Free trade debate
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Free trade is one of the most debated topics in economics of the 19th, 20th, and 21st century. Arguments over free trade can be divided into economic, moral, and socio-political arguments.
- 1 Definitional issues
- 2 Arguments for free trade
- 2.1 Moral arguments in favor of free trade
- 2.2 Economic arguments for free trade
- 2.3 Pragmatic arguments in favor of free trade
- 2.4 The economic benefits of free trade exceed the environmental costs
- 3 Criticisms of free trade
- 3.1 Economic arguments against free trade
- 3.1.1 Free trade in raw materials retrogrades development
- 3.1.2 International trade requires more resources to distribute
- 3.1.3 Sheltering young industries may pay off later
- 3.1.4 Free trade favors developed nations in certain areas
- 3.1.5 Influence of foreign firms
- 3.1.6 Free trade benefits only the wealthy within countries
- 3.1.7 Free trade increases offshoring
- 3.1.8 Capital mobility and comparative advantage
- 3.1.9 Diversification and economic bubbles
- 3.2 Sociopolitical arguments against free trade
- 3.1 Economic arguments against free trade
- 4 Debate on applicability of "free trade" to current economic conditions
- 5 See also
- 6 References
- 7 External links
The World Trade Organization (WTO) was created to open up markets and promote international trade based on the 'Free Trade' paradigm. The WTO creates and monitors agreements to reduce trade barriers, and arbitrates in disputes over foreign market access, and violations of these agreements. Its definition of 'Free Trade' is trade on a level playing field, so that the unlimited exchange of goods between countries is not necessarily 'Free'. If a country with aircraft producers, say, subsidizes corporate research and development (R&D) or enacts regulations requiring the industry to procure its aircraft part suppliers be domestic producers, then the WTO considers this a violation of Free Trade, even when the barriers to trade are not imposed at the national borders in an import-export transaction step (like a tariff).
Some economists argue that a foreign governmental producer-subsidy is another form of "comparative advantage"' and should not be used as a reason to impose domestic barriers on the purchase of overseas goods.
These economists argue that (since the surplus benefit to domestic consumers outweighs the surplus loss of domestic producers) the lower price of foreign subsidized goods is a net positive (as in the standard Ricardian argument) and the source of the "comparative advantage" is irrelevant. Therefore, any import restriction (even on "dumped goods") makes the domestic society as a whole worse off than it would be with unlimited imports.
This "abolitionist" position has had little governmental support in the developed world, due to the following considerations:
- Producer lobbyists and job-protectionists are more organized than consumer advocates.
- The "artificial" handicap of a foreign subsidy seems much less "just" to local production than advantages deriving from geography, natural resources, or native skill. Electorates often prefer "fairplay" to Utilitarian considerations.
- Despite accepting that a country would be better off without tariffs than with them, some game theory models consider that a long-term strategy superior to immediately dropping all tariffs is to negotiate progressively lower barriers bilaterally so as to pry open foreign markets to domestic producers of goods, benefiting both domestic consumers and domestic producers. (The justification for tariffs is not important; tariffs only exist to be relinquished.)
- If trade barriers are already low, the threat of a "trade war" of tit-for-tat tariff increases may reduce the temptation for either partner in bilateral trade to raise import barriers.
- It would tend to decrease the political power and revenue flowing to government bureaucrats.
Arguments for free trade
In the history of free trade, two types of arguments have been advanced in favor of allowing purchases from abroad, and free trade in the broader sense.
- Another set of arguments is essentially economic, that free trade will make society more prosperous. These are mostly technical arguments from the discipline of economics, starting especially with Smith's The Wealth of Nations, which overthrew the mercantile orthodoxy.
Moral arguments in favor of free trade
The 18th and 19th century intellectuals who backed free trade rarely did so under the rubric of increasing material wealth. In many cases this was given as the least important reason for free trade. Rather, they argued that international society would be improved by increased commerce. Some of these, and later, sociopolitical arguments are listed here.
Free trade is a right
The libertarian position argues that any trade restraint is immoral a priori, since restricting the rights of sovereign consumers to purchase foreign goods is outside the scope of legitimate government. This is in the tradition of the Anti-Corn Law radicals, like Richard Cobden, who concluded their 1838 parliamentary petition with an appeal to "negative liberty":
Holding one of the principles of eternal justice to be inalienable right of every man freely to exchange the result of his labour for the productions of other people, and maintaining the practice of protecting one part of the community at the expense of all other classes to be unsound and unjustifiable, your petitioners earnestly implore your honourable House to repeal all laws relating to the importation of foreign corn and other foreign articles of subsistence, and to carry out to the fullest extent, both as affects agriculture and manufactures, the true and peaceful principles of Free Trade, by removing all existing obstacles to the unrestricted employment of industry and capital.
