a) Definition of free trade
b) Definition of political economy of international trade
III. National Welfare and Free Trade
a) The case for free trade
b) Case against free trade
c) Issues affecting free trade
d) Effects of tariffs and dumping on free trade
e) Market failure
f) Domestic market failure argument on tariffs
g) Economists supporting Free Trade
h) Theoretical and Practical Issues of Political Economy of International Trade Policy
IV. Political Models of Trade Policy
a) Median voter theorem
b) Collective action
c) Analysis of government policies on trade
d) Protection of agriculture, clothing and textile
V. International negotiations on Trade
a) World Trade Organization and general agreements
b) Multilateral negotiations and trade restrictions
c) Issues of PTA (Preferential Trade Agreements)
VI. Conclusion
VII. References
Abstract
There have been political arguments regarding national welfare and open borders for free trade. It has been noted that open borders allows free trade which helps in raising the GDP of a country but on the same distorts national welfare. Economists assert that divergence from free trade decreases national welfare but there is a critical belief that trade policies increases national welfare. In this view, this paper will define free trade and underline its costs and benefits. It will also assess political economy for international trade policy where two models, Median voter theorem and collective action will be assessed. Government polices such as tariff, subsidies, quotas and export tax will be assessed and their effects on free trade highlighted. The role of World Trade Organizations on trade restrictions will also be evaluated.
Introduction
International trade is defined as the trade of goods, services and capital crosswise international territories (Harrigan, 2003). It is imperative to note that international trade is quite significance as it leads to increment of GDP (Gross Domestic Product). Additionally, international trade allows countries to expand their market share for both services and goods. Goods that are not available in one country can be obtained from other countries through international trade. For instance, Brazil is one of the major exporters of goods and services to the United States while the United States a great importer of Brazilian products and services (Barbosa, 2010). In this view, international trade greatly contributes to the global economy.
On the other hand, political economy of international trade interprets buying, selling and production and their link to governments, laws and customs (Lederman, 2005). Particularly, political economy deals with allocation of wealth and national income for international trade through the process of budget. International political economy is a policy that handles guiding principles to finance and international trade. The policy also includes guidelines such as fiscal and monetary policies that affect international trade (Lederman, 2005). This brief overview therefore critically assesses the political economy for international trade policy.
National Welfare and Free Trade
The Case for Free Trade
Free trade allows countries to export and Import goods without limitations and remittance of extra costs. It does not involve tariffs which were conventionally taken as the principle source of revenue for governments (Kerr & Gaisford, 2008). Of note is that free trade comes with scores of benefits to international trade in the sense that countries can freely import and export products from other countries. One of the major benefits of free trade is improved production and effectiveness. Countries that hold a comparative advantage on a particular product increases their level of production hence increase in productivity. In this view, free trade allows countries to specialize in production of commodities which are advantageous to them. These countries allocate adequate resources which they buy at better prices from other nations. Notably, this aspect increases their effectiveness thereby making products available to other customers at affordable prices.
It is realized that free market enhances international trade making consumers to leap the benefits of competition and that of different types of commodities made available to them. Moreover, expansion of free trade increases competition which subsequently increases innovation (Kerr & Gaisford, 2008). This is so because companies seek for creative ways to gain a comparative advantage through producing unique and enhanced products as means of increasing the satisfaction of consumers. More significantly, free trade creates employment opportunities to scores of people. These jobs are created in the export and import markets.
Furthermore, with lowered trade restrictions, GDP raises which triggers economic growth. Decreased level of poverty and gains from foreign exchange are other predominant benefits of free trade. When a country like Brazil exports products to America with money, the country sends America non-interest IOU (a document conceding a debt) exchange for tangible commodities (McGuigan & Harris, 2010). Additionally, free trade adds to a country’s income. As matter of fact, countries that do not employ trade restrictions have a high growth rate economically, socially and politically due to diversity of ideas, products to mention but a few. It must be noted that, free trade also increases a country’s exports.
Improved exports are another principle benefit of free trade (Kerr & Gaisford, 2008). It is imperative to note that countries with trade restrictions limit its capacity to export products. On the contrary, countries that have embraced free trade make other countries to freely accept their imports. It is also realized that with free trade, chances of war are minimized in countries that have less or no trade restrictions (McGuigan & Harris, 2010). As matter of fact, such countries hold mutual respect among themselves hence a peaceful business environment. In particular, free trade comes with notable benefits which are beneficial to countries as well as to the consumers of international products. It must be appreciated that free trade helps in effective growth of economy, production, foreign exchange and creation of employment opportunities
Case against Free Trade
Despite the fact that free trade has various benefits to the countries and the consumers; there are disadvantages that come with free trade. It is noted that while trade restrictions are removed, structural unemployment may be experienced. While this effect may be a short time effect, a number of workers are affected together with their families. This process also impacts a country’s economy (Kerr & Gaisford, 2008). More significantly, free trade also raises instability of domestic economy due to international cycles. This happens due to the actuality that free trade allows a country’s economy to be dependent on international markets. As an example economic recession in the United States which is a major exporter and importer of products from Brazil affects the demand of Brazilian products. This consequently compresses incomes from exports thereby causing unemployment, low incomes, low GDP and low demand for domestic products.
