Overview and definition of Free Trade


Types of Protectionism===

Definition of Free Trade

Free trade is a system that allows countries to trade and transact without government interference (e.g. through the uses of tariffs, quotas, subsides, etc.). An ideal trading situation is one of the free trade, because each country has comparative advantages in producing certain things. Comparative advantages make trade the most efficient method of production and consumption. Free trade differs from other forms, such as trade policy where the allocation of goods and services amongst trading countries are determined by artificial prices that may or may not reflect the true nature of supply and demand.


Tariffs are taxes that are placed on imported goods. They raise revenue for the government, but also raises the price for the citizens because the domestic equilibrium price is almost always higher than the international price. This hurts foreign suppliers because it raises their prices, lowering their consumption and cutting their overall revenue. Tariffs are good for the domestic producers because their goods seem relatively cheaper with tariffs on foreign goods. Tariffs are also good for the government because of the money the government collects with the tariff in place. Tariffs are bad for the consumer, the foreign producer and create a dead weight loss. However, tariffs are in some ways better than quotas, because the country still gets some revenue out of the tariffs. Still, both are bad since all trade barriers create losses in the long run.


A quota is a protectionist trade restriction that limits the quantity of a good that can be imported into a country. Limiting the supply of a good raises the price of the imported good and makes it more expensive in comparison to the price under free trade. Quotas make it easier for domestic producers to compete with foreign producers because importing from foreigners is now more expensive than purchasing domestically. Therefore, quotas can be quite useful in protecting infant industry. In contrast to tariffs, quotas do not bring in revenue for the government. Quotas are usually a bad idea because they make these dead weight loss spots where the government can be earning tax money instead of it just going to waste. It is often a loss for both countries. The net loss for quotas will go to foreign producers.


A subsidy is defined as a grant paid by the government to an enterprise that benefits the specific business. Subsidies are a form of financial assistance that are generally given by the government of a country to a producer in a given industry, usually to keep the industry afloat and help keep production steady. Common subsidies include money to expand a company or to hire more workers. Subsidies are also a trade barrier, as subsidizing companies within the country makes it harder for foreign companies to compete. When a subsidy is in place, the producer gains but the consumer loses without knowing it. From a consumer's point of view, a good seems cheaper than it actually is, because they are unaware of the amount they are paying for the good through their taxes. Subsidies are only good for goods with positive externalities. • Voluntary Export Restraints (VERs)

A trade restriction on the quantity of a good that an exporting country is allowed to export to another country. This limit is self-imposed by the exporting country. Typically, VERs are a result of requests made by the importing country to provide a measure of protection for its domestic businesses that produce substitute goods. VERs are often created because the exporting countries would prefer to impose their own restrictions than risk sustaining worse terms from tariffs and/or quotas.

Administrative obstacles:

They usually come in the form of Bureaucracies or VERs which is defined in the above section. Bureaucracies are organizations with set laws or rules that may intervene with trade in the country. An example of a bureaucracy is OHSA, this bureaucracy makes sure that certain policies are met within companies that may or may not interfere with trade. • Health and safety standards: Basically, we are not accepting goods because of possible health risks. If something was to go wrong, then many lives would be at stake both in the United States and outside countries. Any industry crucial to national security, such as producers of military hardware, should be protected. That way the nation will not have to depend on outside suppliers during political or military crises.

National security is at stake with regard to some industries. Defense is the best example of an industry that requires protection on the basis of national security. Steel may be another, but the steel industry has been only partly successful with this argument. Oil is another industry on which national security can depend, although U.S. consumption of and dependence on foreign oil has been virtually encouraged by the phase out of fuel efficiency standards for passenger vehicles and low gasoline taxes (relative to those in Europe).

Although economists disagree about various ways to protect industries on which national security depends, most agree that some industries warrant such protection. They also agree that some industries that have claimed this status probably do not warrant it.

It all depends on how much we are willing to sacrifice our health and safety standards in the free trade and protectionism. If we value our safety more, it will be harder to accept free trade

Environmental standards:

From an environmental viewpoint, free trade is not necessarily a good thing. It is a generally accepted concept that the environment will suffer if trade is liberalized. One reason that the standards are bound to worsen is that the international trade law under WTO regulations gives countries and incentive to decrease environmental regulation of domestic production, so that the domestic producers will be on the same level as the foreign competition. Another concern had is that the ideals behind the General Agreement on Tariffs and Trade (GATT) support the policy of “product, not process”. This prohibits the discrimination of trade based on how it is produced, which causes producers to use the cheapest methods available to make their good, which are often the most damaging methods for the environment.