Protectionism sullies the cause of patriotism
Adam Smith thought that protectionism against free trade was a scam on the public on behalf of producers, carried out in the name of nationalism. Even if overall economic interests had not been harmed by tariffs, he was opposed to them on the grounds that patriotism should not be perverted by scoundrels to enrich themselves.
Economic arguments for free trade
Classical economic analysis shows that free trade increases the global level of output because free trade permits specialization among countries. Specialization allows nations to devote their scarce resources to the production of the particular goods and services for which that nation has a comparative advantage. The benefits of specialization, coupled with economies of scale, increase the global production possibility frontier. An increase in the global production possibility frontier indicates that the absolute quantity of goods and services produced is highest under free trade. Not only are the absolute quantity of goods and services higher, but the particular combination of goods and services actually produced will yield the highest possible utility to global consumers.
Free trade policies are often associated with general laissez-faire economic politics and parties, which permit faster growth. Voluntary exchange, by virtue of its voluntary nature, is assumed to be beneficial (ex ante) to the parties involved—why else would they engage in the exchange? Thus, the restriction of voluntary exchange restricts commerce and ultimately the accumulation of wealth in the absence of real-world externalities such as infant industry protection.
Production possibilities frontiers and indifference curves
Here is the production possibilities frontier for a fictional country, "Country A". For simplicity, assume that the country produces only two goods, meat and rice. Because Country A has limited resources, the production of an additional unit of rice means some resources must be diverted away from the production of meat. The particular rate of trade-off between meat and rice is not important for this analysis, so it can be ignored.
Here is the production possibilities frontier for a second fictional country, "Country B". Like Country A, Country B can produce only the same two goods, meat and rice. Like before, limited resources mean that the production of an additional unit of rice means some resources must be diverted away from the production of meat. The particular rate of trade-off between meat and rice is not important for this analysis, so it can be ignored. The fact that the two countries have different relative rates of trade-off is important. This difference gives rise to a comparative advantage, a key concept in economics. Even if one country has an absolute advantage in the production of all goods, both nations can benefit from trade due to comparative advantage.
The first two images above assume a state of autarky, which means no trade occurs between the two countries. If free trade is possible, the green line is the production possibilities frontier (or "PPF") for the entire world. The world PPF is made up by combining the two countries' PPFs. Linear PPFs will always combine to form a shape with an inflection point, as shown at right.
Compare the world's production possibilities frontier with each individual nation's. Clearly, the world can produce and consume more when free trade is allowed. To arrive at the world's production possibilities frontier, vector addition must be used. Country A and Country B's meat and rice outputs must be added together for each possible production point.
An intuitive way of arriving at the world's production possibilities frontier is to first assume that each country tries to specialize by producing only one product. In the graph at right, the first units of meat are produced only by Country B (red). Once Country B is using all its resources to produce meat, then Country A (blue) begins shifting resources away from the production of rice and into the production of meat. On the other axis, assume that the first units of rice are always produced by Country A. Additional units of rice can only be obtained if Country B shifts some resources into rice production.
Returning to Country A, here is the same production possibilities graph, now with indifference curves added in. Indifference curves are a measure of preference and utility. Interplay between the country's preferences and production result in the actual combination of goods produced and consumed. Remember, this is the state of Country A under autarky.
Here is the same view of Country B's economy. Again, the actual combination of goods produced and consumed is dependent on the country's productive abilities and its citizens' preferences. Thus, it is not surprising that the combination of goods consumed in Country B differs from that in Country A.
Graphical information of the two countries can be combined in a single graph, as shown here.
When the two countries' autarkic consumptions are added, the total quantity of each good produced/consumed is less than the world's PPF under free trade. This indicates that by trading, the absolute quantity of goods available for consumption is higher than the quantity available under autarky.
Reciprocal free trade is in exporters' interests
An early lobbying effort on behalf of free trade was made by the businesspeople of the Anti-Corn Law League. Members of the league owned textile factories, and believed that repeal of the Corn Law import-ban would allow 1830s United Kingdom to sell cotton clothing to wheat-exporting nations. David Ricardo intervened on the Anti-Corn Law side developing his theory of comparative advantage in the process.
