The International Free Trade

Published Date: 02 Nov 2017

International trade could be explicated as a series of economic transactions that are carried out among various countries/economies. These transactions could relate to the trade of consumer goods, such as electronics, clothing and other durable and non-durable commodities, or could involve the exchange of capital goods such as machinery; and raw materials like minerals and metals. Further to this, international trade also entitles the exchange/trade of services, such as travel services and in present times customer services (call center services) etc. International trade transactions are facilitated by international financial institutes, in which both private and government financial sector like banks and lenders are involved, bearing a direct impact on a country’s economy.

International trading in essence acts as an aid to a country’s economy as, it provides a country with an opportunity to acquire those resources or commodities that it lacks in. in exchange, it gets to benefit from selling off those commodities that it has in abundance. Thus, international trade in collaboration with effective micro economic policies aids in raising the standards of living within an economy. In recent decades, international trade has been given a boast as globalization has become an emerging phenomenon. Essentially, globalization has made the world a boundary-less territory where cross-border trade has become a common practice.

International Free Trade

Successively, globalisation has demolished the global trade barriers and has reshaped the world economy to a great extent. This termination of trade barriers has given birth to the concept of international free trade. Free trade which is also referred to as "trade liberalization" is the opening up of economies. In a nut shell free trade is opening of trade opportunities for economies on non-discriminatory basis and with support from governments through elimination of tariffs, import quotas and other restrictions. However, free trade entitles the exchange of only goods and services and not of capital or labour.

According to Adam Smith, free trade is "that system of commercial policy which draws no distinction between domestic and foreign commodities and, therefore, neither imposes additional burdens on latter, nor grants any special favours to the former."

According to Jagdish Bagwati, "Fair trade policy involves complete absence of tarrifs, quotas, exchange restrictions, taxes and subsidies on production, factor use and consumption."

Such free trade policies or laissez-faire policy are generally introduced by bi-lateral and multi-lateral trade agreements among countries. Some examples of such collaborations are the various agreements under World Trade Organization (WTO), European Union (EU), Council of Arab Economic Unity (CAEU), Greater Arab Free Trade Area (GAFTA), Cooperation Council for the Arab States of the Gulf (CCASG) Asian Free Trade Area (AFTA), Central European Free Trade Agreement (CEFTA), Commonwealth of Independent States Free Trade Agreement (CISFTA), Common Market for Eastern and Southern Africa (COMESA), North American Free Trade Agreement (NAFTA), Central America Free Trade Agreement (CAFTA) etc.

Features of Free trade

Under fair trade the difference between domestic trade and international trade disappears.

Free access to markets

Free access to market information

Inability of firms to misrepresent markets through government -imposed monopoly or oligopoly power

Trade of goods without taxes or other trade barriers like import quotas or subsidies for producers.

Trade in services without taxes or other trade barriers

Absence of "trade-distorting" rules that give some companies or factors of production an advantage over others.

Free trade creates a natural course of trade flow and balance between the participating economies.

Theory of comparative advantage:

There is a popular story told amongst economists that once it was asked from Nobel laureate Paul Samuelson, to provide a meaningful and consequential result from the economics discipline, Samuelson quickly responded with, "comparative advantage."

Theory of Comparative Advantage refers to the ability of an individual, a firm, or a country to produce a particular good or service at a lower marginal cost and opportunity cost than another individual, firm or country. It explains how two or more parties involved in mutual trade can benefit even when one can produce all goods with fewer resources than the other. By the concentration of each party on production of one product in which they hold the comparative advantage over the other results in net benefits for both through mutual trade.

The classical theory of comparative advantage sometimes also known as comparative cost theory was first discussed by David Ricardo, an English political economist, in 1817, in his book 'Principles of Political Economy and Taxation'. Thus the model on which the theory is based upon is known as ‘Ricardian Model'.

Ricardian Model of Comparative Advantage:

Ricardian model require some stringent assumptions to be outlined to realize the full potential of this framework. Nonetheless, some of the underlying assumptions have a more profound foundation in theoretical context. That is, the empirical application of these assumptions is rather unrealistic.

Simplifying the assumptions from the model:

There exits perfect competition both in the product and factor market

Each of the economies has a fixed endowment of resources which are internally mobile but are not transportable internationally.

There exists homogenous and permanent technology, while only one input is needed for the production of the goods in question.

Invariable proceeds to scale exist.

There is no transportation cost and goods produced are consistent.

According to the classical theory of international trade, each economy strives to produce those commodities which bring about the maximum utilization of its accessible resources. Alongside this the production decision is dependent upon the adequateness of natural endowments climate, quality of soil, means of transport, capital, etc. Thus, the commodities which bring about maximization of resource utilization are produced in excess of economy’s internal demand. The surplus of such commodities is than traded with other economies, to attain commodities that could not be produced efficiently within the economy. Thus all economies seek to produce and export those commodities in which they have a cost advantage while import those commodities that could not be efficiently produced internally.

Under the theory of comparative advantage such trade policies provide mutual benefits to the participating economies.

Neo Classical economics and theory of comparative advantage:

Neoclassical economics pursues the study of human behavior in light of the demand and supply mechanism. This behavioral approach towards economic advantage is based upon subjective articulations of human psychologies. That is, a demand and supply relationship is built based on the subjective inclination of producers and consumers towards trade practices.