Businesses want to produce as cheaply as possible, and not reducing pollution saves them a lot of money. Domestic producers can claim that foreign producers have an unfair advantage because of their country’s lower environmental standards, so the domestic producers lobby for lower standards at home, so they can still compete. An example of this is the tuna-dolphin scandal between the U.S. and Mexico, which began in about 1960, but continued far beyond. The U.S. imposed trade restrictions on Mexico because of the large number of dolphins killed by their tuna fishermen. Mexico appealed to GATT and won, with GATT deciding that the U.S. was imposing unfair trade practices, and that they had overlooked several less extreme options when they used an embargo. As a result, U.S. canneries started to print “dolphin-friendly” on their labels, because people don’t like things that hurt dolphins, and would much rather buy dead tuna that doesn’t do so.

There is some argument that the predicted environmental consequences of free trade are exaggerated, but in general, the theory is accepted. Now it’s just a race to see which will win, trade or the environment.

Arguments for ProtectionismEdit

Infant industry argument - If an industry is newly developing in a country, it will not be able to be competitive with international prices from companies that have been producing the particular good for a long time. The government sets up trade barriers in order to protect this industry from foreign businesses until it is developed enough to keep up in the world market. However, if the industry continues to be protected, it may never become ready for the world market because it has not had an incentive to be more efficient and therefore cheaper. It is also impossible to keep track and measure when the business is old enough to "walk on its own."
Efforts of a developing country to diversify - A country should diversify because if it only produces a small variety of goods in a few industries, when something bad happens to those industries they could be in a lot of trouble financially. They would lose those specific exports with none other to still rely on. This is why with small countries, when there is a destruction of their limited factories, they suffer greatly. This idea is very similar to the idea of having a biologically diversified population.
Ex: Instead of specializing in one product like rice in Thailand. They should produce other products too, so they are not so dependant on the exports of rice.
• Protection of employment -This argument stems, usually from misguided patriotism. The claim is that buying goods from other countries as opposed to domestic producers will destroy jobs at home. The counter argument is that buying at the lowest price allows for higher levels of production and other lost jobs will be made up in other sectors and by lowered input prices.
• Source of government revenue- tariff equals bringing in government revenue
- Once government has more money from tariffs, tax, etc...they will be able to plug it back into the economy through government spending or investment, which allows an economy to become more advanced.
• Strategic arguments- A country should avoid importing weapons and other materials for national security from other countries. For example, if country A is receiving national security technology from country B, and they end up in conflict with each other, country A is at risk. Because now that supply from country B will be cut, leaving country A vulnerable to country B attacks.
• Means to overcome a balance of payments disequilibrium- A balance of payments disequilibrium (current account deficit)is a situation where export revenue for a country is less than import expenditure (trade deficit). The country would then put a tariff on the importing country so that the consumers would want to buy more domestic goods rather than foreign goods.
• Anti-dumping- When a country sells goods below the production costs-or domestic price level- then these goods are being dumped on the importing country. When the importing country taxes these imported goods to reflect the true cost of production, that is called anti-dumping. Usually anti-dumping action means charging extra import duty on the particular product from the exporting country in order to bring its price closer to the “normal value” or to remove the injury to domestic industry in the importing country. The problem with this policy is that it is often impossible to know whether goods are being sold at prices beneath actual value; therefore anti-dumping policy may create more problems than it solves.

Arguments against ProtectionismEdit

Free trade is always beneficial to the countries involved unless they have exactly the same production power.
Inefficiency of resource allocation - When a country produces a good and it does not have a comparative advantage in producing, the country pays a higher opportunity cost and there is net welfare loss because of the increased opportunity cost. When a country does have comparative advantage, it is much less of an opportunity cost to obtain it from them. They could obtain it from foreigners, decreasing the opportunity cost of making it themselves. with protectionism it will prevent a country from efficiently allocating their resources.
• Costs of long-run reliance on protectionist methods- Countries who place trade barriers in place for the infant industry argument assume that eventually the domestic industry will be able to compete internationally. However, the industry may use the barrier as a crutch and never properly develop its product. They will rely on these trade barriers to often keep people to buy domestically. This is oftentimes the case in developing countries who initially intend to transition from primary to secondary and tertiary goods. A protectionist measure that can be helpful in the short-run is not lifted and encourages retaliation.
• Increased prices of goods and services to consumers- If trade barriers were placed on input goods, not only will it increase the price of those input goods but also the product from the input goods. In the end, consumers are the one paying more for the input costs and the regular cost of the product.
• The cost effect of protected imports on export competitiveness- By putting up trade barriers, other countries can retaliate and put up their own trade barriers. This in turn backfires and causes your goods to now be more expensive also. Decreasing your number of exports, decreasing AD because exports a factor of aggregate demand, causing AD to shift to the left.
Disincentive costs