In 1950 Jacob Viner showed that a trading bloc mutually lowering tariffs would produce gains not merely on the demand side but also on the supply side. This was called trade creation: the benefits to the supply side as a whole accrue as resources are reallocated towards firms producing at the highest comparative advantage (among the partners) in each country.
Pragmatic arguments in favor of free trade
Increasing commerce makes war less likely
War is made less likely as a function of economic interdependence, a key feature of liberalism, a theory within the study of International Relations (IR). Liberalism suggests that states who share strong mutually beneficial trading relationships will be far less likely to wage war with one another. This is because liberalism, unlike realism and other theories within IR, does not stipulate that states are unitary actors (i.e., liberalism holds that the state does not function as would a single human). On the contrary, liberalism holds that states are composed of a multitude of competing domestic actors, and also allows for the influence of international institutions, such as trade agreements, the WTO, etc. The competing actors are constantly jockeying for political influence. Political resources being a function of wealth, the result is that states within the liberal system are greatly in influenced by wealthy and politically able actors, many of whose economic interests depend upon political stability and increasingly transnational supply chains.
Qualitative analysis suggests that free trade encourages economic interdependence between countries, reducing the likelihood of war. However, the belief that free trade would reduce war was hypothetical rather than empirical (at least until the 1950s). Twenty-two years after Ricardo advanced his theories of comparative advantage they were used as justification by the British to start the First Opium War. Also, it is hard to know when the occurrence of free trade has prevented the outbreak of war, but easy to know when it hasn't; critics of free trade sometimes cite World War I as an instance where developed, industrialized countries with reasonably extensive trade links abruptly broke off those trade links and entered into a particularly destructive war; however, most industrializing nations, with the notable exception of Britain, raised trade barriers and tariffs from the late 19th century onwards. It is an open question whether the First World War, its causes, and the economic environment that preceded it are sufficiently similar to the modern globalized economy to draw parallels between 1914 and the present.
An example exists in countries that have a McDonald's franchise. Of the many countries with franchises, the only armed conflicts to have taken place between these countries have been the United States invasion of Panama, the NATO Bombing Campaign during the Kosovo War, the 2006 Lebanon War, the Kargil War the 2008 South Ossetia war, and the Salvadoran Civil War. According to Thomas Friedman this is because intensifying of global economic integration, symbolized by a McDonald's network, increases the costs of war for both victor and defeated to a greater degree than ever before.
The process of free trade, especially in post industrial economies, effectively eliminates the existence of unequal resource distribution. Japan imports much of its food source, and in return exports mainly the produce of its extensive and high-tech workforce. Continuing the example, Japan would not likely be able to sustain the population it does today without one of three possibilities: an unbelievable increase in technology to allow for better use of land resources, international trade, or seizing arable land from another state. Trade also allows for better quality produce and competitiveness between nations, effectively raising the living standards of those nations. It would be illogical in such a case to jeopardise those living standards for a war. Finally, increased trade leads to increased bilateral communication between nations and as such, wars not focused on resources or land already cured by trade, including ideological arguments become less evident.
After World War II many liberals said that the war's ultimate cause had been the restrictive trade practices of Nazi Germany and the British Empire. They thought that free trade would increase the likelihood of a lasting peace. Cordell Hull, the U.S. secretary of state until 1944, believed this, and argued that as trade barriers dovetail with war, so free trade does with peace. The post war consensus expressed at Bretton Woods was that government coordination was necessary to prevent trade wars and competitive devaluations, to ensure free trade and peace.
Free trade reduces poverty
Conflating the "moral" and "economic" arguments are those campaigners who say that increased trade is the best way to relieve extreme poverty throughout the world. Opposing free trade, they argue, is tantamount to supporting economic injustice (as is displayed in the magazine The Economist for example). This argument was demonstrated in Jeffrey Sachs' The End of Poverty.
The thrust of this point is that economic and moral issues cannot properly be separated, and that any other particular socioeconomic problems can be combated most effectively through rising living standards.[clarification needed]
Bjørn Lomborg's Copenhagen Consensus on international development challenges ranked trade liberalization as third on the list of development priorities; the experts judged that modest costs could have large benefits for developing nations. (They ranked free trade as a "Very Good" opportunity fighting misery along with cheap measures against HIV infection, micronutrient distribution, and anti-malarial programs.) The conference was of the opinion that reducing subsidies and tariffs would improve the well-being of the global poor more than any agricultural, political, or environmental program.[clarification needed] They considered that the free trade in labour would also be a significant (although less important) move against poverty, especially if skilled worker migration were permitted.
