free trade

free trade. The basic tenet of the theory of international trade is that free trade, which is the absence of any artificial restrictions on the level or composition of trade or the price at which commodities are exchanged, represents the superior form of organization in international markets. Free trade assumes a state of perfect competition. Departure from free trade in the form of protection introduces distortions in the operation of markets which add to costs, fragment production, reduce competition, and allow excess profits.

There are, however, very few examples of any country following a free trade policy, Victorian Britain constituting a notable exception. The repeal of the Corn Laws in 1846 brought a shift in political perceptions, although not an immediate substantive reduction in tariffs, by removing the protection traditionally given to agriculture in favour of securing cheap imported food for the industrial areas. (See protectionism.) This established the principle of free trade, the Navigation Acts were repealed in 1849, and all remaining protectionist regulations disappeared in 1860. The anomaly of the British adoption of free trade, by contemporary international standards, is a reflection of the unusual economic structure of the country. In the Victorian period the British economy was heavily dependent on international trade and finance, especially the latter, as massive overseas investment generated substantial ‘invisible earnings’ in returns on investment, insurance premiums, and earnings from transport services. No other country, before or since, has diverted such a large share of national income to overseas investment. Furthermore, British industry depended heavily on export markets. It was thus in the interests of the British economy that international trade flourished. Substantial invisible earnings meant that Britain could sustain a trade deficit, the value of exports being less than imports, without experiencing a balance of payments deficit because invisibles added to exports exceeded imports. This free trade policy stimulated world growth by allowing many countries to run a balance of trade surplus with Britain, effectively dumping on the British market.

This structure of trade and the free trade policy could only be sustained as long as the value of invisible earnings was maintained. In time this advantage would doubtless have been eroded, as other countries provided investment and shipping services. In fact, the First World War severely undermined the British balance of payments as overseas investments were sold to pay for the war and shipping earnings were much reduced as peacetime trade activity went into abeyance. The depressed state of the world economy in the 1920s further eroded the balance of payments as export industries found their markets diminished. The 1929–32 depression marked the end of the fixed exchange rate regime which had, effectively, been based on sterling underpinned by the balance of payments surplus. It also marked the end of free trade. In 1932 a general tariff was introduced imposing a 10 per cent import tax, but allowing preferential treatment to Commonwealth countries in return for concessions on British exports. Thus Britain adjusted to a policy of imperial preference, hoping to create a trading regime with the colonial and imperial territories, exchanging their raw materials for British goods.

After the Second World War, the General Agreement on Tariffs and Trade (GATT) was signed in 1948 to reduce tariff barriers. In 1995 it was replaced by the World Trade Organization. It was a primary objective of the European Economic Community to reduce tariffs between member states. See also European Free Trade Association.

Clive H. Lee