Free trade refers to the unregulated exchange of raw materials, commodities, and services among people and nations. One of the foundational propositions of economic theory since the seminal work of Adam Smith (1723–1790) is that free trade is ultimately superior to protectionism if the principal economic objective is the greatest possible quantity of aggregate wealth or national income, and, indeed, the greatest good for all people. This proposition has widely and regularly been subjected to theoretical and political critique, and, despite the contemporary resurgence in free trade economics, free trade remains far more a theoretical ideal than an actual mode of economic practice and organization.
Before Adam Smith published his exhaustive study, The Wealth of Nations, in 1776, the mercantilist argument for the protection of markets largely dominated economic literature and practice. The mercantilists composed their tracts during the seventeenth and eighteenth centuries, a period of tremendous colonial activity, trade growth, and, not coincidentally, nation-state formation. Mercantilists predictably celebrated foreign trade but also believed strongly in the need to protect national industries and markets. They supported a wide range of protectionist measures, including tariffs on imports and subsidies for exports.
While few, if any, of the central ideas in Smith’s Wealth of Nations are original—many were asserted and developed by French physiocrats and British moral philosophers—he made a case for free trade that was and to a considerable degree remains incomparable in its rhetorical persuasiveness, thoroughness, and analytic precision.
Among Smith’s contributions was the theoretical refutation of the mercantilist argument for the promotion of exports and discouragement of imports, especially manufactured imports. Smith argued that the economywide impact of trade policies and regulations had to be examined. For instance, high duties on imports that were produced more cheaply elsewhere tended to diminish domestic competition and promote expansion of an inefficient industry. For example, protecting the British textile industry from cheaper colonial imports would lead to more investment of labor and resources in a demonstrably inefficient sector of the economy. Without protections, resources could be allocated to industries that were more competitive on the world market and which would thus realize greater economic aggregate growth, also known as static gains from trade.
Full analyses of the economic benefits of the division of labor and the public benefits of private self-interest were among Smith’s foremost contributions to free trade economics. The rewards from the division of labor are implicit in his argument for static gains: Nations that specialize in industries in which they are most competitive in unregulated conditions make the most efficient use of their labor and productive resources; thus both the specializing nations and the nations with which they trade will benefit. In the long term, these specialization-based static gains lead to dynamic gains; though dynamic gains are less clearly defined and more difficult to measure, they potentially accrue through the general economic impact of the more efficient use of resources.
The powerful case for free trade submitted by Smith was made into prescriptive economic doctrine by the next generation of economists, who further developed what came to be labeled classical economics. The most well-known figure is David Ricardo (1772–1823), who is generally credited with the theory of comparative advantage —in short, the idea that even nations that lacked absolute advantage (producing goods at the least possible cost) could still realize gains by concentrating on production of goods of the greatest market competitiveness relative to other goods. Though Ricardo’s name is most frequently associated with this theory, scholars are now more prone to give credit to James Mill (1773–1836)—father of another great and influential economist, John Stuart Mill (1806–1873)—for developing the most comprehensive explanation of comparative advantage among the classical economists.
In response to a vigorous public debate regarding Britain’s protectionist Corn Laws, Mill explained that protectionist tariffs led to an absolute economic loss. Taxes on imported corn led to increases in the price of corn in Britain, which in turn led to an increase in the cultivation of less-productive land, which in turn increased the value and rent costs of land, which finally led to necessary wage increases. Thus, in protecting an inefficient product, a widespread set of increased costs ensued, netting a general or absolute loss. Resources would have been far better and more naturally invested in sectors of the economy that did not need to be protected because they were already competitive, or, in other words, sectors in which national comparative advantage already existed.
The doctrine of comparative advantage did much to establish free trade as the ruling economic orthodoxy for several succeeding generations of economists and, until the arrival of the Great Depression and the British economist John Maynard Keynes (1883–1946), it ruled economic theory (if not quite practice) with little exception. Two exceptions that received the most vigorous debate were related to “infant industries” and national defense. The infant industries argument proposed that new industries deserved some form of government protection until they had the chance to establish themselves as competitors in the global market. While his assertion was vigorously disputed, the idea was effectively made practice (to no small success) by Alexander Hamilton (1755/57–1804) in the early years of American national economic development. Also, in times of national emergency (e.g., war), interference in the workings of the free market was widely accepted as advisable. How, for instance, was supplying your enemy with goods for war to be justified? While wars may well be fought in the interests of the free market, the conditions and implications of war merit exception.