Free trade enhances national security
Free trade can enhance national security, on the condition that a nation does not trade with its enemies. Free trade increases a nation's relative power vis-à-vis its rivals, because free trade gives optimal economic advantages, which translates into more economic and military power and more technological innovation. A clear example is the US, which enjoys to a certain degree free trade. Without this quite liberal trade the military burden (i.e., its military expenditures of about $500 billion) would weigh heavy on its economy. The closed-economy Soviet Union would have had to spend 15–20% of its GDP if it wanted to equal the US (which now spends almost 4% of its GDP). According to most economists heavy military expenditures slow the economic growth of an economy. The higher the expenditures, the higher the disadvantages. Once the burden becomes too high, an economy recesses, forcing the military expenditures to be decreased. According to many political scientists this was the case in the 1980s in the Soviet Union when their 10-year-long war in Afghanistan created what has been referred to as "The Soviet's Vietnam".
Free trade enriches cultures
Concepts such as cultural conservatism and nationalism are premised on the notion that a given culture is both valuable and endangered. To the extent that local culture is valued, products and services reflective of that culture are desired and thus available among the many alternatives. According to this argument, all major cultures have evolved through hybridization with external influences throughout history. Attempts to subvert this process by erecting trade and investment barriers deprive cultures of the positive influences that keep it from stagnating. This argument focuses on the fact that every culture evolves and that free trade supports cultural exchange, as cultural products can be traded freely.
The economic benefits of free trade exceed the environmental costs
A 2016 study in the American Economic Journal: Economic Policy found that "the benefits of international trade exceed trade's environmental costs due to CO2 emissions by two orders of magnitude. While proposed regional carbon taxes on the CO2 emissions from shipping would increase global welfare and increase the implementing region's GDP, they would also harm poor countries."
Criticisms of free trade
Trade agreements are negotiated by independent nations with their own interests and values in mind. There are values and interests other than maximum global output. Some level of protectionism is used by almost every nation that has the power to use it in the form of subsidies or tariffs to protect industries that nation considers essential, such as food and steel production.
Economic arguments against free trade criticize the assumptions or conclusions of economic theories. Sociopolitical arguments against free trade cite social and political effects that economic arguments do not capture, such as political stability, national security, human rights and environmental protection.
Economic arguments against free trade
Free trade in raw materials retrogrades development
The argument that a country could get locked into serving the needs of the world market in raw materials, and therefore not develop industrially was first advanced by Friedrich List in 1841, and received empirical support in the 20th century. It was discovered that African and Arab nations rich in natural resources (e.g., diamonds or oil) developed less rapidly than those nations without such 'bounty'. This is also a sociopolitical argument against free trade, because it is said that:
- The regimes exporting such valuable commodities to the west tended to be autocratic, and remain in unpopular power because of the massive payment streams from exports that flow to the state either because of state control of the means of production or increased tax revenue.
- The reason that civil wars and violence are correlated with the discovery of mineral wealth in the developing world is the world market for the commodities. This is one area of free trade which has few supporters, and conflict diamonds cannot be openly imported into any country.
It was also discovered that developed nations uncovering natural resources could suffer as a result of free trade, and for similar reasons. The massive capital influx to the Netherlands after it started exporting natural gas increased prices in the Dutch disease.
International trade requires more resources to distribute
Delivering food produced on the other side of the world to a supermarket has an environmental impact because it requires the use of fossil fuel in delivery from overseas, as compared to local delivery. In a perfectly efficient market, the costs of the fossil fuel would include the externalities associated with their consumption. Thus the full impact of their transportation costs would be reflected in the market price of the good. In the real world, there are no perfectly efficient markets. Much of the true costs of transporting goods around the world and consuming fossil fuel must be paid in the future dealing with the health and environmental effects of pollution. It is also likely that economic disruptions will be caused by future shortages of fossil fuel energy and spikes in fuel prices since it is a finite resource that is being depleted.
Sheltering young industries may pay off later
New Trade theorists challenge the assumption of diminishing returns to scale, and some argue that using protectionist measures to build up a huge industrial base in certain industries will then allow those sectors to dominate the world market. Less quantitative forms of the infant industry argument against totally free trade have been advanced by trade theorists since at least 1848.
