Perfect competition is regarded as the most efficient setting for a market to achieve equilibrium in. Consumers obtain goods at the best prices and producers make normal profits on sales. If the assumptions of perfect competition are extrapolated into the field of international trade, the advantages of free trade would come to light. Free trade is a term used to define unrestricted, non-biased trade between regions within a country as well as on a global scale. The Law of Comparative Advantage states that countries export goods which are intensive in the factor present in abundance while they import goods intensive in the scarce factor. Thus one of the advantages of free trade is that it allows countries to make full use of their comparative advantage benefitting both parties in the process.
Most countries impose trade restrictions in the form of import duties and export subsidies for certain sectors/industries that require national support. For instance, developing nations such as India provide subsidies on sugar exports as well as on certain inputs like fertilisers. Agriculture is a sensitive sector in India since it is a source of income and livelihood for bulk of the population. Another example of export subsidies is the Export Enhancement Program (EEP) introduces by the US in the 1980s to provide an impetus to wheat exports from USA aimed to counter the subsidies provided in the EU. However these subsidies had an adverse impact on wheat trade from other countries including Canada and Australia. These subsidies counter the advantages of free trade.
Subsidies allow domestic producers to sell their goods at competitive prices in the foreign markets. Another medium through which trade barriers can be introduced to protect domestic protection is the imposition of trade tariffs. These tariffs or taxes are applicable on imported goods and are either borne by the suppliers and will then have a reductive effect on their profits or can be borne by consumers. The latter case results in higher prices of the imported commodity in domestic markets impacting its demand negatively. Thus all these measures are aimed at promoting the interests of domestic producers by keeping the foreign competition at bay.
However as mentioned earlier, the law of comparative advantage can only be used to nations’ benefit if they allow free trade. Bodies such as the WTO (erstwhile GATT) have been formed with the intention of promoting free trade and spreading the advantages of free trade among all countries. The directives of the WTO are aimed at reducing trade barriers in the form of tariffs, subsidies and other non-tariff barriers.
Free Trade: Comparative Advantage
Free trade allows countries to exploit their comparative advantages in terms of natural endowments or acquired skills. For instance, Brazil which is the largest producer of coffee in the world has a comparative advantage in that commodity in terms of sheer quantity. However there is only so much domestic demand present within the country. A free trade system allows Brazil access to a whole new ‘world market’. Thus the excess supply of coffee within the country is met by an equal demand in the international market providing Brazilian coffee producers a vast market. The increased scale of production results in lower average costs increasing productivity. This is further translated into increased production. Thus free trade grants wider market access to domestic producers, allowing them to make full use of their comparative advantage. Another consequence of exports from comparative advantage is that it results in a favourable balance of payments.
Sectors in the economy which enjoy a comparative advantage benefit in a free trade scenario due to increased production. This has a positive effect on the employment levels in this industry as well. Thus as more resources and capital are directed towards these sectors to enhance production, a greater labour force is also required. However as employment in these sectors increases, it will be negatively affected in those sectors where production falls as a result of foreign competition. Thus employment will increase in the exporting industries and fall in industries which face heavy competition from foreign imports. These are some of the major advantages of free trade.
Free Trade: Consumers Advantage
As per the age old adage “Consumer is King”, all trade activities are focussed on satisfying the most important aspect of the production and distribution chain – the consumer. In a free trade scenario, the consumer obtains the best prices for each commodity contrary to a restricted system. Trade barriers such as tariffs and subsidies are enforced with the aim of protecting certain industries and sections of society. These measures result in prices of the said commodities being maintained at a particular level above the international prices. If they were to be removed, foreign goods at competitive prices would be introduced into the domestic market levelling the prices. Thus the consumer is at an advantage if free trade conditions existed in the economy.
Sometimes countries which produce excesses of a certain commodity try to sell them in the international markets at a price lower than that offered in the home country. This is known as dumping and while it is highly favourable for consumers, it puts added pressure on domestic producers of the good. For this purpose stringent anti-dumping laws have been developed by the WTO.
Free Trade: Leading to Economic Growth
The WTO guidelines call for its members to accord MFN (Most Favoured Nation) status to fellow members. This entails that the nation accorded this status be treated equally advantageously as any other nation with the status. Bilateral ties between countries may also be strengthened by preferential treatment agreements. These treatments allow for relatively free flowing trade between the countries involved. Free trade results in higher levels of production which may well lead to a growth in GDP as well as increased income levels among the population. Thus overall economic growth is achieved through free trade measures. Higher levels of competition also make domestic industries conform to higher standards.
Free Trade: Developing Country Advantage
Free trade benefits developing countries to a large extent. This is evident in the cases of India and China whose growth rates shot up after the economies adopted liberalisation. Ever since China liberalised in 1978 its growth rates have remained well over 7% and there has been a drastic fall in poverty. Trade liberalisation has led to higher FDI inflows into China from $590 million in 1979 to $50 billion today. Similar changes have been recorded in India after its liberalisation in 1991 which resulted in the GDP growth to be accelerated from a measly 1.25% in 1991 to 7.5% in 1995 and growth in FDI from $132 million to $5.3 billion within the same period.
Additional advantages of free trade are the free flow of information and technology across boundaries. These encourage better, more efficient production techniques globally. The responsibility to promote environmental protection and maintain appropriate standards during international trade has been assumed by the WTO. It stands for open, non-discriminatory trade flows which are transparent and competitive.
Though there are many arguments against free trade benefitting developing countries since it might have a detrimental impact on domestic industries which run the chance of being crushed by international competition. However empirical evidence suggests that advantages of free trade far outweigh the disadvantages. Most developing nations which undertake slow and steady trade liberalisation measures have benefitted in terms of increased production (reflected in the GDP growth rates) and more FDI/FII inflows into the economy. Thus among the various advantages of free trade, the most important one is that it helps in the development of emerging nations.