Whatever the sideline debates among economists regarding the particular cases for suspending the rules of free trade, it took the work of Keynes to establish a rigorous and widely accepted critique of free trade doctrine. Keynes, with considerable theoretical sophistication, faced the facts of the catastrophic market failure that goes by the name of the Great Depression and demonstrated the need to pursue protectionist measures. His General Theory of Employment, Interest, and Money (1936) included arguments for government spending on public works and promoting public investment and consumption during periods of high unemployment. Keynes did not believe that free market conditions realized, or “settled” at, full employment and that unemployment was a principal indicator of economic inefficiency. Government interventions in the market, including protective tariffs and subsidies, were, he asserted, sometimes necessary to restore employment and general economic health.
Keynes was enormously influential, not least in the United States, where his theories informed Franklin D. Roosevelt’s (1882–1945) massive government market intervention known as the New Deal. Toward the end of World War II (1939–1945), Keynes was a key figure at the meeting in Bretton Woods, New Hampshire, where two institutions were created that would come to dominate international economic relations in the later decades of the twentieth century: the International Monetary Fund (IMF) and the World Bank. However, these organizations, chartered under the banner of free trade principles, did not become important institutions of global economic management until after the cold war ended. Until the end of the cold war, the global free market was effectively compromised by the maneuverings of the superpowers as they intervened in the economic affairs of nations according to their particular national and ideological interests.
Since the cold war, the IMF and the World Bank, along with the World Trade Organization (WTO, established in 1995), have come to dominate the vigorous global articulation of free trade principles and practices. Throughout the cold war, developing nations were generally able to secure loans at very favorable terms, and banks were willing to lend freely under the assumption that bad loans would be covered by superpowers unwilling to see regimes fall to a competing ideology. When the cold war ended, the insecurity of these assumptions was revealed, and when bailouts were no longer forthcoming, debt crises struck developing nations hard. The World Bank and the IMF suddenly achieved a new relevance as they worked to negotiate debts no longer mediated by interested superpowers.
The terms demanded by the IMF and the World Bank for the renegotiations of loans were based firmly on free trade principles. These terms, which have been called structural adjustments, austerity measures, or conditionalities, have sparked spirited and sometimes violent debate. Nations, particularly the heavily indebted nations of Africa, Central and South America, and eastern Europe, in order to secure solvency loans, have been required to enact a host of free trade measures, including the devaluation of their currencies, removal of protective tariffs, reductions in public spending, and the privatization of key industries and services, including health care and education.
Those who dispute the effectiveness of these free trade conditions imposed on poorer countries argue that the “conditionalities” have never been fully practiced by the wealthy nations whose representatives dominate the IMF and World Bank. They point out that at no time during the critical years when the United States or Britain were developing their economies were their currencies devalued or key social support programs privatized. These critics can also point to the vivid and devastating consequences of reductions in public spending, particularly in the area of health care in Africa. For their part, the supporters of free trade doctrines can point to the indisputable economic growth of such major nations as India and China. In the early years of the twenty-first century, it was reliably estimated that one million people a month were being pulled out of poverty by China’s embrace of the free market.
Though the neoliberal globalization of the free market increased rapidly after the fall of the Soviet Union and the opening of China to trade, the intellectual roots for the reemergence of free trade were established decades earlier in Europe and the United States. Important figures include the Austrian economist Friedrich von Hayek (1899–1992), who argued, in works such as The Road to Serfdom (1944), that any centralized control over social and economic matters would inevitably lead to totalitarianism. Even more influential was the University of Chicago economist Milton Friedman (1912–2006). Friedman was largely responsible for the shift in academic economics away from Keynesian ideas and toward monetarism, or the idea that money supply rather then employment should be the focus of economic policies. While Friedman’s monetarist theories have proved of dubious value, his attacks on virtually all forms of government regulation or even involvement in social and economic life have been very influential indeed. Throughout the years of the Margaret Thatcher and Ronald Reagan (1911–2004) administrations in the 1980s, the deregulations advocated by Friedman and his followers were aggressively implemented, and they established the political basis for the free market orthodoxy that dominates national and international economic affairs even to this day.