Free trade favors developed nations in certain areas
Some services exported by developed nations are intangibles, such as medicinal formulae, trademarks, software, and entertainment. The value of this intellectual property is derived from legal protection against unauthorized reproduction. Some advocates of the poor claim that the reason IP-rights are strongly protected in International trade is the power developed nations have to protect the interests of intellectual property owners during trade negotiations. WTO-signatory nations renounce the right to produce generic copies of life-saving drugs, the only affordable treatment in developing nations.
Influence of foreign firms
Within developing countries, the local populace often stages protests against multinational corporations. Protesters insist that once allowed free rein the corporations will use their superior resources and experience to sway the political establishment of a country in favor of excessive concessions (tax holidays, underpaying for property, etc.) and try to influence the political system to fulfill corporate interests, which may or may not be shared by the citizenry. The concessions sought by these multinational corporations in turn collide with the free trade idea that subsidies should not be used to prop up corporations—in other words, subsidizing local corporations invites accusations of Protectionism by free trade proponents, while concessions to foreign corporations are portrayed as mere rational incentives.
Free trade benefits only the wealthy within countries
Some (like Friedrich List) argue the following:
- The wealthy own more capital, which increases in value as companies are able to produce at the lowest cost in the world.
- As the world's markets merge into a single global market the number of market-leading companies worldwide drops, with takeovers of smaller local corporations by larger multinational corporations. This process concentrates wealth in fewer corporations.
- Free trade replaces low-skilled jobs often done by the poor more easily than high-skilled jobs. This implication of the Stolper-Samuelson theorem is challenged on the basis that technology makes offshoring high value-added work feasible and more profitable than moving low-skilled jobs.
Free trade increases offshoring
Free trade allows companies the possibility of "outsourcing" the production of goods for domestic sale. Environmental and labor standards imposed upon these companies can be less in foreign production. Labor and environmental advocates argue that free trade thereby creates conditions that allow companies to circumvent domestic regulations by producing elsewhere. As free trade increases, the balance of power shifts in favour of companies and away from governments. This is considered to pose a threat to democratic self-determination by anti-globalizers and authoritarian control by totalitarian states. It has also been argued that free trade hurts developed nations because it causes jobs from those nations to move to other countries, and accelerates the "race to the bottom". As well as reducing rich-country GDP through lost jobs, competitive pressures will undermine democracy by creating pressures to lower wage demands, and protections like environmental and safety standards. The "race to the bottom" is blamed on international competition to attract traded-goods production, which, with Free Trade, can be sited anywhere.
Capital mobility and comparative advantage
Some descriptions of comparative advantage rest on a necessary condition of capital immobility. If financial or labor resources can move between countries, then comparative advantage erodes, and absolute advantage dominates. For instance, the Heckscher-Ohlin model derives comparative advantage from differing relative abundances of capital and labour between countries. Capital mobility and the competitive drive for the highest return on investment would give all countries identical relative abundances for new investment, eliminating comparative advantage and trade.
Other conceptions of comparative advantage are sound in all instances where the factors of production not homogenous between the parties notwithstanding mobility factors.
Given the liberalization of capital flows under free trade agreements of the 1990s, the condition of capital immobility no longer holds. David Korten argues that the theory of comparative advantage "is replaced by that of downward levelling". However, capital immobility is only one route to comparative advantage, useful to basic models, but not essential to it.
Basic models assuming capital immobility were convenient and not essential to the principle. Although greater capital mobility is likely to reduce comparative advantage, barriers to capital flows are not the only way to derive it.
- Early qualitative descriptions of the principle were based on the greater ease of producing different commodities in one country than another, and not on capital mobility. The comparative advantage of France over Iceland in wine production is not based on capital immobility.
- Comparative advantage can be derived from more complicated models including capital mobility (i.e., international borrowing, lending, and labor movement) and often posit movement of capital as analogous to the movement of goods.
Diversification and economic bubbles
It is also suggested that unchecked free trade increases the risk of economic bubbles that may affect entire nations and perhaps the world instead of just individuals. Diversification in personal and corporate investment portfolios is commonly accepted advice to reduce risk; similarly, diversity in economies can also act as a buffer against problems with specific product or product category demand.
Some feel free trade will tend to create economies too dependent on narrow specialties, those that are the numeric comparative advantage. When demand for those narrow specialties drops, the adjustment will be much more difficult than if existing diversification was already in place. It is usually much easier to grow an existing specialty than to start one from scratch when changes require it. Diversification of specialties tends to conflict with strict adherence to the theory of comparative advantage.
