Free Trade Policy

A. Advantages of free trade Free trade occurs when there are no artificial barriers put in place by governments to restrict the flow of goods and services between trading nations. When trade barriers, such as tariffs and subsidies are put in place, they protect domestic producers from international competition and redirect, rather than create trade flows. i. Increased production Free trade enables countries to specialise in the production of those commodities in which they have a comparative advantage. With specialisation countries are able to take advantage of efficiencies generated from economies of scale and increased output. International trade increases the size of a firms market, resulting in lower average costs and increased productivity, ultimately leading to increased production. ii. Production efficiencies Free trade improves the efficiency of resource allocation. The more efficient use of resources leads to higher productivity and increasing total domestic output of goods and services. Increased competition promotes innovative production methods, the use of new technology, marketing and distribution methods. iii. Benefits to consumers Consumers benefit in the domestic economy as they can now obtain a greater variety of goods and services. The increased competition ensures goods and services, as well as inputs, are supplied at the lowest prices. For example in Australia imported motor vehicles would cost 35% more if the 1998 tariff levels still applied. Clothing and footwear would also cost around 24% more. iv. Foreign exchange gains When Australia sells exports overseas it receives hard currency from the countries that buy the goods. This money is then used to pay for imports such as electrical equipment and cars that are produced more cheaply overseas. v. Employment Trade liberalisation creates losers and winners as resources move to more productive areas of the economy. Employment will increase in exporting industries and workers will be displaced as import competing industries fold (close down) in the competitive environment. With free trade many jobs have been created in Australia, especially in

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manufacturing and service industries, which can absorb the unemployment created through restructuring as firms close down or downsize their workforce. When tariffs were increased substantially in the period 19741984 for textiles and footwear employment in the sector actually fell by 50 000, adding to overall unemployment. Economic growth The countries involved in free trade experience rising living standards, increased real incomes and higher rates of economic growth. This is created by more competitive industries, increased productivity, efficiency and production levels.

B. Disadvantages of free trade Although free trade has benefits, there are a number of arguments put forward by lobby groups and protestors who oppose free trade and trade liberalisation. These include:

With the removal of trade barriers, structural unemployment may occur in the short term. This can impact upon large numbers of workers, their families and local economies. Often it can be difficult for these workers to find employment in growth industries and government assistance is necessary. Increased domestic economic instability from international trade cycles, as economies become dependent on global markets. This means that businesses, employees and consumers are more vulnerable to downturns in the economies of our trading partners, eg. Recession in the USA leads to decreased demand for Australian exports, leading to falling export incomes, lower GDP, lower incomes, lower domestic demand and rising unemployment. International markets are not a level playing field as countries with surplus products may dump them on world markets at below cost. Some efficient industries may find it difficult to compete for long periods under such conditions. Further, countries whose economies are largely agricultural face unfavourable terms of trade (ratio of export prices to import prices) whereby their export income is much smaller than the import payments they make for high value added imports, leading to large CADs and subsequently large foreign debt levels. Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by governments, according to the infant industries argument. It is difficult to develop economies of scale in the face of competition from large foreign TNCs. This can be applied to infant industries or infant economies (developing economies). Free trade can lead to pollution and other environmental problems as companies fail to include these costs in the price of goods in trying to compete with companies operating under weaker environmental legislation in some countries. Pressure to increase protection during the GFC During the global financial crisis and recession of 2008-2009, the impact of falling employment meant that protection pressures started to rise in many countries. In New South Wales, for example, the state government was criticised for purchasing imported uniforms for police and firefighters at cheaper prices rather than purchasing Australian made uniforms from Australian companies. Similar pressures were faced by governments in the United States, Britain and other European countries.

Arguments in favour of protectionism

Infant industry argument: It is argued that government should go in for protectionist measure to protect infant industries, or else they will not get an opportunity to survive due to international trade. Efforts of a developing country to diversify: Developing countries need to protect industries in which they want to diversify. Protection of employment: Protecting domestic industries also means protecting domestic employment. Source of government revenue: Tariffs form a good source of revenue for governments. Strategic arguments: it means use of a tariff to protect military capability. The idea is, to consume the goods of our country to promote the national industry and so, in the case of war we don't have to buy the products in a foreign country and our industries have the capacity to produce all the goods that our country need. We want tariffs to reduce the dependence on international resources. Means to overcome a balance of payments disequilibrium: High imports as compared to exports might lead to severe balance of payments issues. Government might resort to protectionist measures such as tariffs and quotas to restrict import and thereby control the balance of payment disequilibrium. Anti-dumping: Dumping is when manufacturers export a product to another country at a price either below the price charged in its home market. This harms the domestic industry and employment. The importing country might resort to protectionist measures such as tariffs to control dumping of these goods.

Arguments against Protectionism

misallocation of resources: It leads to global misallocation of resources, as it supports inefficient producers and in certain cases (tariffs and quotas) consumer surplus is scarified. the danger of retaliation and trade wars: Continuous protectionist measures by a country might lead to retaliation of other countries and they might also put protectionist measures on the imports. the potential for corruption: Putting administrative controls might also lead to corruption. increased costs of production due to lack of competition: Constant protection to the domestic producers and lack of competition propagates inefficiency and lack of initiative to control cost. higher prices for domestic consumers: As we can see due to tariffs and quotas domestic consumers end up paying more. Increased costs of imported factors of production: Imported goods become expensive which might also lead to imported inflation. reduced export competitiveness: Continuous protection to domestic industries (such as subsidies) might make them inefficient in terms of cost and technology. In the long run they might become uncompetitive in the exports market.