In the first decade of the twenty-first century, the principles of free market globalization almost exclusively govern the economic practices of nations and the institutions that administer the world’s economy, most notably the IMF, the World Bank, and the WTO. However, there are movements of national exception in countries such as Venezuela and Bolivia and activist assertions of dissent such as that expressed in the 1999 WTO protests in Seattle. A strong body of evidence now exists that the current free market orthodoxy has been implemented in ways that violate its core principles of economic freedom. This is especially evident in the removal of barriers to capital flows on the one hand but the increasing restrictions on the movement of labor on the other hand. Thus the North American Free Trade Agreement (NAFTA), negotiated among Mexico, Canada, and the United States and implemented in 1994, greatly increased the ability of goods and capital to move across borders even as the increasing militarization of the U.S.–Mexico border has made it more difficult for workers to pursue preferred employments. It remains to be seen if the current expansion of free trade ideas and practices will help or hinder the aspiration for the greatest common good that runs as a consistent theme in the writings of the movement’s best thinkers.
SEE ALSO Absolute and Comparative Advantage; Capital Controls; Cold War; Corn Laws; Customs Union; Economics, International; Friedman, Milton; Globalization, Social and Economic Aspects of; Great Depression; Industrialization; Infant Industry; International Monetary Fund; Keynes, John Maynard; Liberalization, Trade; Mercantilism; Mill, James; Mill, John Stuart; Monetarism; Neoliberalism; New Deal, The; North American Free Trade Agreement; Philosophy, Moral; Physiocracy; Protectionism; Ricardo, David; Roosevelt, Franklin D.; Scottish Moralists; Smith, Adam; Tariffs; Trade; Washington Consensus; World Bank, The; World Trade Organization
Friedman, Milton.  2002. Capitalism and Freedom. Chicago: University of Chicago Press.
Keynes, John Maynard.  1997. The General Theory of Employment, Interest, and Money. Amherst, NY: Prometheus.
Polanyi, Karl. 1944 . The Great Transformation: The Political and Economic Origins of Our Time. Boston: Beacon.
Smith, Adam.  2000. The Wealth of Nations. New York: Modern Library.
Paul R. Krugman
Stephen A. Germic
Free Trade (Issue)
FREE TRADE (ISSUE)
Free trade was arguably one of the founding principles of the United States. The colonies grew up under the Mercantilist system of international commercial competition between the great trading nations of the time: the Dutch, the French, and the English. (By the eighteenth century Spain was already in decline as a trading nation.) The role of the colonies in a Mercantilist economy was to provide staple goods— agricultural commodities or raw materials like cotton—for the mother country; a market for finished goods produced by the mother country; and a tax base to help pay for the administrative and military costs of imperialism. Mercantilism, as practiced by the main commercial nations of Europe, required government granting of monopolies, government checking for "quality control" in the colonies' commercial products, government stipulation of trade routes, and government imposition of tariffs (import taxes).
Mercantilism was the opposite of the free trade system advocated by economist Adam Smith in the late eighteenth century. Adam Smith, in his brilliant summary of the free trade system, The Wealth of Nations (1776), argued that the government only got in the way of wealth creation under a capitalist economy. Much of what Smith said was true, but the inertia of government policy steered the colonial policy of the British Parliament in the direction of greater government intervention and regulation of the economy. The Navigation Acts of the late seventeenth century had already required the American merchant marine to channel its trade with Europe through English ports, where the goods were taxed.
After the exhausting Seven Years War (1754–1763), the Board of Trade in victorious England attempted to spread the costs the conflict among the colonies by taxing everything from sugar to stamps. It was this internal system of taxation that rankled the American commercial and consuming classes and moved the country in the direction of Revolution. But after the colonists won the revolution one of the first pieces of legislation to be passed by the first Congress in 1789 was a tariff act whose purpose was to raise revenue.
