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The Limitations Of Free Trade

The idea of free trade came into prominence in the late 18th century and largely replaced the then-dominant idea of mercantilism. Ever since the ideas and publications by Adam Smith and David Ricardo came to light, there has been a consensus among economists that free trade is a net benefit for the whole of society. The arguments for free trade are convincing and the benefits are superior and more inexpensive products along with increasing trade. David Ricardo went on to argue that a nation should concentrate resources only in industries where it has a comparative advantage. This gives a country a reason to trade even though it is not as competitive as the other countries. Centuries have passed since the emergence of the free trade idea and our world has changed drastically since then. The nature of work has been modified and international trade consists of more countries with different qualities. 


Looking at the political climate today there is a growing negative sentiment towards globalization and international trade. The debate is very much divided tending to extremes on both ends. On one end there is a demand for higher tariffs, new trade deals and bringing jobs back from low wage countries. On the other end, people are advocating for more free trade agreements and closer integration with other countries to increase world trade. These two contradicting points of views yield the following question: what are the protectionists seeing that the others are not?


During the 16th and much of the 18th century, the dominant economic policy was called mercantilism. It emerged during the time of competing national states in Europe. Its aim was to maximize exports and minimize imports to increase the country’s wealth which was measured in the amount of gold it possessed. As the mercantile classes, also known as, the leaders of the industries, were paying taxes to the government, they saw that the government’s job was to protect their industries. Imports were reduced by tariffs, quotas and taxes in order to protect local manufacturers and exports were supported by giving subsidies and tax cuts to local industries. Wars were frequent during this era and protecting domestic industries was seen as improving national security and the competitiveness of the country.


During the end of the mercantilist era when the United States was still a British colony the North American country was not able to impose tariffs, as the British did not want the US to industrialize because of their desire to buy cheap raw materials from them. After the American revolutionary war, which was partly fought due to tariffs, people in the United States argued that economic independence equals political independence and they started to impose tariffs as to protect their infant industries from the competition of the more developed British manufacturers. It was also seen as a national security issue to protect important industries such as defence. Ever since tariffs have been common in the United States and they were a partial reason as to why the US was able to develop their economy and later on grow their industries much bigger than those of the British.


Interestingly there is a story of a British man called Samuel Slater who was given the nickname “Slater the Traitor”. During the beginning of the industrial revolution, the US did not have a textile industry and the British wanted to maintain their monopoly position of textile manufacturing by banning exports of textile machines and the emigration of people familiar with the machines. Slater managed to illegally migrate to the US having memorized the designs of these machines. By having the know-how he began businesses and turned himself into a wealthy man. Alternatively, he has been called the father of the American industrial revolution and his act can be seen as an intellectual property theft, which gave a major boost to the industrial revolution in the United States, allowing them to compete in the world markets. 


The latter part of the 20th century was dominated by free trade as more countries joined the World Trade Organization and signed trade agreements which reduced tariffs and advanced foreign trade. These developments have increased the overall GDP of countries and raised millions of people out of poverty, just to mention a couple of the positive consequences. 


Something peculiar has recently been emerging in the world: nationalism and economic protectionism. President Donald Trump has been pushing his America first economic policy which, at least, as an idea seems to have been appealing to the majority of the American people. He has been renegotiating trade deals like NAFTA and even gone after the WTO for being unfair towards the US. Additionally, he has been putting in place protectionist policies like tariffs. Moreover, he has especially targeted China for “ripping off” the United States for decades. To make any sense of all of this let’s play along for a while and try to see the world from the perspective of someone who would possibly find his claims appealing. 


Let us first start with the idea of free trade which relies heavily on the 18th century born economist David Ricardo’s idea of comparative advantage. Comparative advantage means that a country has a lower opportunity cost in producing products than the other country. According to the theory, a country should invest in industries where it has a comparative advantage and the rest of the goods and services should be imported from other countries that are better at producing them. This idea has been used as an argument for international trade and as an example of how trade benefits us all. However, this theory has also been criticised by people advocating for protectionism. 

Some of the following are arguments against free trade and comparative advantage and they resonate with the message of Donald Trump. 


Cross-industrial movement, the ability of workers to move from one industry to another. Think of a situation where you have been working in the same job for years. The job does not require any education but is physically demanding and repetitive. Suddenly, your line manager tells you that the products you have been producing can be produced cheaper in another country and after 3 months you will be without a job. There are no similar jobs to the one you have been performing as the whole city you have been living in was revolving around this industry. You have the opportunity to either re-educate yourself or move to a bigger city in search of a new job. The first option is not viable as you have never thrived in school and besides the tuition fees are too expensive and the idea of taking on debt is not compelling to you. So, you are left with the possibility of moving into a bigger city but this a huge change in your life and on top of that you are already 40 years old and your social network is in your hometown. In addition, moving into a big city means that your rent is likely to increase and as an unskilled worker you are likely to work in a service job which doesn’t suit your strongpoint. 


