Free Trade

What It Means

Free trade in its ideal form refers to a situation in which all countries allow foreign goods and services to flow across national borders without imposing any restrictions, such as quotas (limitations on the amount of certain imported products) or tariffs (special taxes imposed on imported products). Free trade has almost certainly never existed in this form. Economists and politicians often use the term free trade when discussing the government’s role in international business.

International trade sounds like something that occurs between two nations, but in reality this trading most commonly takes the form of individual business transactions between members of different nations. For instance, anytime someone in the United States buys a watch made in Switzerland or a banana grown in Ecuador, he or she is participating in international trade. There are much more complex forms of international trade, but even in these cases governments primarily play only a regulatory role.

Although many governments support the notion that trade should become increasingly free in the world at large, all nations restrict imports to some degree, usually to protect certain domestic industries (domestic means that the industry is based in the home country). For instance, if the United States wants to protect domestic manufacturers of toothpaste, and if the U.S. government knows that manufacturers in India can produce high-quality toothpaste more cheaply than their American counterparts can, the government might impose a steep tariff on toothpaste originating in India. Indian toothpaste manufacturers, in order to compensate for the money lost to the tariff, must charge a higher price for their product in the United States, and American consumers will be more likely to buy American toothpaste than Indian toothpaste.

Economists today generally argue for increased freedom of international trade (that is, for a reduction, in most cases, of such restrictions as quotas and tariffs), believing that freedom from import restrictions usually benefits all countries that trade with one another. Economists also tend to claim that protecting an industry only postpones the problems that will eventually threaten that industry anyway. This overall relaxation of restrictions on international trade is what is usually meant when free trade is mentioned by the media and in politics.

Ordinary citizens in the United States and abroad are much more divided in their opinions about free trade than are economists, and the issue plays a large role in politics around the world. Because international trade is increasingly important to the economy in many countries today, the political decisions made about free trade have a great impact on individual businesses and workers, even if they do not realize it.

When Did It Begin

International trade has existed for as long as there have been organized states, kingdoms, and nations, but free trade in its ideal form has probably never existed. In fact, it was not until the late eighteenth century that economic thinkers began to take the idea of free trade seriously.

From the sixteenth century through the eighteenth century, European countries laid the groundwork for today’s capitalist economic system (in which most businesses are owned by private individuals and not the government) while adhering to trade policies outlined by a theory called mercantilism. Mercantilism argues that a nation’s economic strength is crucially tied to its possession of precious metals such as gold and that a country should make sure that it exports more goods than it imports, thereby stockpiling gold and guaranteeing its economic superiority.

It was not until 1776 that the first coherent argument against the mercantilist system emerged. That argument came in the form of the landmark work An Inquiry into the Nature and Causes of the Wealth of Nations by political economist and philosopher Adam Smith (1723–90). Among many other influential notions, Smith put forward the idea that a nation’s wealth should not be judged by the size of its gold stockpiles but by the goods and services to which the nation’s people have access. Smith also believed that the greatest good was achieved when each individual, acting in his own self-interest, was free to compete in the economic marketplace. By the nineteenth century these ideas had opened the door to a freer international exchange of goods and services than had ever been seen before.

More Detailed Information

Economists maintain that the free exchange of goods and services between the members of two countries nearly always benefits both countries in the long run. Because of differences in climate, geography, and the makeup of their populations (including such factors as skills and education), each country in the world brings different advantages to the global marketplace. If countries are able to trade freely with one another, all are able to benefit from their natural advantages while avoiding wastes of both money and time in the pursuit of business ventures to which they are not suited.

Because of the climate in the United States, for instance, growing bananas would cost more there than in Ecuador, and the bananas might also be inferior to those grown in a more naturally suitable tropical climate. American consumers save money by eating Ecuadorian bananas, and Ecuador enjoys a large U.S. market for its bananas, which it can produce very easily and expertly compared to other nations. Such adeptness in the production of a certain product is called an absolute advantage, one of the key principles economists talk about when explaining the benefits of free trade.