Neoclassical economics depart from the so-called objective value theory of classical economics, according to which the value of commodity could be determined in relation to some basic commodity or the labour input required to produce a good.

Neo-classicists anticipated that by creating subjectivity in the determination of prices and getting rid of objective value, one will be able to understand and predict economics more precisely following a scientifically accurate approach. Law of comparative advantage relates to neoclassical economists due to the common dependencies of supply and demand.

Keeping the neoclassical economics in context with the comparative theory of advantage, international free trade have got its advantages to a great extent in the global trade industry, however, in reality, free trade cannot be assumed to be fair trade.

Economic gap between developed and lesser developed countries:

Inevitably, free trade provides a moderately straight forward solution to creation of balance of trade advantages shared by economies participating in trade. Still, it has to be remembered that the comparative theory is based upon theoretical assumptions that are difficult to duplicate in the real world.

Further to this, a consideration when applying this framework to the real world is the disparity of natural endowments among economies. Such disparity in endowment of natural resources or factors, creates a consequential disequilibrium as free trade enables privileged economies to gain more from free trade than disadvantaged economies. This, in turn defies the concept of symmetrical free trade among the participating countries or economies.

This possible creation of disequilibrium calls for the formation of defined Free Trade Agreements to maintain economic balance globally. The principal example here is of the European Union, which is essentially the most economically active trader across the globe. The European Union has collaborated efforts to ensure that Free trade is encouraged among its members. The European Union is committed to facilitating liberalization of world trade in a manner that benefits both the rich and the under-privileged economies alike. It not only has trade ties among its member countries but also have international trade agreements with other non-European Union countries.

The operations of the European Union have been supported by a number of factors such as the use of a common currency, the Euro (€), in the region. Similarly, the added advantage of close proximity of countries and border sharing the countries also allows European countries to reap maximum benefits of free trade. Thus, European countries are able to concentrate on the products which gave them competitive advantage over the other. Now by means of the freedom and economic viability provided under the free trade agreements, products from one country are readily available in the other country. Further, economies/countries have increasingly, recognized their internal strengths and shifted concentration towards specialized production. This has thus proved that, such trade arrangements are positive for the involved economies and provide them with financial gains.

At the same time, free trade has given additional benefit to developing countries by means of comparative advantage mechanism. An apt example of this has been the shift of manufacturing industry from developed countries towards the developing countries. Developing countries such as, Poland and Czech Republic have claimed the manufacturing industry of developed economies such as France, by providing cheap labour and easy access to raw material. Renault's, a leading automobiles manufacturer has moved some of its production facility to Poland, just to benefit from lower costs. Thus, trade policies, under the umbrella of free trade agreements, tend to aid economic growth in developing countries. Conversely, such agreements also result in economic stagnancy in developed countries.

Taking a holistic view to these International Free Trade commitments shows that such arrangements do reduce the gap between the developed and the under developed countries to a certain extent.

But such a holistic approach and outcome is not always applicable as international free trade is not just limited to European Union. In time of recent financial adversity, European Union is fighting with a possible economic collapse. Empirically, developed economies are under constant pressure to maintain economic wellbeing in the region. However, they are increasingly, faced with adversities in the economic and political development in other developing countries such as, Greece.

Another grey area to look into is the role of multinational companies (MNCs) in utilizing the opportunities provided by free trade. MNCs are generally based in developed countries and tend to utilise the comparative advantage of the countries where they operate or manufacture. However, a common practice for MNC’s is to take the major portions of the gains back to the developed countries. Such operations of MNC’s create a potential disequilibrium in global economic dynamics. With plants and factories located in developing countries, MNC’s benefit from cheaper labor services and skills as well as gain access to readily and cheaply available, sources of raw materials. With clientele is around the globe, they gain revenue from around the globe. The revenues earned majorly go to the business stakeholders, who are mostly based in the developed countries. Although, multinational companies do bring job and revenue to the developing countries as they employee local labour force and purchase raw material from these countries but the margins of profit which go back to the developed countries are far greater.

These MNCs are sometime single company or at occasions monopolies, associations, unions, and alliances of companies with common aim of attain cost efficiencies. Since they are able to utilize relative strengths of different countries, they are able to achieve market dominance. As a consequence of this dominance, they are able to extort huge gains from the great difference between expenditure they pay for resources and services in the developing or under developed countries and profits they earn from their sales in the developing countries.

Conclusion:

In conclusion to the above discussion and in light of the present economic situation it is quite difficult to infer whether international free trade is being successful in narrowing the income gap between developed and developing countries. Empirically, the countries involved in trading do experience the advantages of free trade however; commonly it is usually the developed countries which are at the receiving end of greater profits.

To comprehensively understand the possible benefits of free trade, the neo-classic approach and the principal of comparative advantage theory are based upon more realistic assumptions. That is, a realistic framework should be operational that takes into account the actual factors that play a part in building up comparative advantage. Also, it is essential to evaluate the possible benefits that developing countries reap from free trade, such as higher employment rate, against the comparative financial gains that developed countries gain.

To ensure that an effective and flawless free trade mechanism is in place, it is essential that impartial and unbiased fair free trade agreements are put in place to ensure that the countries involved receive fair economic gains.