Free trade does not offer an equivalent ratio of prices of exports and those of imports. As noted in various occurrences, countries with surplus commodities may decide to dump them in the international markets. From this prospect, countries with productive industries may be unable to compete under such provisions. Moreover, countries such as Brazil whose economies largely depend on agricultural products suffer a great deal of unstable imports and exports ratios (Kerr & Gaisford, 2008). The gains from their exports maybe much smaller than the exports from the United States. This aspect leads to increase in foreign debts due to the fact that their exports are less costly than their imports.
With no protection strategies from governments, new and developing industries may not be in a position to compete in the global markets. It is usually hard to build up economies of scale in competing world markets for new industries. It is also discovered that free trade can cause environmental issues as scores of companies due to competition do not include environmental legislation costs because they want to sell products at cheaper costs in order to remain competitive.
During GFC (Global Financial Crisis), pressure to improve protection is experienced (Kerr & Gaisford, 2008). In addition, free trade can create unbalanced development of a country’s economy due to international specialization. This is because a country can choose to build up sectors where it has a comparative advantage leaving other sectors undeveloped. Free trade also creates international monopolies due to introduction of multinational companies which in the long run attains monopoly thereby negatively affecting the interest of a country’s population.
More essentially, dumping is a major aspect that negatively affects free trade. As a matter of fact, dumping causes products to trade at lower prices usually below the cost of production. Dumping therefore makes people to view international market as an unbalanced trade field (McGuigan & Harris, 2010). It affects productive industries that become unable to compete with countries that dump their surplus in the global market at reduced prices.
However, tariffs, which are tax or duty imposed on imports by governments, prevent competition and dumping. It is discovered that tariffs harms a country’s economy in the sense that they raises domestic cost of production leading to sale of few products in the international markets. Particularly, tariffs limit products to and from international markets thereby affecting sales which subsequently affect international trade and more significantly a country’s economy (McGuigan & Harris, 2010). Import duty also affects production and consumption of products
Issues that Affect Free Trade
It is imperative to note many governments impose export taxes as an industrial strategy that helps them in raising revenue. The taxes are meant to magnetize foreign investment, promote value added and new industries as well as to support price stability. Moreover, export tax are also imposed in order to handle inflation and devaluations of currencies, to ensure domestic security of food and more essentially in addressing tariff intensification in countries that imports products.
While export tax benefits the country that is exporting products to other countries, these taxes greatly affects free trade. For instance Deese & Reeder (2007) confirms that in 1996 Brazil had forced exports tax on its agricultural products while it employed degree of difference in export of soybean meal as a way of promoting the exports of these products. We must admit that this step maximized the welfare of the country in the sense that it helped in enhancement of trade terms (Deese & Reeder, 2007).
Although the country leaps the benefits of export taxes, the United States which is a major importer of agricultural products from Brazil found it hard to import products from Brazil due to the rising prices (Barbosa, 2010). Remember that export tax add a burden to those importing products hence leading to scarcity of products in the international markets. Therefore, export taxes are among the major aspects that influences free trade. Of note is that these are taxes that are imposed on commodities for sale in other countries which are employed as percentage of the value of the product or as a fixed rate on product units.
Specifically, an export tax that completely prohibits exports leads to less economic growth due to reduced investments and foreign revenue. On the other hand, a positive export tax rate helps in maximization of the welfare of a given country through a rise in terms of trade. As indicated earlier export tax increases the price of exports in the international market thereby increasing the terms of trade. As an example, export tax or import tariffs imposed by the United States governments improve the general welfare of the country while its major importers suffer increased prices. This is because the burden of tax is passed on to foreign consumers especially when the demand of the taxed export is extremely inelastic. However, in order to balance the effects of export tax and import tariffs, countries that are affected may also retaliate through imposing import tariffs on their imports and at the same time impose export tax on their exports.
