FAQ: What are the theoretical benefits of free trade?

Talking Points:

International trade theory has its roots in the 18th-century writings of Adam Smith. Not only did he refute arguments for restricted trade, which relied on the belief that material gains acquired by one nation were done so at the expense of the other, but he demonstrated the potential gains of free trade. Thus, trade among nations is not a zero sum game, but rather, a win-win situation.

According to Smith, nations can increase their combined output if each specializes in producing the goods at which it is most efficient and then engages in trade with other nations. Each country will be better off, in terms of the quantity of goods available for consumption, resources expended and additional output obtained through specialization.

Demonstrated by David Ricardo, a prominent classical economist, even if a trading nation does not possess an absolute advantage in the production of a commodity, it will still gain by producing and exporting those products at which it has a comparative advantage. In other words, the less efficient nation should specialize in and export the commodity at which it has the least disadvantage. To understand this point, consider the following example on a personal level. If you can type letters faster than your assistant, who is paid considerably less than you are, should you put aside your more sophisticated and profitable projects so you can type? The answer is no. You are better off delegating the typing to your assistant even though you are more proficient at it.

Today the contemporary international trade environment is significantly different than what it was during the lives of Adam Smith and David Ricardo. Nevertheless, free trade principles remain valid. Michael Porter, a contemporary trade theorist, explains that the principal economic goal of a nation is to produce a high and rising standard of living for its citizens. Porter contends that the ability to do so depends on the productivity with which a nation’s resources are employed. Productivity is defined as the value of the output produced by a unit of labor or capital. It depends on both quality and features of products as well as the efficiency in which they are produced. As such, the ability to export many goods produced with high productivity allows a nation to import many goods involving lower productivity. This is desirable because it translates into higher national productivity.

In pursuit of both increased productivity and international competitiveness, governments should promote trade without barriers—or free trade—without which the economic growth of a nation will be stunted. Overall, free trade promotes the creation of economies of scale, an increase in efficiency and competitiveness, a reduction of resources used in the production of goods and a higher standard of living. Yet, at the same time, governments also must provide safety nets for those who are unable to adapt.

Often unrecognized, the best example of totally free trade is the unobstructed trade among states in the United States. As a result, the United States is unquestionably the wealthiest single market and an extremely efficient producer of goods and services.

FAQ: Do small businesses benefit from free trade?

Talking Points:

Since 1992, trade agreements such as the Tokyo Round and the Uruguay Round of the GATT, the predecessor of the WTO, and NAFTA, as well as hundreds of other lesser-known trade agreements, have been negotiated and implemented by the United States. Without a doubt, small businesses have benefited from the resulting substantial reduction in foreign trade barriers.

Nevertheless, obstacles remain. For instance, some high foreign duties have prevented many small U.S. firms with limited resources from exporting. Large companies, however, often have circumvented these barriers by establishing a presence in the foreign country, achieving secure and competitive access. By the U.S. participating in trade agreements and thereby reducing and eliminating foreign tariffs, small companies’ products can be more price competitive, enabling them to export more goods and create new jobs.

Foreign red tape or non-tariff barriers, such as import license requirements, also have prevented small companies from exporting. Again, large companies often have the resources to hire consultants or the in-house expertise to work through these sometimes hidden barriers. Small companies usually don’t. By eliminating confusing red tape through trade agreements, small companies are put on a more level playing field and are better positioned to grow internationally. Additionally, small companies often are able to respond more quickly to market changes than large firms. This can give them an edge as the pace of global change quickens. Importantly, as more “niche” market opportunities present themselves—which may be considered insignificant in size for large multinationals—small firms often find them very profitable and well worth the pursuit.

FAQ: How is free trade different from a custom union or a common market?

Talking Points:

A free trade area is formed when two or more nations establish preferential trade liberalization policies by eliminating or substantially reducing trade barriers among themselves. A customs union surpasses free trade liberalization policies by establishing a common external tariff for non-members. A common market goes even further. Members eliminate restrictions on the movement of labor and capital among each other. Additionally, members may harmonize national policies to some degree, including monetary, fiscal and social policies, and concede a degree of political and legal control to a single ruling authority.

Most trade accords owe their success, at least in part, to prior reductions in trade barriers between the parties to the agreement. For example, the U.S.-Canada Free Trade Agreement was preceded in 1965 by the Automotive Products Trade Act (APTA), which allowed duty-free trade between the United States and Canada in almost all motor vehicles and parts. This resulted in extensive integration of motor vehicle production between the two countries.

Overall, free trade agreements, like custom unions and common markets, have had a major impact on trade and investment worldwide. In fact, they are responsible for shaping business relationships among companies across the globe. In order to succeed in the international environment, companies and organizations need to be aware of the impact trade agreements have had and will continue to have on their businesses and industries.

FAQ: How did trade liberalization policies give birth to the European Union?

Talking Points:

On April 18, 1951, the European Coal and Steel Community was formed. Its success prompted the March 25, 1957 signing of the Treaties of Rome, creating the European Economic Community (EEC) and the European Atomic Energy Community. On April 8, 1965, the three organizations merged into the European Communities, simply referred to as the European Community or EC. On July 8, 1968, the EC formally established a customs union. What prompted all this?

An economic decline in the 1970s, compounded by a recession in 1980, caused EC economies to stagnate. Declining confidence in EC policy and increased import competition from members and non-members alike resulted in individual EC countries establishing non-tariff barriers directed toward competitors, including other EC members. Consequently, industries became increasingly inefficient and less competitive with the United States, Japan and the newly industrialized countries of the Far East.

In an attempt to reverse this trend, in 1982, the European Council, composed of EC member nation heads, agreed that the completion of a unified market was a priority and requested that the EC Commission propose a timetable for removing all obstacles. In June 1985, the Commission released its white paper detailing a timetable ending December 31, 1992, for the implementation of some 300 directives or measures intended to eliminate all physical, technical and fiscal barriers to intra-EC trade. Essential to its success was the enactment of the 1987 Single European Act that changed EC voting procedure. This body has matured into a common market, now known as the European Union or EU. Policies include the elimination of barriers to labor and capital movements, coordinated monetary and fiscal policies, a common agricultural policy, use of common investment funds, and similar rules for wage and welfare payments.

This section appeared in Part III: Frequently Asked Questions and Talking Points of the book Grasping Globalization: Its Impact and Your Corporate Response, 2005.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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