In the simplest of terms, free trade is the total absence of government policies restricting the import and export of goods and services. While economists have long argued that trade among nations is the key to maintaining a healthy global economy, few efforts to actually implement pure free-trade policies have ever succeeded. What exactly is free trade, and why do economists and the general public view it so differently?
Key Takeaways: Free Trade
- Free trade is the unrestricted importing and exporting of goods and services between countries.
- The opposite of free trade is protectionism—a highly-restrictive trade policy intended to eliminate competition from other countries.
- Today, most industrialized nations take part in hybrid free trade agreements (FTAs), negotiated multinational pacts which allow for, but regulate tariffs, quotas, and other trade restrictions.
Free Trade Definition
Free trade is a largely theoretical policy under which governments impose absolutely no tariffs, taxes, or duties on imports, or quotas on exports. In this sense, free trade is the opposite of protectionism, a defensive trade policy intended to eliminate the possibility of foreign competition.
In reality, however, governments with generally free-trade policies still impose some measures to control imports and exports. Like the United States, most industrialized nations negotiate “free trade agreements,” or FTAs with other nations which determine the tariffs, duties, and subsidies the countries can impose on their imports and exports. For example, the North American Free Trade Agreement (NAFTA), between the United States, Canada, and Mexico is one of the best-known FTAs. Now common in international trade, FTA’s rarely result in pure, unrestricted free trade.
In 1948, the United States along with more than 100 other countries agreed to the General Agreement on Tariffs and Trade (GATT), a pact that reduced tariffs and other barriers to trade between the signatory countries. In 1995, GATT was replaced by the World Trade Organization (WTO). Today, 164 countries, accounting for 98% of all world trade belong to the WTO.
Despite their participation in FTAs and global trade organizations like the WTO, most governments still impose some protectionist-like trade restrictions such as tariffs and subsidies to protect local employment. For example, the so-called “Chicken Tax,” a 25% tariff on certain imported cars, light trucks, and vans imposed by President Lyndon Johnson in 1963 to protect U.S. automakers remains in effect today.
Free Trade Theories
Since the days of the Ancient Greeks, economists have studied and debated the theories and effects of international trade policy. Do trade restrictions help or hurt the countries that impose them? And which trade policy, from strict protectionism to totally free trade is best for a given country? Through the years of debates over the benefits versus the costs of free trade policies to domestic industries, two predominant theories of free trade have emerged: mercantilism and comparative advantage.
Mercantilism is the theory of maximizing revenue through exporting goods and services. The goal of mercantilism is a favorable balance of trade, in which the value of the goods a country exports exceeds the value of goods it imports. High tariffs on imported manufactured goods are a common characteristic of mercantilist policy. Advocates argue that mercantilist policy helps governments avoid trade deficits, in which expenditures for imports exceeds revenue from exports. For example, the United States, due to its elimination of mercantilist policies over time, has suffered a trade deficit since 1975.
Dominant in Europe from the 16th to the 18th centuries, mercantilism often led to colonial expansion and wars. As a result, it quickly declined in popularity. Today, as multinational organizations such as the WTO work to reduce tariffs globally, free trade agreements and non-tariff trade restrictions are supplanting mercantilist theory.
Comparative advantage holds that all countries will always benefit from cooperation and participation in free trade. Popularly attributed to English economist David Ricardo and his 1817 book “Principles of Political Economy and Taxation,” the law of comparative advantage refers to a country’s ability to produce goods and provide services at a lower cost than other countries. Comparative advantage shares many of the characteristics of globalization, the theory that worldwide openness in trade will improve the standard of living in all countries.
Comparative advantage is the opposite of absolute advantage—a country’s ability to produce more goods at a lower unit cost than other countries. Countries that can charge less for its goods than other countries and still make a profit are said to have an absolute advantage.
Pros and Cons of Free Trade
Would pure global free trade help or hurt the world? Here are a few issues to consider.
5 Advantages of Free Trade
- It stimulates economic growth: Even when limited restrictions like tariffs are applied, all countries involved tend to realize greater economic growth. For example, the Office of the US Trade Representative estimates that being a signatory of NAFTA (the North American Free Trade Agreement) increased the United States’ economic growth by 5% annually.
- It helps consumers: Trade restrictions like tariffs and quotas are implemented to protect local businesses and industries. When trade restrictions are removed, consumers tend to see lower prices because more products imported from countries with lower labor costs become available at the local level.
- It increases foreign investment: When not faced with trade restrictions, foreign investors tend to pour money into local businesses helping them expand and compete. In addition, many developing and isolated countries benefit from an influx of money from U.S. investors.
- It reduces government spending: Governments often subsidize local industries, like agriculture, for their loss of income due to export quotas. Once the quotas are lifted, the government’s tax revenues can be used for other purposes.
- It encourages technology transfer: In addition to human expertise, domestic businesses gain access to the latest technologies developed by their multinational partners.
5 Disadvantages of Free Trade
- It causes job loss through outsourcing: Tariffs tend to prevent job outsourcing by keeping product pricing at competitive levels. Free of tariffs, products imported from foreign countries with lower wages cost less. While this may be seemingly good for consumers, it makes it hard for local companies to compete, forcing them to reduce their workforce. Indeed, one of the main objections to NAFTA was that it outsourced American jobs to Mexico.
- It encourages theft of intellectual property: Many foreign governments, especially those in developing countries, often fail to take intellectual property rights seriously. Without the protection of patent laws, companies often have their innovations and new technologies stolen, forcing them to compete with lower-priced domestically-made fake products.
- It allows for poor working conditions:Similarly, governments in developing countries rarely have laws to regulate and ensure safe and fair working conditions. Because free trade is partially dependent on a lack of government restrictions, women and children are often forced to work in factories doing heavy labor under grueling working conditions.