The debate between free trade or protectionism became one of the most contentious and long-standing issues in the politics in the new republic. It was central to the argument between the Federalists and the Republicans over economic policy. Alexander Hamilton (1755–1804) held an American mercantilist position— promoting, in his Report on Manufactures (1791), a policy of protective tariffs and federal subsidies to foster a domestic manufacturing base for the U.S. economy. James Madison (1751–1836) and Thomas Jefferson (1743–1826), who represented the dominant agricultural side of the economy, attacked Hamilton's farsighted reforms, arguing that any measure which increased the power of the central government would not be in the national interest.
Over the next century the leaders in the U.S. government espoused global free trade in principle, but in practice they raised trade barriers to protect import-sensitive sectors of the economy. Tariffs became an integral part of the conflict between the North and South that led to the American Civil War (1861–1865). In 1828 the Tariff of Abominations placed tariffs on almost every imaginable manufactured good. Southern politicians feared and resented the tariffs because they raised prices for goods that the South needed, and displayed the growing political power of the North—a development the South feared because it seemed to indicate a more powerful might impose further restrictions on slavery.
As the U.S. economy became more productive it encountered the problem of over-production. This meant that the domestic market could not absorb the goods that industry and agriculture were producing. The obvious solution was to encourage trade with the markets of other countries. But this could not be accomplished if the United States was maintaining high tariffs keeping other countries from penetrating the its market. Potential trading partners would simply raise their own tariff walls and foreign trade would wither. This became clear in 1930, early in the Great Depression (1929–1939). The agricultural sector of the U.S. economy had been in a depression for the better part of a decade when President Herbert Hoover (1929–1933) attempted to protect U.S. farmers from international competition through the Smoot-Hawley Tariff. Passed in 1930, the Smoot-Hawley Tariff raised the protective barrier to an average of 53 percent of the commodity price—an unheard of level. Hoover had hoped the bill would convince the commodity exchanges to buy domestic agricultural products. Instead, foreign governments retaliated with higher tariffs and quotas of their own. Foreign governments saw Smoot-Hawley as a hostile act, yet another symbol of U.S. isolationism. It provoked a global trade war, which led to a fall in the volume of international trade and resulted in national economies plummeting into a worldwide depression. Scholars estimate that, largely as a result of Smoot-Hawley, the value of world trade in 1933 was one-third what it was in 1929. This demonstrated the perils of protectionism and the virtue of free trade.
Hoover's successor to the presidency, Franklin D. Roosevelt (1933–1945), marked a turning point in U.S. trade policy. With the encouragement of the Secretary of State, Cordell Hull, Roosevelt pushed the Reciprocal Trade Agreements Act of 1934. For the first time in history the executive branch was given authority to reduce tariffs up to fifty percent if the other country reciprocated. Also for the first time, as a step in the direction of expanding global production and employment, the government engaged in continual bilateral negotiations to reduce trade barriers. U.S. trade negotiators signed about twenty-five bilateral trade agreements by the early 1940s. Despite the disruption of trade relations by World War II (1939–1945) the Roosevelt administration had begun the process of trade liberalization that continued with the United States serving as the dominant postwar global economic power.
By 1950 the United States had implemented a trade policy which favored Western Europe and Japan, with massive financial assistance to rebuild their war-torn economies. In the hope of integrating industrialized democracies into a stable and peaceful international economic order the United States gave Western Europe and Japan permission to protect their rebuilt industries with high tariffs against U.S. goods. The United States supported regional economic cooperation among Western European countries even though they maintained protective tariffs against U.S. exports. This free trade umbrella evolved into the European Economic Community and, eventually, in the 1990s, into the European Union. Meanwhile, successive U.S. administrations used trade policy as a foreign policy tool to contain the expansion of communism. Communist countries were excluded from the "free world's" trading system.