Sociopolitical arguments against free trade
Free trade undermines cultural diversity
Some French critics argue that allowing Hollywood movies to compete against French films would be culturally destructive; hence free trade in culture must be limited, otherwise, the French language and the visibility of a French perspective on the world would be threatened. Food imports competing with French farmers are restricted on the grounds that high food prices are necessary to sustain rural French culture.
Throughout the world, forces that many blame on free trade are eroding traditional ways of living and rural cultures. For instance, Sir James Goldsmith attacked free trade for causing the conversion of small-scale agriculture to large-scale agribusiness across the developing world: "The loss of rural employment and migration from the countryside to the cities causes a fundamental and irreversible shift. It has contributed throughout the world to the destabilization of rural society and to the growth of vast urban concentrations. In the urban slums congregate uprooted individuals whose families have been splintered, whose cultural traditions have been extinguished and who have been reduced to dependence on welfare from the state."
Some Canadian nationalists argue that the North American Free Trade Agreement or an extension could harm Canadian culture, due to foreign corporations (magazine publishers, television broadcasters, and satellite providers) challenging Canada's cultural content laws. These laws encourage Canadian content in the media.
Free trade causes excess dislocation and pain
Free trade may cause an employee to seek employment in several fields over his or her lifetime. Once, a farmer could expect to finish his or her life as a farmer, although his or her children might have sought employment in fields outside of agriculture. Now, changes may happen on a sub-generational level, faster than natural attrition. Coping with these transitions can be difficult, especially for the middle-aged and the elderly due to age itself or age discrimination. A pace of change that matches or exceeds generational cycles may be more palatable to populations. Problems associated with economic adaptation are generally not factored into the calculation of free trade's effects.
Welfare economics deals with the issue of the overall benefit to society of changes that harm some and help others. In a utilitarian view, the overall benefit of cheaper goods and services is given equal weight with the concentrated impact of lost jobs. Free trade is generally considered to achieve an overall increase in utility in a society, but it can also create winners and losers (see Stolper–Samuelson theorem). Individuals can be made worse off by an opening of trade but society has a whole should theoretically have more wealth.
"Free trade" has been accused of being a disguised form of colonialism or imperialism, particularly by proponents of economic nationalism and the school of mercantilism. In the 19th century these largely took the form of attacks on British calls for free trade, seeing these as expansion of the British Empire. Since the 1950s these attacks fall under the rubric of dependency theory.
Gentlemen deceive themselves. It is not free trade that they are recommending to our acceptance. It is, in effect, the British colonial system that we are invited to adopt; and, if their policy prevail, it will lead, substantially, to the recolonization of these States, under the commercial dominion of Great Britain.
Critics of imperialism sometimes focused on how imperial powers gained influence over weaker countries through specialization. Weaker countries would develop areas, typically in raw materials and agriculture, that would be economically dependent on the mother country. In the post-imperial world, this criticism changed. Imperial powers that controlled capital flows could maintain their economic status vis-a-vis their former colonies by using this dependency to their advantage. Imperial powers would have more choice (more competitive market) in countries from which they could acquire raw materials than those countries would have in buying final goods, particularly as imperial countries had the bulk of the world's financial resources and chose to behave oligopolistically. This pattern of exploitation, which may or may not lead to the benefit of imperial nations, focuses on the importance of political power in the international system and its weight in policy choices.
Rule of law and regulations
Although in David Ricardo's time economists regarded the regulatory powers of the state as being more destructive than beneficial, the economic shocks of the later nineteenth century, the early twentieth century and the Great Depression produced a strain of economists led by John Maynard Keynes who criticized laissez-faire capitalism as self-destructive. After World War II these Keynesians assisted the state in the development of regulatory institutions that were promoted as limiting the excesses and mitigating the failures of the free market and which were intended to sustain free trade through regulation. The later twentieth century saw the development of new economic theories that criticized the stress on regulatory institutions, though it is an uncommon opinion even among modern neoclassical economists to wholly regard all such regulatory functions of state as damaging to the economy.
These regulatory institutions, and indeed the rule of law itself, are costs to the development of industries. Although a number of laws—the protection of property rights, for instance—are strongly beneficial to corporations interested in the development of an industry in a foreign country, many other laws, regulatory laws in particular, can produce litigation risks or greatly increase the cost of operating in that country. Environmental regulations, labor laws, minimum wages, safety regulations, and (arguably) basic human rights can effectively increase the cost of operating in a country. As a result, these regulations often lead to a competitive disadvantage in the world economy for countries implementing those laws.