- It can harm the environment: Emerging countries have few, if any environmental protection laws. Since many free trade opportunities involve the exporting of natural resources like lumber or iron ore, clear-cutting of forests and un-reclaimed strip mining often decimate local environments.
- It reduces revenues: Due to the high level of competition spurred by unrestricted free trade, the businesses involved ultimately suffer reduced revenues. Smaller businesses in smaller countries are the most vulnerable to this effect.
In the final analysis, the goal of business is to realize a higher profit, while the goal of government is to protect its people. Neither unrestricted free trade nor total protectionism will accomplish both. A mixture of the two, as implemented by multinational free trade agreements, has evolved as the best solution.
Sources and Further Reference
- Baldwin, Robert E. "The Political Economy of U.S. Import Policy," Cambridge: MIT Press, 1985
- Hugbauer, Gary C., and Kimberly A. Elliott. "Measuring the Costs of Protection in the United States." Institute for International Economics, 1994
- Irwin, Douglas A. "Free Trade Under Fire." Princeton University Press, 2005
- Mankiw, N. Gregory. "Economists Actually Agree on This: The Wisdom of Free Trade." New York Times (April 24, 2015)
- Ricardo, David. "Principles of Political Economy and Taxation." The Library of Economics and Liberty
free trade, also called laissez-faire, a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports).What are the pros of free trade? ›
Free trade agreements don't just reduce and eliminate tariffs, they also help address behind-the-border barriers that would otherwise impede the flow of goods and services; encourage investment; and improve the rules affecting such issues as intellectual property, e-commerce and government procurement.What are the cons of free trade? ›
The disadvantages are twofold. If FTAs are not set up within the right framework of policies, they can diminish rather than enhance economic welfare. The second disadvantage is that they are not good vehicles for liberalising trade in sectors on which parties outside the agreement have a major influence.What are the pros and cons of trade barriers? ›
Advantages to trade protectionism include the possibility of a better balance of trade and the protection of emerging domestic industries. Disadvantages include a lack of economic efficiency and lack of choice for consumers.What is free trade definition pros and cons? ›
FTAs can force local industries to become more competitive and rely less on government subsidies. They can open new markets, increase gross domestic product (GDP), and invite new investments. FTAs can open up a country to degradation of natural resources, loss of traditional livelihoods, and local employment issues.What is free trade in a sentence? ›
Free trade is currently being touted as the panacea to both economic and political ills. Moreover, they effectively used the right to free trade as leverage to argue for their right to the city.What are the pros and cons of free trade quizlet? ›
- Pros. increased economic growth, lower gov spending, lower taxes.
- Cons. loss of jobs, poor working conditions, enviro issues.
- Protectionism. Economic policy of shielding an economy from imports.
- Why tariffs? to protect domestic products from competition.
Import tariff disadvantages
- Consumers bear higher prices. ...
- Raises deadweight loss. ...
- Trigger retaliation from partner countries.
It benefits countries in different ways. Its positive effects include introducing various products, services, ideas, technologies, etc. It also gives disadvantages like unhealthy competition for domestic entities, overdependence on foreign nations, overexploitation of human capital, environmental damages, etc.What are cons in trading? ›
- Easy losses. A lot of people think that trading is the simplest method of making money in the stock market, but it is also the easiest way of losing money. ...
- High tax liability. A tax liability is the sum of taxation that industry or an individual acquires based on current tax rules. ...
Opponents often assert that free trade invites foreign competition with domestic industries, causing job loss and harming key industries. In some cases, free trade cause manufacturers to move their operations to countries with fewer regulations, rewarding companies that cause pollution or use abusive labor practices.What is free trade essay? ›
The policy of free trade is one which does not impose any tariff or non-tariff restrictions upon free exchange of goods and services between the trading countries. Such a policy permits a country to buy and consume those goods, which it either cannot produce at all or can produce only at a higher cost.What is pros and cons advantages and disadvantages? ›
The pros and cons of something are its advantages and disadvantages, which you consider carefully so that you can make a sensible decision. They sat for hours debating the pros and cons of setting up their own firm. Motherhood has both its pros and cons.What are the advantages of pros and cons? ›
Weighing up pros and cons can speed up the decision-making process, improve your understanding of the situation, and help you avoid decision-making paralysis . Using a simple "pros" and "cons" list encourages you to approach your decision objectively, without letting your "gut feeling" impact your choice.What are examples of pros and cons? ›
- There are pros and cons to having children.
- I'm weighing the pros and cons of moving to another state.
- The pros and cons of using a laptop for work are debatable.
- The pros and cons of taking a day off work are clear.
- There are pros and cons to every decision we make in life.
Free trade emphasizes the need for less borders, restrictions, and tariffs on goods and services passing through countries and continents. Meanwhile, fair trade involves ensuring that the workers behind these goods and services are treated fairly and that human rights are maintained throughout the supply chain.What are 3 arguments for free trade? ›
Arguments for Free Trade
It allows goods and services to be produced more efficiently. That's because it encourages goods or services to be produced where natural resources, infrastructure, or skills and expertise are best suited to them. It increases productivity, which can lead to higher wages in the long term.
Free trade is a largely theoretical policy under which governments impose absolutely no tariffs, taxes, or duties on imports, or quotas on exports. In this sense, free trade is the opposite of protectionism, a defensive trade policy intended to eliminate the possibility of foreign competition.What is the definition of trade in economics? ›
Trade refers to the voluntary exchange of goods or services between economic actors. Since transactions are consensual, trade is generally considered to benefit both parties. In finance, trading refers to purchasing and selling securities or other assets.