In the 1960s the John F. Kennedy (1961–1963) administration developed a plan to create a more integrated Atlantic Community. Using the concept of "trade or fade," the Kennedy administration pushed for the passage of the Trade Expansion Act of 1962, which authorized reciprocal across-the-board tariff cuts of up to fifty percent. It also authorized negotiations of total tariff elimination on a reciprocal basis when the United States and European Economic Community (EEC) made up at least eighty percent of world trade for a product. As a result, the Europeans and the United States signed an agreement that was the largest round of tariff cuts in history, about thirty-five percent globally.
The 1970s brought a new phase of international economic relations, with U.S. competitiveness decreasing despite the nation's continued political and military world hegemony. Observers expressed doubts about the soundness of a liberal trade policy as the nation's trade surplus continued to diminish. In 1971 the most powerful labor organizations in the United States, the American Federation of Labor-Congress of Industrial Organization (AFL-CIO), adopted a protectionist stance. The labor movement was losing members in droves as early as the 1960s due to deindustrialization, which business analysts attributed to the unwillingness of government policymakers to protect American industry from rising imports and increased overseas investments by U.S. corporations.
The pendulum swung back towards protectionism under President Richard M. Nixon (1969–1974). The Nixon administration brought protectionism back in full swing with the announcement of the New Economic Policy in 1971, which imposed a ten percent surcharge on all import duties and terminated the U.S. obligation to convert dollars held by foreign banks into gold at a fixed price. But the free-trade forces in Congress passed the Trade Act of 1974, which authorized the president to reduce tariffs.
The Trade Act of 1974 had two important and seemingly contradictory legacies. One was the completion of a Tokyo round of multilateral trade negotiations. Marking the decline of unilateral U.S. economic dominance, the industrialized nations indicated their intention to help the economies of less developed countries by authorizing "more favorable treatment" to these economies. Among other things, this meant facilitating increased investment in low wage economies.
Second, the Trade Act of 1974 gave more protection to U.S. interests desiring import relief, mostly from Japan and the newly industrializing nations of Korea, Singapore, Taiwan, and Hong Kong. The United States and the EEC practiced "the new protectionism," reaching a compromise between the protectionism of the 1930s and the internationalist trade liberalization of the 1960s.
During the 1980s Reaganomics had a substantive impact on U.S. trade policy. The Ronald Reagan (1981–1989) administration reduced taxes, brought about a rising budget deficit, and allowed the largest trade deficit in the nation's history. With the continued appreciation of the U.S. dollar many sectors of U.S. industry and agriculture were unable to compete in the international market.
In response, the Reagan administration attempted to increase exports rather than reduce imports. The United States introduced the policy of "reciprocity," a rejection of the U.S. postwar policy of ignoring what the administration considered other countries' unfair trade barriers. Reagan announced in 1985 that he would not "stand by and watch U.S. businesses fail because of unfair trading practices abroad." When other nations were unwilling to "voluntarily" reduce their trade barriers the United States threatened retaliation as it did with Japan and China in 1995.
In the 1990s the successive George Bush (1989–1993) and William Clinton (1993—) administrations concluded negotiations for the North American Free Trade Agreement, an historic accord establishing a free trade block between the United States, Canada, and Mexico. Even though the United States carved out a free trade system on the North American continent, it applied selective import restrictions for the rest of the world. While proclaiming its adherence to free trade policies the United States more often than not instituted protections against selected imports that undermined domestic industrial development. Thus, the United States has continually maintained a complicated and contradictory relationship between protectionism and free trade internationalism throughout its history.
See also: De-industrialization, Foreign Investment in the United States, Foreign Investment of U.S. Companies Abroad, Mercantilism, Protectionism, Report on Manufactures, Smoot-Hawley Tariff, Tariff
Blecker, Robert A., ed. U.S. Trade Policy and Global Growth: New Directions in the International Economy. Armonk, New York: M. E. Sharpe, 1996.
Cohen, Stephen D., Joel R. Paul, and Robert A. Blecker. Fundamentals of U.S. Foreign Trade Policy: Economics, Politics, Laws, and Issues. Boulder, CO: Westview Press, 1996.
Dudley, William. Trade: Opposing Viewpoints. San Diego, CA: Greenhaven Press, Inc., 1991.
Miller, Henri, ed. Free Trade Versus Protectionism. New York: The H.W. Wilson Company, 1996.