Similar arguments can be made for tax laws; corporations can evade high taxes by moving operations to countries with lax tax structures. In countries where the integrity of the state is weak, there can be an incentive for corporations to subvert governments through corrupt means and further undermine the rule of law in those countries in their favor. Accounting, banking, and investment regulations can take a similar direction; countries very interested in attracting investment may make their financial institutions more lax for short term political benefits. Some economists, such as Frederic Mishkin, point to this as an underlying cause of the Asian financial crisis of 1997-1998.
Many developing countries have not developed the financial institutions that developed countries rely on for the efficient functioning of their economies. The financial institutions that do exist in developing countries are often designed for economies with a strong role built for the state, and often with a great deal of corruption already existing. The influx of large amounts of investment capital from developed countries can put a considerable strain on financial institutions as they cope with enlarging their regulatory role, separating it from old state functions. The capital influx creates lucrative opportunities for corruption, especially within the regulating institutions. The development of these institutions runs a difficult course with investors who are interested both in the rule of law as it improves investment opportunities, and also in limiting their risk as investors. The development of these institutions can be a low priority for a poor country, which must bear the cost of modifying its business code, essentially for the benefit of foreign capitalists.
Free trade, then, creates an economic incentive for a race to the bottom in regulatory institutions; countries with lax, lenient, non-enforced, or selectively enforced regulatory legal structures will have a competitive advantage in attracting investment to their countries, and not merely in wages. From the capitalist's point of view, an ideal legal environment would have these features:
- Weak or un-enforced labor and environmental protection laws.
- Low or uncollected taxes.
- Strong legal protection for property rights.
- Changes to the legal code should be few and predictable, allowing business planning. The government should not be likely to override the rule of law, or impose exchange controls.
The difficulty that modern capital finds in meeting all of these conditions is that (1) and (2) are correlated with an immature legal system, but (3) and (4) are correlated with the division of powers, and long-standing legal institutions. As Russian oligarchs and early foreign direct investors in China discovered, the ability of an enterprise to make money is no guarantee that its profits can be retained. Some have argued that firms actually encourage (or at least prefer) the rule of law, judging that, on balance, it is "good for business". If so, the race to the bottom may become a "Race to the middle" in legal enforcement,[original research?] assisted by mobile capital, to create the optimum legal conditions for investment (balancing legal protections for labour and capital).
In theory, globally harmonized regulations regarding wages, the environment, safety, human rights, and other areas of economic control, would also prevent a "race to the bottom." Although globally harmonized regulations appear to be far off, there have been a number of moves toward regional agreements about these sorts of institutions. However, assumed in the "race to the bottom" argument is that greater labor and environmental regulation yield greater benefits, and are inherently good, contentious points. The stagnation of western European countries, France and Germany particularly, who enforce strong labor and environmental regulations, suggests otherwisesource?.
The financial consequences of mobile capital
The diversity of legal systems the world over and the limited degree to which those bureaucracies coordinate their regulatory and tax-collecting efforts can create loopholes to the benefit of corporations and private individuals, who can seek out havens from regulation and tax collection, even if they obey the letter of the law.
The freedom of capital to move outside the purview of a single authority has other harmful effects, even where it is not invested in the real economy. The following are common abuses of the free trade in capital:
One of the chief concerns among modern economists and financiers is to develop methods of harmonizing international regulatory institutions, in particular accounting practices, to improve transparency in world financial markets and reduce the risk experienced by investors.
A purported, salient benefit of increasingly mobile capital, however, is the competition on tax rates, where countries compete to house companies. Lower tax rates offer a competitive advantage to businesses. This has resulted in calls from some countries, particularly France and Germany, to "harmonize" tax rates, to maintain their high tax system, so that competition therein is impossible.
Free trade implies specialized industries and economic change. Economic changes can lead to strains and considerable changes to traditional economic and political systems. Social changes that Europe passed through over centuries—urbanization, development of national infrastructure, development of property rights, secular and national government, centralized administration, the development of financial sectors, and regulatory systems}—can happen quickly in an economy exposed to free trade and capital flows.
Offshore outsourcing and an increase of temporary visa workers resulted in a drop in the demand for computer programmers in the US, for example. Traditionally, the displacement and change caused by free trade was assumed to mostly fall on the poor and less-educated. However, the plentiful supply of low-cost but well-educated labor in Asia, the former Soviet Union countries, Arab countries, and Israel has cast doubt the view that the educated are mostly immune from change.
