S. lose important industries. Harvard economist Dani Rodrik says trade barriers should help poor nations build domestic industries and give rich nations time to retrain workers. But Jagdish N. Bhagwati says jobs will grow in medicine, law and accounting. Blinder has created a list of "highly offshorable" jobs that could be lost in the next 20 years, which claims that 1,815,340 bookkeeping, accounting and auditing jobs could be lost. ^[18]

Ecuadorian President Rafael Correa has denounced the "sophistry of Free Trade," in an introduction he wrote for a book titled The Hidden Face of Free Trade Accords. One of the authors of that book is today Correa's Energy Minister, Alberto Acosta. Citing as his source the book, Kicking Away the Ladder, [3] written by a Korean economist based at Cambridge University, Ha-Joon Chang, Correa identified the difference between an "American system" opposed to "a British System" of free trade. The latter, he says, was explicitly viewed by the Americans as "part of the British imperialist system." Correa wrote that Chang showed that it was Treasury Secretary Alexander Hamilton, and not Friedrich List who was the first to present a systematic argument defending industrial protectionism. (Correa includes List's National System of Political Economy in his bibliographic references.)

[edit] Alternatives to free trade

[edit] Fair Trade

Main article: Fair Trade

Fair trade is an organized social movement and market-based approach that aims to alleviate global poverty and promote sustainability. The movement promotes the payment of a what it sees as a fair price as well as social and environmental standards in areas related to the production of a wide variety of goods. It focuses in particular on exports from developing countries to developed countries, most notably handicrafts, coffee, cocoa, sugar, tea, bananas, honey, cotton, wine, fresh fruit, and so on.

[edit] Tobin Tax

Main article: Tobin tax

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

[edit] Protectionism

Main article: Protectionism

Protectionism is the economic and political policy of protecting a country's economy through the imposition of tariffs, quotas, restrictions, border security, and other measures. Supporters of protectionism affirm that it prevents the distortion of the fragile wage and price structure by foreign dumping, unfair trade with undeveloped nations, labor arbitrage, illegal immigration, and other foreign interference in the domestic market.

Protectionism was a key tenet of Alexander Hamilton's economic program, which sought to protect the domestic economic system and wage and price structure from foreign competition. Some pro-administration newspapers called the Tariff Act of 1789, signed into law by President Washington on July 4 1789, the "second declaration of independence."

[edit] Balanced trade

Main article: Balanced trade

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

[edit] International barter

Some nations have prohibited trade under monetary terms of trade. For example, Hjalmar Schacht arranged barter for Nazi Germany to bypass the free market which he thought was rigged by Anglo-American capitalists.^[19] The former Soviet Union occasionally arranged bilateral barter within its sphere of influence. See Comprehensive Program for Socialist Economic Integration or Comecon. Arab League nations have also occasionally replaced monetary trade with barter.

[edit] Increase the credit risk to international loans

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

[edit] International price floors

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

[edit] Separating world prices from domestic prices

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

It is difficult for governments to sustain different internal prices over the long term. If the internal price is set below world prices, smugglers try to profit from the differential by illegally exporting the product to nations where they can sell it at a higher price. To the extent smugglers succeed, the domestic government is indirectly subsidizing foreign consumers. This problem has been vividly illustrated in nations where fuel prices are subsidized below world prices; domestic shortages frequently occur as a significant portion of the good is illegally smuggled out of the country. Rationing and black markets are stimulated by artificially low prices; in Iraq the famously long petrol pump queues for petrol at 50 dinars/litre can be bypassed by buying on the black market at 250 dinars/litre. Unofficial markets are a common problem wherever the "official" price is below (or above) the free trade price.^[20]

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

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

[edit] Regional trading blocs

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

[edit] Miscellaneous

The relative costs, benefits and beneficiaries of free trade are debated by academics, governments and interest groups. While the academic debate is essentially settled in favor of free trade, a number of arguments for and against in the ongoing public debate can be seen in the free trade debate article.

Depending on the specific context, use of the term free trade can signify one or more of the above conditions. However, it is fundamental that only governments can restrict trade: they have the legal monopoly over the use of physical force to influence trade in a geographical area.

The term free trade has become very politically based, and it is not uncommon for so-called "free trade agreements" to impose additional trade restrictions. Such restrictions on trade are often due to domestic political pressure by powerful corporate, environmental or labor interest groups seeking special protections of their perceived interests.

Free trade agreements are a key element of customs unions and free trade areas. The details and differences of these agreements are covered in their respective articles.

[edit] See also

Concepts/topics

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

Trade organizations

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

Other lists

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

Criticism

• Lou Dobbs
• Anti-Globalism

Conservative Opposition to Free Trade

• Paleoconservatism
• Chronicles (magazine)
• The American Conservative
• John Birch Society
• Middle American News
• VDare
• Russell Kirk
• Paul Craig Roberts
• Pat Buchanan
• Thomas Fleming (author)
• Rockford Institute
• Rod Dreher
• Clyde N. Wilson
• Citizens' Informer

[edit] References

• Fair trade certification overview (2004). TransFair USA. February 18, 2007.

[edit] External links

• Foundation for Economic Education (FEE), one of the oldest free-market organizations in the United States.
• Freetrade.org, Center for Trade Policy Studies, Cato Institute
  • Freedom to Trade: Refuting the New Protectionism edited by Edward L. Hudgins (online version of the book)
• About.com's Pros & Cons of Free Trade Agreements
• Embracing the Challenge of Free Trade: Competing and Prospering in a Global Economy speech by Federal Reserve chairman Ben Bernanke
• Stop Calling It “Free Trade!”
• BBC News - The argument for free trade
• Guardian Unlimited - Food & Trade - Hunger in a world of plenty
• Free Trade as Ideology, by Edward Luttwak, August 1, 2001
• Why developing countries should liberalise trade
• Worried about a Recession? Don’t Blame Free Trade
• An article on free trade issues involving Canada and the United States from The Canadian Encyclopedia

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