[t]he u.s. government espoused global free trade in principle, but in practice they raised trade barriers to protect import-sensitive sectors of the economy
FREE TRADE. The economic rationale for free trade lies in the principle that if trade is free, certain goods and services can be obtained at lower cost abroad than if domestic substitutes are produced in their place. The concept has each country producing for export those goods in which production is relatively efficient, thereby financing the import of goods that would be inefficiently produced at home. This comparative advantage in production between nations is expected to shift over time with changes in such factors as resource endowments and rates of technological advance. Free trade is therefore thought to facilitate the optimal use of economic resources: each country commands a higher level of consumption for a given level of resource use than would be otherwise possible. Advocates of tariff protection take exception to the doctrine on two fundamental bases: at times national goals other than maximized consumption must be served (for example, national defense), and the interests of specific groups do not parallel those of the nation as a whole. Thus, the history of tariffs and other barriers to free trade is a chronicle of shifting economic interests between industries and geographic areas.
Until 1808 the export of American farm and forest products to foreign markets was so profitable and imports were so cheap that there was little incentive to engage in manufacturing. Existing duties were low and designed for revenue rather than protection. War and embargo in the years 1808–1815 stimulated manufacturing (wool, cotton, iron); restoration of peace caused a flood of imports. Free trade then became a sectional issue, a strong protectionist movement developing in the middle and western states. Depression in 1819 and 1820 convinced workers that protection was necessary to save jobs from foreign competition, whereas farmers felt that building strong American industry would create higher demand and prices for farm goods. New England was divided between the manufacturing and the commercial interests, while the South solidly favored free trade because of its desire for cheap imports and fear of English retaliation against raw cotton imported from the United States.
By 1833 free-trade sentiment revived, as northern farmers, believing that young industries no longer needed protection, joined forces with John C. Calhoun and the South in an alliance that kept tariffs low until 1860. After the Civil War the protectionists controlled tariff policy for many years. Continued southern devotion to free trade and persistent, although wavering, low-tariff sentiment in the West produced only the short-lived horizontal duty reduction of 1872 and a few haphazard reductions in 1883. In the campaign of 1888 free-traders rallied around Grover Cleveland as the tariff for the first time became strictly a party issue. But the protectionists won again and passed the Tariff Act of 1890.
Popular hatred of monopoly—evidenced in the Sherman Antitrust Act of 1890—came to the support of free trade by implicating the tariff as "the mother of trusts." Cleveland won election in 1892 against the high-tariff Republicans, but the Democrats were torn over free silver and lost the opportunity to liberalize tariffs. However, continued antitrust feeling had bred such hostility to extreme protectionism that even the Republicans promised tariff reduction in the election of 1908. Sectional interests continued to thin the ranks of free-traders; the West and South demanded lower tariffs in general but supported the particular agricultural tariffs that served their interests in the Tariff Act of 1909.
Recurring economic crises, particularly the depressions of 1893–1897 and 1907–1908, further shook public confidence in the virtues of the "American system." Only the large industrial interests appeared to be consistently served by the cyclical pattern of economic growth (for example, Standard Oil's combining of small companies during depression, as indicated in the Sherman antitrust case of 1911). The height of tariffs, identified closely by the public with large industry, became a major political issue in 1912. The victorious Democrats promised reduction but held that no "legitimate" industry would be sacrificed. Although a considerable number of items were placed on the free list, rates were reduced, on an average, 10 percent only.
After World War I, with the Republicans in power, extreme protection held sway. Agriculture accepted any tariffs on farm products—although still grumbling about industrial tariffs—and the South found its former solid free-trade front broken by districts with a stake in tariffs on products of farm and factory. In the campaign of 1928 the tariff positions of the two major parties were scarcely distinguishable. Following a full year of debate in Congress, the Hawley-Smoot Tariff Act became law in 1930; the act constructed the highest tariff wall in the nation's history, and its contribution to the shrinkage of world trade and the severity of worldwide depression was considerable. Revulsion from the indiscriminate protectionism, distress with the worsening depression, and the leadership of Cordell Hull, an old-fashioned southern tariff liberal, again turned the country toward trade liberalization.