Market Failure
Market failure refers to the condition where free markets run short of allocating resources in the most efficient manner (Vaidya, 2006). This affects free trade in the sense that markets fails to contain monopoly power. The markets also fails to completely meet requirements of public goods such national defense, infrastructure, street lighting. Particularly, there are six types of market failures which influence free trade. They include natural monopoly whereby a certain firm produces goods and services at much lower prices than any other company. It is of the essence to note that natural economy occurs when costs are lowered in a firm’s scale or in the services and product’s scope. Natural monopoly allows monopolists to increase their tariffs and costs due to the fact that they have incentives for productivity (Vaidya, 2006). .
The second type of market failure is externalities which comprises of any benefit or cost included in the price of services or goods. Externalities can either be positive or negative where positive ones occurs when producers are not in a position to put into consideration all the benefits realized in the undertaken activities hence leading to production of less products. On the other hand, negative externalities occur when a producer does not cater for all the costs of his production. A good example of negative externalities is air pollution. When a producer is not charged for polluting the environment during the production process, more products are manufactured but with no social benefits (Pearson, 2006).
A public good is another type of market failure. Of note that public goods are products that when consumed by one person do not in any way decrease their availability to other people. This is opposite of private goods which when consumed by one person are actually not available to other people. Public goods include radio broadcast, health, education, and national defense to mention but a few (Pearson, 2006). Asymmetric information as a type of market failure makes market to perform inefficiently especially when people hold different or private information. It is important that buyers get complete information regarding a particular product so that they can pay according to the value of a product on sale.
Moral hazards on the other hand, refers to the availability of incentive that people utilizes without bearing the costs incurred. For instance, a person under medical insurance effectively gets unlimited medical care because he does not have to bear the cost of care. Such an individual may also become socially irresponsible because he/she is aware that any cost of care will be covered not by him/her but by the insurance company (Vaidya, 2006). The last type of market failure is transactions costs. Transactions costs are incurred when consumers and producers are made to pay for information provided to them regarding market opportunities and completion of transactions. These costs lead to inefficiency of markets.
Considering the effects of market failure on producers and consumers, domestic markets failure supports regulation as a way of protecting consumers and producers. Domestic market argues that hands-off strategy is inspirational in markets if other markets are functioning properly. This is an indication that supports imposition of tariffs to maximize national welfare while at the same time supporting domestic markets. Domestic market failure occurs when market prices fails to mirror social benefits and costs (Pomfret, 2008). Intervention from governments that may distort inducements in one market helps in augmenting welfare through offsetting the impacts of market failure. Domestic market failure requires a domestic policy through utilization of cost-benefits assessment to cater for unmeasured social benefits. Tariffs cause extra production which yields more social benefits despite distorting production and use of products (Pomfret, 2008).
Economists Supporting Free Trade
Using the idea of producer and consumer surplus, free trade theoretical case rests on cost-benefit assessment. Economists on the other hand, do not support free trade citing that the concepts of consumer and producer surplus do not appropriately measure benefits and costs of free trade (Pomfret, 2008). They ascertain that free trade is not a major source of non-performances in internal markets but they confirm that imperfections in internal markets greatly interfere with external trade and industry relations. In this view, economists therefore suggest that a trade policy should be put in place to offer partial resolution to free trade.
Theoretical and Practical Issues of Political Economy of International Trade Policy
Economists argue that divergence from free trade decreases national welfare. However, trade policies sometimes augment national welfare. It is realized that while trade policy for international trade works well for free trade, it in many occasions ignore domestic welfare. This occurs when trade policy is predominantly influenced by politics of special interests (Pomfret, 2008). It is found out that trade policy for international trade creates a gap between particular groups’ welfare and national welfare.
Nonetheless the differences between national welfare and group’s welfare clarify particular issues that affect political economy for international trade. It must be noted that trade policies in reality does not support national welfare as claimed by supporters of these policies. From this prospect, it is discovered that political economy for international trade policy meets the wishes of individuals which are imperfectly replicated in the governments’ objectives. It is also believed that governments’ objective is to capitalize on political success as opposed to catering for theoretical measure of domestic welfare (Pomfret, 2008). Policy makers replicate their own interests and preferences at the expense of the nation as whole. This confirms that politics is a kind of market where policy choices are put on sale for resource transfer and political support.
Political Models of Trade Policy
However, it is imperative to note that political economy for international trade is determined through political models. These models include median voter theorem and collective-interest group theory. Median voter theorem provides that autonomous political parties alter their strategies in order to encourage voters in ideological spectrum (Delvin, & Estervadeordal, 2003). This model makes assumptions that two political parties are in competition and the goals of each party is to win over the other.
On the other hand, voters have different choices and in this case their tariff preferences hold opposing views. Median voter theorem also indicates that each party involved decides on the tariff level (Delvin, & Estervadeordal, 2003). When one party suggests a tariff which is higher and the other party puts forward a much lower tariff, the one with a low tariff rate wins by majority votes. From this theory, a trade policy that imposes huge losses to less people but on the other hand benefit scores of people should be legally enacted.
