Free Trade versus Protectionism

The mutual benefits that international trade can provide to all countries participating in it are obvious. To see how countries gain from trade, we can use a very simple example which involves only two countries. Because of the difference in their climatic conditions. one can produce oranges and the other apples. Without trade, people in each country would be restricted to the consumption of only one kind of fruit. With the free exchange of goods between them, they have the choice between oranges or apples.

Since countries have different quantities of various productive resources, it is neces­sary for them to distribute them among themselves. Thus, for example in country A, la­bour may be scarce and expensive, but capital is plentiful, while in country B it may be the other way round. It will then be natural for country A to utilise the cheap labour of country B, and for country B to make use of country A’s surplus capital. This makes it easy to see how specialization – more detailed division of labour – among nations becomes possible.

The advantages of trade make it possible for each nation to participate – in different de­grees – in the global production of goods. Japanese cars, Italian shoes, Swiss watches, and Russian vodka are available all over the world.

Despite the apparent benefits of international trade, governments have erected a variety of barriers to free trade over the years, so that economists sometimes seem to stand alone in their defense of the principle of free trade.

The major arguments against free trade are centred on the defense of some national in­terest: the protection of the country’s economy or the defense of the national security. The protection of the infant industry is a popular argument for protection. The idea is that the government should allow emerging industries to grow in a market protected from harsh international competition. Protectionism can be justified to a certain extent – on economic grounds – still it is not the best policy. Consumers will have to pay higher prices, and subsidies provided to the industries that the government wants to protect may be used inefficiently. Some European governments provide massive subsidies to many of their basic industries at a far higher cost than can be justified by the benefits.

Another argument for protection is the employment argument. Advocates of protection­ism argue that employment in certain industries is threatened by foreign imports, and it is the government’s duty to provide assistance to these industries by imposing protective tar­iffs or setting import quotas. But if we cut back on imports, then output and employment in our export industries will also fall in the long run. And worse, protection discourages workers and managers from adjusting to the realities of foreign competition.

Political considerations will often induce governments to impose embargoes. The prob­lem with embargoes is that they can easily backfire. An embargo may be almost as damag­ing to the country that imposes it as to the one on which it is imposed. The smaller a country – the more vulnerable it is to embargoes, while big nations are not very sensitive to them. More important, however, is the fact that effective embargoes are rare. Quite often nations disregarding these trade restrictions may benefit from an embargo against a country.

Despite the advantages that free trade can give and the difficulties that tariffs, quotas and embargoes can cause, most governments have imposed a vast number of restrictions on international trade around the world. The reason for this is that countries are not in the same economic situation, and they will formulate their policies in their own best interests. Thus, as long as there are economic inequalities and conflicting interests between the na­tions, the interpretation of the freedom of trade will be different.

Text 2.

The majority of economists believe in the comparative cost principle, which proposes that all nations will raise their living standards and real income if they specialize in the production of those goods and services in which they have the highest relative productivity. Nations may have an absolute or a comparative advantage in producing goods or services because of factors of production (notably raw materials), climate, division of labour, economies of scale, and so forth.

This theory explains why there is international trade between North and South, e.g. semiconductors going from the USA to Brazil, and coffee going in the opposite direction. But it does not explain the fact that over 75% of the exports of the advanced industrial countries go to other similar advanced nations, with similar resources, wage rates, and levels of technology, education, and capital. It is more a historical accident than a result of natural resources that the US leads in building aircraft, semiconductors, computers and software, while Germany makes luxury automobiles, machine tools and cameras.

However the economists who recommend free trade do not face elections every four or five years. Democratic governments do, which often encourages them to impose tariffs and quotas in order to protect what they see as strategic industries – notably agriculture – without which the country would be in danger if there was a war, as well as other jobs. Abandoning all sectors in which a country does not have a comparative advantage is likely to lead to structural unemployment in the short (and sometimes medium and long) term.

Other reasons for imposing tariffs include the following:

  • To make imports more expensive than home-produced substitutes, and thereby reduce a balance of payments deficit;
  • As a protection against dumping (the selling of goods abroad at below cost price in order to destroy or weaken competitors or to earn foreign currency to pay for necessary imports);
  • To retaliate against restrictions imposed by other countries.
  • To protect infant industries until they are large enough to achieve economies of scale and strong enough to compete internationally.

With tariffs, it is impossible to know the quantity  that will be imported, because prices might be elastic. With quotas, governments can set a limit to imports. Yet unlike tariffs, quotas provide no revenue for the government. Other non-tariff barriers that some countries use include so-called safety norms, and the deliberate creation of customs difficulties and delays.

The General Agreement on Tariffs and Trade (GATT) had the objectives of encouraging international trade, of making tariffs the only form of protectionism, and of reducing these as much as possible. The most favoured nation clause of the GATT agreement specified that countries could not have favoured trading partners, but had to grant equally favourable conditions to all trading partners. The successor of GATT is the World Trade Organization.

It took nearly 50 years to arrive at the final GATT agreement because until the 1980s, most developing countries opposed free trade. They wanted to industrialize in order to counteract what they rightly saw as an inevitable fall in commodity prices. They practised import substitution (producing and protecting goods that cost more than those made abroad), and imposed high tariff barriers to protect their infant industries.

Nowadays, however, many developing countries have huge debts with Western commercial banks on which they are unable to pay the interest, let alone repay the principal. Thus they need to rollover (or renew) the loans, to reschedule (or postpone) repayments, or to borrow further money from the International Monetary Fund, often just to pay the interest on existing loans. Under these circumstances, the IMF imposes severe conditions, usually including the obligation to export as much as possible.

Quite apart from IMF pressure. Third World governments are aware of the export successes of the East Asian ‘Tiger’ economies (Hong Kong, Singapore, South Korea and Taiwan), and of the collapse of the Soviet economic model. They were afraid of being excluded from the world trading system by the development of trading blocks such as the European Union, finalized by the Maastricht Treaty, and the North American Free Trade Agreement (NAFTA), both signed in the early 1990s. So they tended to liberalize their economies, lowering trade barriers and opening up to international trade.