The Trade Agreements Act of 1934 and its twelve extensions through 1962 beat a steady retreat from the high-water mark of protection reached in 1930. Reacting to the severe decline in the volume of U.S. exports after 1930, the administration of Franklin D. Roosevelt conceived reciprocal trade concessions as an antidepression measure to generate recovery in export-related industries. Following World War II a political impetus was added; by opening its markets, the United States could assist the war-ravaged European economies in reconstruction and could similarly aid the development in poor nations. The economic implications of the Trade Agreements Act and its extensions were conflicting: there was a steady trend of tariff reduction, expedited after 1945 through the General Agreements on Tariffs and Trade (GATT) and the application of the unconditional most-favored-nation concept; but the reductions were tempered by a "no-injury" philosophy, adopted to minimize injury to domestic industry. Escape clauses, peril points, and national security regulations have hedged the U.S. commitment to agreed tariff reductions. The 1958 extension was notable in firmly establishing these concepts and the necessary enforcement machinery. Under the peril-point provision the U.S. tariff commission was to determine before negotiations the level to which a tariff rate could fall before seriously damaging the domestic industry; this estimate was to provide an effective limit to the authority extended negotiators. An industry experiencing severe injury from a tariff already reduced could petition for relief under the escape clause, which had appeared in U.S. trade agreements since 1943; if the U.S. Tariff Commission found sufficient injury, the concession could be withdrawn.
The Trade Expansion Act of 1962 made a significant departure from the reciprocal agreements in providing programs for alleviating injury caused by trade liberalization. Benefits and retraining for labor and special loans and tax treatment for industry were extended on the rationale of reallocating resources into more efficient uses. The reciprocal trade legislation had avoided this process by rescinding the tariff reduction when injury was inflicted. Administration of the provisions of the 1962 act has been difficult, however, because of the difficulty of distinguishing losses owing to increased imports from losses owing to the domestic industry's inefficiency. The 1962 act extended authority for sizable tariff reductions, to be negotiated through the offices of GATT during the five years following. Tariff reductions on items not excepted from this Kennedy Round of negotiations amounted to about 35 percent. As the U.S. trade balance worsened in the late 1960s, culminating in a trade deficit in 1971—the first in the twentieth century—the forces of protection threatened to reverse the forty-year trend of trade liberalization.
Throughout the 1970s, the executive branch resisted congressional initiatives to raise trade barriers. In 1980, Ronald Reagan's election to the presidency ushered in a new era of free trade in American foreign policy, one that would last for the remainder of the century and beyond. In the 1980s the Reagan Administration promoted a new round of GATT talks, and by the early 1990s the United States, Mexico, and Canada had agreed to create a continental free trade zone, known as the North American Free Trade Agreement (NAFTA).
The collapse of communism added momentum to the global trend toward free trade and free markets. During the 1990s governments across the world embraced free-trade policies, including countries that once belonged to the communist bloc, such as Russia, Poland, and China. By the early twenty-first century free trade had emerged as a cornerstone of the new global economy. Nevertheless, substantial opposition to free-trade policies remained an active force in global politics. In particular, environ-mental and labor groups condemned free trade policies on the grounds that they made it easier for multinational corporations to pollute the environment and to pay sweat-shop wages without fear of government regulation. The debate over free trade showed no signs of cooling off as the twenty-first century began.
LaFeber, Walter. The New Empire: An Interpretation of American Expansion, 1860–1898. Ithaca, N.Y.: Cornell University Press, 1963.
Lake, David A. Power, Protection, and Free Trade: International Sources of U.S. Commercial Strategy, 1887–1939. Ithaca, N.Y.: Cornell University Press, 1988.
Terrill, Thomas E. The Tariff, Politics, and American Foreign Policy, 1874–1901. Westport, Conn.: Greenwood Press, 1973.
Thomas L.Edwards/a. g.
See alsoCommerce, Department of ; Free Society of Traders ; General Agreement on Tariffs and Trade ; Interstate Commerce Laws ; North American Free Trade Agreement ; Trade Agreements ; Trade with the Enemy Acts .
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.
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.
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