Free Trade

Article byKosha Mehta
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Free Trade?

Free trade implies a trade policy that does not restrict importing or exporting goods. It is also possible to interpret it as applying the free market concept to global trade. It is believed to be good for public as when trade barriers are eliminated, prices tend to decrease for consumers.

Free Trade

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Political leaders that hold institutional liberal positions are the most likely to advocate for free trade within the government. On the other hand, parties that hold economic nationalist positions and left-wing political positions usually follow protectionist measures, which is the opposite of free trade.

Key Takeaways

  • Free Trade largely refers to the unrestrained import and export of commodities and services between nations worldwide.
  • It is beneficial for consumers as they get low-price options in products.
  • Protectionism is the antithesis of free trade. It is a very restrictive trade policy to prevent competition from other nations.
  • The vast majority of industrialized countries participate in hybrid free trade agreements (FTAs), which are multilateral trade pacts that have been negotiated and allow for tariffs, quotas, and other trade restrictions while also regulating them.

Free Trade Explained

Free trade, often known as laissez-faire, is a kind of economic policy in which a nation’s government doesn’t penalize imports or intervene with exports by laying taxes (on imports) or subsidies.

The concept of free trade is held in high esteem while also drawing strong opposition. Some individuals believe that it makes everyone wealthy and fosters growth in nations that were previously not developed. Others believe it widens existing wealth gaps and grants companies excessive power.

Free trade definition also refers to the absence of government intervention in economic markets. In general, economists are in favor of unrestricted free trade. On the other hand, protectionism has been shown to harm economic growth and people’s prosperity. In contrast, free trade and the elimination of trade barriers have been shown to affect the economy and economic strength positively. This is a widely held belief among economists. In the near term, however, trade liberalization can result in serious and unequally distributed losses and the economic displacement of workers in industries competing with imports.

From 1815 to the beginning of World War I, countries’ free trade policies and practices highly expanded. The 1920s saw a return to a rise in trade liberalization, which continued until the Great Depression when it was followed by a precipitous decline (particularly in Europe and North America). Then, beginning in the 1950s and continuing ahead, there was a discernible uptick in the degree of openness to trade (albeit with a slowdown during the 1973 oil crisis). As a result, economists and economic historians believe the degrees of openness to trade that exist now are at their greatest level ever recorded.

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Examples

Let us have a look at the examples to understand the concept better.

Example #1

An update by Reuters highlights the status of free trade between the U.K. and India. Kemi Badenoch, the minister of trade for the United Kingdom, stated that a trade deal between the United Kingdom and India could not contain all that the services industry needs as the time to finalize the pact draws closer.

Prime MInister Boris Johnson has stated in the past that an agreement with India might result in a doubling of the trade and investments between the two nations. Still, the primary focus needs to be on negotiating a deal that benefits both the United Kingdom and India and not any particular industry.”

Example #2

A recent article by Asia times focuses on the topic of how to save the global free trade order in the face of unexpected and complicated hurdles, such as the competition between the United States and China, the Russian war in Ukraine, the Covid-19 problem, and climate change. One way to do this is through local trade agreements, often known as RTAs.

These aim to increase trade between members by favorably removing trade hurdles. The alternative strategy entails the promotion of plurilateral accords, in which nations with similar perspectives agree on the rules that will govern a subject and forgo the pursuit of WTO-wide decisions.

Benefits

Free Trade Advantages

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1. Increased Growth

Even when minor limitations, like tariffs, are imposed, all concerned nations experience increased economic growth. United States yearly economic growth improved due to its participation in NAFTA (the North American Free Trade Agreement).

2. Aids Customers

Safeguarding local firms and sectors and trade restrictions such as tariffs and quotas are enacted. When trade barriers are not present, prices tend to decrease for consumers because more goods imported from nations with cheaper labor costs become available locally.

3. Boosts International Investment

When foreign investors are not confronted with trade barriers, they tend to invest in local enterprises, helping them develop and compete. In addition, several emerging and remote nations gain from an infusion of U.S. investment capital.

4. Decreases Government Expenditures

Governments often support local firms, such as agriculture, for their income loss from export quotas. In addition, the government’s tax earnings can be used for other purposes after the quotas are abolished.

5. Facilitates Technology Transfer

In addition to human skills, local firms receive access to the most modern technology created by their international partners.

Drawbacks

Free Trade Disadvantages

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1. Job Losses Due To Outsourcing

Tariffs tend to deter job outsourcing by keeping product prices competitive. In addition, the removal of tariffs makes imported products cost less. While this appears beneficial to consumers, it makes it difficult for local firms to compete, causing them to reduce their staff. Indeed, one of the primary criticism of NAFTA was that it sent American jobs to Mexico.

2. Intellectual Property Theft

Many foreign governments fail to take intellectual property rights seriously, particularly those in developing nations. As a result, firms’ inventions and new technology are at threat without the protection of patent laws. It forces them to compete with low priced and locally made fake items.

3. Bad Working Conditions

Similarly, governments in poor nations rarely have laws in place to maintain safe and equal working conditions. Women and children are often forced to work in industries doing hard labor under difficult conditions since free trade is largely predicated on a lack of government strict quotas.

4. Harmful To The Environment

Emerging nations have little, if any, environmental rules. Because many free trade options entail exporting natural resources such as timber or iron ore, cutting forests and unclaimed strip mining often ruins local places.

5. Decreases Revenues

Because of the high competition by unfettered free trade, the firms engaged experience lower income. Smaller firms in growing nations are particularly sensitive to this effect.

Free Trade vs Protectionism

  • The primary goal of protectionism is to shield home firms and industries from foreign competition. And to prevent the outcome resulting from free market supply and demand forces. As a result, open trade is the polar opposite of protectionism.
  • Free trade expands the overall size of the economy. It enables better production of products and services. Protectionism can assist in keeping jobs in certain industries or, at the very least, limit the pace of change.
  • Consumers benefit from free trade. It brings down prices by creating fewer hurdles and encouraging competition. Increased competition will almost certainly increase quality and choice. On the other hand, the latter limits customers’ access to localized enterprises’ offerings.
  • Companies that deal in many nations might reduce their ‘compliance’ expenses by working with a single set of laws. But on the other hand, the latter may lead to bad trade wars. It increases prices and uncertainty as each party tries to safeguard its own economy.

Frequently Asked Questions (FAQs)

What was free trade?

The concept of “free trade” refers to the belief that goods and services should be allowed to be exchanged between nations with as few prohibitions or restrictions as is practically practicable.

What was the free trade agreement?

Free trade agreements, sometimes known as FTAs, are agreements between two or more nations to lower or remove certain obstacles to trade and investment and facilitate deeper economic and commercial relations between the countries participating in the agreement.

Who benefits from free trade?

An economy can become more specialized in producing the goods for which it is most capable when free trade is allowed. Therefore, people who are employed in export industries stand to benefit from the positive effects of trade.

What are free trade zones?

Free trade zone is one type of special economic zone. It is a geographical region where commodities may be imported, stored, handled, produced, or reconfigured and re-exported following certain customs regulations and are normally exempt from customs charges.

This article has been a guide to What is Free Trade and its definition. We explain its benefits, drawbacks, examples, and compare it with protectionism. You can also go through our recommended articles on corporate finance –

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