Reflective Thinking, Analytical Skills, Ethical Reasoning Free trade is a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports).
According to the law of comparative advantage the policy permits trading partners mutual gains from trade of goods and services. 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 tariffs, non-tariff barriers, such as regulatory legislation and import quotas, 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.The Main features of free trade are: ? 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 powerTrade barriers are government-induced restrictions on international trade. The barriers can take many forms, including the following: ? Tariffs ? Non-tariff barriers to trade 0 Import licenses 0 Export licenses 0 Import quotas 0 Subsidies 0 Voluntary Export Restraints 0 Local content requirements 0 Embargo 0 Currency devaluation Most trade barriers work on the same principle: the imposition of some sort of cost on trade that raises the price of the traded products. If two or more nations repeatedly use trade barriers against each other, then a trade war results.Economists generally agree that trade barriers are detrimental and decrease overall economic efficiency, this can be explained by the theory of comparative advantage.
In theory, free trade involves the removal of all such barriers, except perhaps those considered necessary for health or national security. In practice, however, even those countries promoting free trade heavily subsidize certain industries, such as agriculture and steel. Trade barriers are often criticized for the effect they have on the developing world.Because rich-country players call most of the shots and set trade policies, goods such as crops that developing countries are best at producing still face high barriers. Trade barriers such as taxes on food imports or subsidies for farmers in developed economies lead to overproduction and dumping on world markets, thus lowering prices and hurting poor-country farmers.
Tariffs also tend to be anti-poor, with low rates for raw commodities and high rates for labor-intensive processed goods.The Commitment to Development Index measures the effect that rich country trade policies actually have on the developing world. Another negative aspect of trade barriers is that it would cause a limited choice of products and would therefore force customers to pay higher prices and accept inferior quality. Many business surveys on trade barriers draw attention to the fact that tariffs continue to cause problems for companies, large and small, that wish to access foreign markets.
They also indicate that non-tariff barriers matter equally, if not more, with customs procedures and domestic regulations emerging as widely noted impediments. Furthermore less direct and visible procedural barriers can, by themselves, influence market access significantly. Because of their size, SMEs are in a vulnerable position in relation to trade barriers, which discourages internationalisation. Overcoming trade barriers requires significant investment in both time and resources.As a result, an SME may be unable or unwilling to fully engage and take advantage of available government consultation mechanisms and strategies for dealing with barriers in foreign markets, such as engaging trading partners in negotiations, launching legal proceedings or pursuing trade advocacy.
The economic case for an open trading system based on multilaterally agreed rules is simple enough and rests largely on commercial common sense. But it is also supported by evidence: the experience of world trade and economic growth since the Second World War.Tariffs on industrial products have fallen steeply and now average less than 5% in industrial countries. During the first 25 years after the war, world economic growth averaged about 5% per year, a high rate that was partly the result of lower trade barriers. World trade grew even faster, averaging about 8% during the period. Suppose country A is better than country B at making automobiles, and country B is better than country A at making bread.
It is obvious (the academics would say “trivial”) that both would benefit if A specialized in automobiles, B specialized in bread and they traded their products.That is a case of absolute advantage. But what if a country is bad at making everything? Will trade drive all producers out of business? The answer, according to Ricardo, is no. The reason is the principle of comparative advantage.
It says, countries A and B still stand to benefit from trading with each other even if A is better than B at making everything. If A is much more superior at making automobiles and only slightlysuperior at making bread, then A should still invest resources in what it does best — producing automobiles — and export the product to B.B should still invest in what it does best — making bread — and export that product to A, even if it is not as efficient as A. Both would still benefit from the trade.
A country does not have to be best at anything to gain from trade. That is comparative advantage. The theory dates back to classical economist David Ricardo. It is one of the most widely accepted among economists.
It is also one of the most misunderstood among non-economists because it is confused with absolute advantage.