Absolute advantage does not explain all cases in which it may be beneficial for a nation to cease production of certain goods. Economists use a concept called comparative advantage to talk about another primary way in which free international trade naturally distributes the global workload efficiently.

To take a hypothetical example, suppose that U.S. workers were slightly better at producing electric fans than Taiwanese workers, but that U.S. workers could produce desk lamps that were many times better and cheaper than those produced by most other countries in the world. In this case, even though the United States can hold its own or better in electric-fan production, it has a comparative advantage in the field of desk-lamp production. Therefore, it would be more productive for the United States to allow the Taiwanese to assume the burden as well as the benefits of the electric-fan industry, while American time and energy are devoted to desk-lamp production. Put another way, the United States would need to give up relatively large amounts of desk lamps to produce a relatively small amount of electric fans. The benefits the United States derived from making desk lamps would be greater than the benefits from continuing to make both electric-fan and desk-lamp production together. Taiwan, meanwhile, would benefit in a more obvious way from acquiring a larger share of the electric-fan industry.

Great Britain offers a useful real-world illustration of the principle of comparative advantage. Great Britain no longer produces enough food to feed its population, but this is not because British farmers are incapable of doing so. It is true, however, that because of its climate, geography, and the nature of its population, Great Britain might never be a world agricultural leader. The British do, however, surpass most other countries in such industries as manufacturing, shipping, and finance, so it makes sense for them to focus on these industries (which represent its comparative advantages) while importing much of their food. Great Britain thus prospers more than it would by continuing to supply its own food, and those countries with comparative advantages in agriculture benefit by having an enlarged market for their farm produce. Every country, even the poorest and least productive ones, enjoy comparative advantage in some good or industry. Trade theory suggests that countries get the greatest benefit by specializing in those goods in which they have a comparative advantage.

In business, as in all areas of life, time and resources are never unlimited. A country, like an individual, must choose how to spend its time and resources most effectively, even if this means giving up a business at which it has excelled in the past. According to its proponents, free trade, by opening up all industries to competition with one another regardless of nationality, would result in ever-increasing degrees of business efficiency.

The reality of the economic changes produced by free international trade often seems messy, however. When confronted with the spectacle of a collapsed industry, individuals and even governments have trouble seeing the benefits of free trade.

For instance, the hundreds of thousands of American steelworkers who lost their jobs in the late twentieth century make a deeper and more vivid impression on most Americans than would any figures supplied by an economist to show why the industry’s decline was ultimately a positive development. Likewise, no doubt British farmers of a hundred years ago would be displeased with the country’s move away from agricultural production.

Partly for such emotional and cultural reasons, and partly because established industries tend to have great influence over politicians and government officials, all governments protect certain industries. There are also remnants of the mercantilist mindset even today. For instance, the belief that a country should export more than it imports remains widespread more than 200 years after Adam Smith convincingly refuted it.

Recent Trends

In the late twentieth and early twenty-first century, large numbers of people around the world became dissatisfied with their governments’ commitment to increasing free trade. These dissatisfied people were most visible to mainstream society when they participated in so-called antiglobalization protests. These protests, often organized to coincide with meetings of powerful international officials committed to increasing free trade, were part of a loosely organized social movement commonly referred to as the antiglobalization movement.

Some antiglobalization critics of free trade believe that free trade empowers corporations at the expense of ordinary citizens, especially citizens of developing countries (also called Third World countries). Other critics of globalization contend that free trade disproportionately favors rich nations such as the United States. They also argue that globalization in effect makes every nation more and more like the United States because many of the world’s most powerful corporations (examples include Coca-Cola, Microsoft, and Wal-Mart) have roots in the that country. Still other critics worry about the potential of ever-increasing business efficiency to trump all other concerns, such as cultural values, the health of ecosystems, and personal morality.

Meanwhile, the strongest U.S. opposition to free trade tends to arise regionally, in areas where large numbers of businesses have been shuttered as a result of international competition or the relocation of jobs to countries where labor is cheaper. This form of labor-oriented opposition to free trade continues to influence national politics, even though most economists agree that government intervention to preserve American jobs is not realistic in the long term.