The internet has made it easier for dispersed groups to coordinate work on a project. Thus, education as immunity from the churn of economic failure is now being questioned. Education may merely be a prerequisite for economic success, not a barrier from failure.
Free trade and capital flows can conflict with existing systems. Western financial institutions which are based on lending is an affront to some traditionalists.[who?] The introduction of property rights, such as in tribal areas where property is held communally or where they existed in a traditional sense, poses considerable difficulties for governments. That question can arouse concerns of justice, equity, class, and ethnic strife between groups that feel victimized by history. Property rights in developing countries and their implications for free trade has been raised by the Peruvian economist Hernando de Soto.
Free trade can be profoundly redistributive, forcing thousands if not millions to change professions as previously marginalised foreigners out-compete them in their former ones. In the United States and in many developed countries there are systems of state trade adjustment assistance that help to smooth the transition for workers and industries from a pre-globalized economy to an economy transformed by free trade. In countries without those resources, a sense of victimization can rise in laborers displaced by trade that can contribute to a loss of confidence in national policy. Even with trade adjustment assistance in the United States, some of the most outspoken resistance to free trade, in particular to the North American Free Trade Agreement, came from left wing groups, such as labor unions. Even with assistance to smooth a transition between economic structures, there can be resistance to change in the character of an industry for economic and social reasons.
Free trade can change relationships between economic classes and interests. Balances between groups in society—a disproportionate share of power for an industry or group—can be undermined by free trade.
Changes to the national economy can undermine developing countries. Critics of free trade sometimes point to the fall of the Suharto government in Indonesia in the wake of the Asian financial crisis on sociopolitical stability.
Traditionally only the total value of goods and services are used to calculate the best economic model. However, opponents of free trade feel that change rates should also be a factor. Thus, instability and displacement risks (such as economic bubbles and career change) of a given approach are factored. Here is a hypothetical example of what this kind of trade-off may look like:
|Value of Goods and Services||Disruption Pace|
Traditional economics would favor approach A because it produces the most total goods and services. However, skeptics of full free trade would point out that approach A has a large disruption pace associated with it, and so approach B and perhaps C should be considered because of the stability they provide. Generally there will be some tradeoff between total wealth (goods and services) and stability such that both cannot be maximized at the same time.
An analysis comparable to the risk-return spectrum of free trade with respect to both country (recessions and bubbles) and careers (job-loss, retraining) is an area in need of further research. Stability is difficult to model compared to average return, and thus may have been under-emphasized.
Debate on applicability of "free trade" to current economic conditions
Another aspect of the debate over "free trade" revolves around the question of how much the concept accurately describes particular policies or economic conditions. Economist Dean Baker has argued in his book the Conservative Nanny State that regional trade agreements such as the North American Free Trade Agreement and Dominican Republic-Central America Free Trade Agreement and global trade agreements such as the World Trade Organization cannot accurately be termed "free trade" agreements because they actually increase certain barriers to trade (such as through the creation of monopoly patents for pharmaceuticals), while decreasing other barriers. Baker recommends calling these policies "trade" agreements.
- Emphasis added to Cobden's quotation of the petition, in a free-trade speech delivered in 1846, the full text of which is available at "Free Trade With All Nations."
- Thomas L. Friedman. The Lexus and the Olive Tree. Farrar, Straus and Giroux. ISBN 0-374-18552-2 p. 240
- "The Soviet's Vietnam," The Washington Post, Richard Cohen, April 22, 1988.
- Free Trade.org
- Shapiro, Joseph S. (2016-11-01). "Trade Costs, CO2, and the Environment". American Economic Journal: Economic Policy. 8 (4): 220–254. doi:10.1257/pol.20150168. ISSN 1945-7731.
- Quotation from page 103 of James Goldsmith's The Trap, 1994, Macmillan ISBN 0-333-64224-4 (summarized in Art Hilgart' review). Goldsmith had a background in corporate takeovers, but breaking up conglomerates within nations would still be permissible in his model, so long as no part of the conglomerate exported outside its area of production. His concern for the harm done to rural societies by the effects of free trade is summarized on page 103 with the sentence: "The cost of such social breakdown can never be measured. The damage is too fundamental."
- Clay, Henry (1843), The Life and Speeches of Henry Clay, II, pp. 23–24