In a situation like this, there is the option to use protectionist measures or to adapt to the increased competition brought by international trade. The decision is not going to be easy and the consequences depending on the policy chosen can in a bad situation vary from increased prices to unemployment and social unrest. The situation is not made any easier by the fact that jobs are getting more cognitively challenging and often do require higher education which is costly to attain. Due to these factors, cross-industrial movement is not as easy as it used to be. Putting those two factors aside: what then could make production in other countries so much cheaper to the point that it is preferable to cut jobs domestically?


Externalities, Which could be advantageous or disadvantageous to a country depending on how they have to deal with them under their laws and regulations. Say that in one country they do not have any regulations on how much pollution a factory can emit and in the other country there are regulations regarding emissions. Then, the country with less strict regulations is able to sell their products much cheaper and dominate the market. Also, some countries might gain an unfair advantage where they can attract companies and reduce costs of exports by not having the obligation to invest in the improvement of workplace conditions. The latter might lead to “sweatshop” like working environments. These problems can be addressed with international agreements but, there is still more progress to be done. Trump announcing to leave the Paris agreement can be seen as a protectionist policy, where he wants to help American energy companies by giving them the competitive advantage of not having to pay for the environmental harm they are causing. 


Balanced trade, which differs from free trade, is characterized by supply and demand forces that lead to an equilibrium in the long-run. This has recently become a hot topic as Trump has declared to put a stop on the large trade deficits that the US has been running for decades. Some economists argue that trade deficits, in the long run, are bad as they weaken domestic industries and that too much reliance on imports could leave a country vulnerable as it is not as self-sufficient. On the other hand, economists argue that a trade deficit is nothing to worry about as the trade deficit does not lower economic growth and that foreign investment is to come in the future. The trade deficits and surpluses vary over time depending on many reasons but one important stabilizer is the floating exchange rates.


Trump has tried to reverse the trade deficit by imposing tariffs and renegotiating deals to boost US exports. Furthermore, he has claimed that the Chinese currency is undervalued, thus, giving China an advantage in international markets due to cheaper exports. This sets US exports at a competitive disadvantage. The topic is slightly controversial but Trump does not stand alone with his claims as many economists agree with him. Notably, one of them being Paul Krugman. If his claims would turn out to be true, then the exchange rates, which stabilize trade in the long-term, are not working properly. In theory, the adjustment should happen through the changes of the Chinese labour wages as the currency is fixed and not floating. But as the Chinese government is subsidizing its industries then this stabilization effect might be harder to attain.  


All the claims that President Donald Trump is making regarding trade and economics might sound comical and absurd, but in some of them might lie a small seed of truth. His claims might appeal to citizens who feel like they have been left out or pushed aside due to the increased competition by free trade and globalisation. Also, people might feel that other countries have a competitive advantage due to violations of trade rules and laws that favour them. However, Trump’s policies on tackling these issues are rather unconventional. Also, his effort to try to label China as a country who is ripping off the people of the United States sounds like an old trick in politics to label a common foe. 


The claim that the Chinese economic growth is a loss for the United States sounds like something which contradicts with the idea that free trade benefits us all. Looking at the development of the Chinese economy one can see that it was not developed only by free trade policies although they were a major reason. Also, their ability to use protectionist policies in some ways similarly as the US did when they first got independent. The undervaluation of the Chinese currency can be seen as protectionist as it created more demand for Chinese exports. Also, the Chinese government heavily subsidizes its exports giving them tax benefits, cash subsidies and lower tariffs on machinery and intermediate inputs. In addition, they have gained much through their policies on foreign firms entering their market, which requires the foreign firm to start a joint venture with a Chinese one giving the Chinese access to intellectual property. This has lead to many Chinese companies looking like exact copies of those founded in other countries e.g. Baidu and Google. This has been criticized in the world as intellectual property theft. 


In conclusion, as the world has changed it has also brought into the surface some of the weak points of free trade. However, the solutions that Trump is giving seem more like mercantilist economic protectionist policies. These might be outdated in the world integrated by free trade. Nevertheless, as the majority of Americans has voted him as the president, then, there might be something to take away from his claims on trade, and the global leaders should consider them to make free trade work for everyone equally. 

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