Friday, August 28, 2009

Free Trade

Free trade policy refers to a trade policy without any tarrifs, quantitative restrictions and other devices obstructing the movement of goods between countries.

Arguments in favour of Free Trade:

The classical economists were in favour of free trade policy of the modern economists Haberler advanced the following arguments in favour of free trade.

1. Maximization of output: Under free trade a country specializes in the production of those commodities which for those imports which it can obtain more cheaply. This maximises the output of all the participating countries because all gain from trade which in turn increases the real national in come of the world economy. Thus free trade leads to the maximisation of output.

2. Optimum utilization of resources: Free trade leads to international specialization and division of labour. As a result the existing resources in each trading country are employed more productively and the resource allocation becomes more efficient. There is more efficient utilization of factors within a firm or industry. Thus international trade and division of labour lead to optimum utilization of resources.

3. Optimization of Consumption: Free trade secures the optimization of consumption. In other words it benefits the consumers when they are able to buy a variety of commodities from abroad at the minimum possible prices. This in turn has effect of the raising their standard of living.

4. Educative Value: According to Haberler free trade has an educative value. International competition encourages home producers to sacrifice leisure in order to increase productivity. For this they innovate and bring improvements in organization and methods of production.

5. Wide Markets: Free trade leads to wide extent of markets for goods. As the demand for goods is not confined to one country but to a number of countries, the entire world becomes the market for all types goods. This leads the production of quality goods at low prices because of world competition.

6. Prevent monopolies: Free trade prevents the establishment of monopolies. Under free trade each country specialises in the production of few commodities, and the firms or industries are of the optimum size so that the cost of production of each commodity is the minimum. Thus free trade ensures a lower price for exports as well as imports and the price mechanism under perfect competition prevents the formation of monopolies.

7. Best policy for economic development: Haberler point out that “substantial free trade with marginal insubstantial corrections and deviations is the best policy from point of view economic development”.

Arguments against the free trade:

There are certain theoretical and practical difficulties in following the free trade policy.

1. Free trade presupposes the existence of laissez faire and the working of price mechanism under perfect competition. But these conditions do not exist in the present dag world. Monopoly, monoprony, cartels, imperfect labour markets and tarrifs led to the abandonment of free trade.

2. Under the policy of free trade, some industries expand in which the country possesses comparative advantage but other industries are not developed. An agricultural country may develop only agriculture and neglect the industrial sector. Or one type of industries may be developed while others may remain undeveloped. This naturally leads to the one sided development of economy. Hence free trade had to be abandoned.

3. There being no restrictions on the movement of goods under free trade, substandard and harmful commodities are likely to be produced and traded. This leads to diminution of social welfare. Trade restriction on import of such commodities become necessary. This was another cause of abandonment of free trade.

4. Countries with better factor endowments are able to produce certain commodities cheaper than others. This led to cut-throat competition in the world markets under free trade. So certain countries like Japan resorted to the policy of dumping whereby they would sell huge quantities of their products at rock-bottom prices in the foreign markets. Naturally this policy led to imposition of trade restrictions.

5. Free trade may lead to the emergence of international monopolies and local monopolies, according to Haberler, such monopolies developed under free trade which proved harmful to the other countries and the domestic interests. This factor also led to the adoption of the policy of protection.

6. Economists do not agree with Haberler that the free trade policy helps in the development of under developed countries. Rather this policy led to the exploitation of countries during the 19th and early 20th centuries. It is now recognised that under developed countries can develop under a policy of protection and not of free trade.

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