Free trade is a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs

(to imports) or subsidies (to exports) or quotas. According to the law of comparative advantage, the policy permits trading partners mutual gains from trade of goods and services. Under a free trade policy, prices emerge from the equilibration of supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from those that would emerge under deregulation. These governed prices are the result of government intervention in the market through price adjustments or supply restrictions, including protectionist policies. Such government interventions can increase as well as decrease the cost of goods and services to both consumers and producers.[citation needed] Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade. Other barriers, however, that may be equally effective in hindering trade include import quotas, taxes, and diverse means of subsidizing domestic industries. Interventions include subsidies, taxes and tariffs, non-tariff barriers, such as regulatory legislation and import quotas, and even inter-government managed trade agreements such as the North American Free Trade Agreement (NAFTA) and Central America Free Trade Agreement (CAFTA) (contrary to their formal titles) and any governmental market intervention resulting in artificial prices.[citation needed]

Features of free trade

Free trade implies the following features:[citation needed]

Trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on imports or subsidies for producers) Trade in services without taxes or other trade barriers The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws) that give some firms, households, or factors of production an advantage over others Free access to markets Free access to market information Inability of firms to distort markets through government-imposed monopoly or oligopoly power.

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 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.

vi.

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.

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.

10 Advantages of free trade: Increased Production and Efficiency 1. Countries that specialize in creating commodities where they have the comparative advantage will increase their production, instead of focusing on products or industries in which other countries have the comparative advantage. 2. By increasing production, countries increase their efficiency. By specializing, countries better allocate their resources and purchase cheaper resources from other countries. Consumer Satisfaction 3. Because free trade leads to a global market, consumers benefit from the competition and variety brought to the market. When other countries produce some items cheaper, the consumer purchases products for less. 4. Another benefit to consumers is increased innovations. As free trade expands, competition also expands. To stay competitive, companies must seek ways to create the comparative advantage. This leads to increased innovation that improves products. Employment and Economic Growth 5. Although free trade may cause jobs in one particular industry to wind up overseas, jobs in the exporting and importing sides will increase. When productivity increases in importing and exporting, wages also tend to rise. 6. As the U.S. has lowered its trade restrictions, the gross domestic product has risen. Since consumers can purchase quality products for cheaper, they have more expendable income.

. The following arguments are given against free trade policy. 1. Unrealistic Policy: Free trade policy is based on the assumption of laissez-faire or government non-intervention. Its success also requires the pre-condition of perfect competition. However, such conditions are unrealistic and do not exist in the actual world. 2. Non-Cooperation of Countries: Free trade policy works smoothly if all the countries cooperate with each other and follow this policy. If some countries decide to gain more by imposing import restrictions, the system of free trade cannot work. 3. Economic Dependence: Free trade increases the economic dependence on other countries for certain essential products such as food, raw materials, etc. Such dependence proves harmful particularly during wartime.

4. Political Slavery: Free trade leads to economic dependence and economic dependence leads to political slavery. For political freedom, economic independence is necessary. This requires abandonment of free trade. 5. Unbalanced Development: Free trade and the resultant international specialisation lead to unbalanced development of national economy. Under this system, only those sectors are developed in which the country has a comparative advantage. Other sectors remain undeveloped. This results in lop-sided development. 6. Dumping: Free trade may lead to cutthroat competition and dumping. Under dumping, goods arc sold at very cheap rates and even below their cost of production in order to capture the foreign markets. 7. Harmful Products: Under free trade, injurious and harmful products may be produced and traded. Trade restrictions are necessary to check the import of such products. 8. International Monopolies: Free trade may lead to international monopolies. It encourages the establishment of multinational corporations. These corporations tend to acquire monopoly position and thus harm the interest of the local people. 9. Reduction in Welfare of Certain Groups: While free trade tends to maximize world production of goods and services, it may simultaneously hurt the welfare of certain group in every country. Under free trade, the output of those commodities in which the country has comparative advantage tend to increase to meet the export demand, and the output of goods in which the country has comparative disadvantage contracts due to pressure from import competition. Thus, the real income of the groups engaged in the export industries will rise and real income of those engaged in the import competing industries will fall. 10. Harmful to Less Developed Countries: Free trade is harmful for the less developed countries for the following reasons: (i) Competition under free trade is unfair and unhealthy. The less developed countries find it difficult to compete with the economically advanced countries.

(ii) Under free trade, gains of trade are unequally distributed depending upon the level of development of different countries. The terms of trade are favourable for the developed countries, and unfavourable for the poor countries. (iii) Less developed countries generally experience unfavourable balance of payments. The problem of un-favourable balance of payments cannot be solved under free trade policy. (iv) Free trade policy adopted by the British government in India led to the destruction of Indian cottage and small scale industries. (v) The less developed countries cannot protect their infant industries under the policy of free trade. (vi) Free trade may endanger economic and political independence of the backward nations.