Unit 1
Unit 3
External Stability
Free Trade
Free trade is a situation in which trade between countries is able to occur without intervention from protectionist policies. If free trade is followed then, according to the theory of comparative advantage, people will only engage in trade that will enhance their standard of living, and as a result both parties to a transaction will benefit. In other words, free trade can – in theory – lead to an increase in global wealth.
Most countries do maintain some level of protection of the local market. For example, here in Australia we do have tariffs that protect certain industries (notably the passenger motor vehicle industry and the textiles, clothing and footwear industry), and we also use subsidies (such as those paid to sugar growers). There are many who argue that using these policies is essential to maintaining employment in a globalised world. In an article in The Age newspaper in November 2009 (“Protect Us From Protectionism: Keep The Doors Open”) Greg Lindsay and Roger Bate argued that using protectionist policies was a bit like arguing that “Victorians would be richer if only they were unable to purchase goods from Queensland or NSW”.
In other words, to understand the benefits of free trade, you need to consider the costs of trade that isn’t free.
First, consider the consequences from the perspective of the country that chooses to implement a protectionist policy. As consumers we will now have to pay for the product, plus an additional cost (such as a tariff) that has been added by the government. When tariffs are used it will add directly to the price that we must pay for imported goods and services, which means that we will not be able to buy as many of them. This means we won’t be able to satisfy as many needs and wants; living standards could be lower.
In addition, producers in the country using a tariff will have no incentive to become more efficient. They will find that they can compete in the market without the need to increase productivity, or improve standards. In the long run this is not good for either productive capacity or employment in the country. Similarly, when we pay a subsidy to a producer this also removes any incentive to find more efficient ways to produce. While this may result in cheaper products for consumers, we still need to finance the subsidy. This can only be done by paying higher taxes, which still represents an additional cost to consumers. In Europe it is estimated that the average family of four pays an extra US$1,000 per year for the food that they buy because of the Common Agricultural Policy.
We should also consider the consequences for the country that is exporting their products. Although they do not have to pay higher costs (the tariff is levied and paid in the destination country), it can still result in lower living standards in that country. For example, if the Australian government levies a tariff on a product, it is now likely that our desire to import that product will fall. This will have an impact on demand for the producer in the other country – they won’t sell as many products as they might otherwise have sold. This will act to reduce their income, and therefore their standard of living.
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