Free Trade

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Free Trade

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