Conversely, collective actions view activities of politics as a general good (Lederman, 2005). As an example, tariffs shield companies in the entire industry but the cost of fighting for the burden of tariffs are catered by a few companies. The collective theory puts forward that well organized industries are shielded. Additionally, the theory provides that trade policies which inflict full amount of huge losses that are shared among several companies or consumer cannot be rejected.
Considering cost-benefits assessment, political trade policies yields less benefits but more costs. In collective action, consumers who come together have the inducements of supporting free trade while an individual person has none due to the fact that the individual consumer will yield more costs as compared to benefits good (Lederman, 2005) . Trade policies which inflict huge losses to the entire society as opposed to individuals face less rejection. Each individual in the society who suffers losses hold strong inducements to support the type of policy he/she desires.
Analysis of Government Policies on Trade
Government policies on trade increases producer surplus through the raise of tariffs, export subsidy, import quotas and voluntary export restraint. On the other hand, through government policies consumer surplus falls with fall in tariff, export subsidy and import quotas. Nonetheless, government revenue rises with introduction of tariffs but falls with export subsidy due to a raise in government spending (Barbosa, 2010). Precisely, tariffs increase the overall national welfare but for small countries, welfare remains ambiguous.
Protection of Agriculture, Clothing and Textile
Through the model of trade policy industries dealing with agriculture, service industry and manufacturing companies are protected through trade policies. As an example, the United States imposes quotas on sugar while in Japan tariff is imposed on imported rice. It is realized that through tariffs and quotas scores of jobs are protected especially in the agriculture, clothing and textile industries. United States, European Union and Japan are major countries are the major countries that use quotas and tariffs to save jobs in the aforementioned industries. According to Barbosa (2010) Brazil has also temporarily banned the rice exports in 2008. However, it is important to note that protecting jobs through, export taxes, quotas and tariffs is not absolutely productive due to the incurred cost per job saved. It should be noted that the costs of saving jobs are higher than the standard yearly income of employees in an industry that is protected.
International Trade Negotiations
International trade negotiations have helped in tariffs reduction as well as reduction in other restrictions to trade. It is worth noting that the agreement of trade and tariffs started in 1947 as impermanent international agreement. The 1948 negotiations in Havana lead to the formation of international trade organizations (ITO) (Barbour, 2010). Later ITO was replaced in 1995 by World Trade Organization (WTO) where exporters were mobilized to promote free trade for the purpose of expansion of export markets. Multilateral negotiations disregarded the support of limited trade and also assisted in preventing trade wars.
World Trade Organization deals with trade restrictions through tariff rates reduction which was made possible through multilateral negotiations (Subramanian, 2007). WTO also employs protection of non-tariff hurdles as way of dealing with trade restrictions. Export subsidies and quotas are turned into tariffs since tariff protection incurs costs. Trade restriction can also be addressed through binding whereby countries that have imposed tariffs on their products are required to maintain a certain rate and not to raise the tariffs.
However, it is very important to note that WTO exempted agricultural exports’ subsidies and market commotions which might be as a result of imports surge. Through the international trade negotiations, WTO established three agreements which include GATT (General Agreement on Tariffs and Trade), GATS (General Agreement on Tariffs and Services) and Agreement on Trade-Related Aspects of Intellectual Property (TRIPS) (Subramanian, 2007). Additionally the organization also set a process through which disputes should be set. The organizations require that a trade dispute be settled in the presence of WTO experts who are supposed to determine a case within 15months.Countries which do not adhere to laid down rules as provided by WTO risks facing severe punishment which is accomplished through allowing other countries to inflict restrictions of trade on the country’s exports.
Preferential Trading Agreement
Of note is that WTO does not permit prejudiced trade policies such as PTA (Preferential Trading Agreement). Nevertheless, an exception to the mentioned rule is permissible only when tariff is at zero rates (Barbour, 2010).The agreements supported by zero rate tariffs include the customs union which is a conformity which supports free trade amongst members but on the other hand, employs external trade policies to countries which are non-members. An example of customs union is European Union (EU) (Barbour, 2010).Zero rate tariffs agreement also include a free trade area which permits free trade amidst members but also allows each member to employ own policies of trade towards countries that are non-members.
Conclusion
International trade supports distribution of products in many countries. However, activities of international markets are enhanced through free trade which allows buying and selling of products with less or no trade restrictions. It is worth noting that free trades come with scores of benefits as well as cost. Free trade is influenced by several factors which include tariffs, export tax, quotas, market failure and trade polices put forth by governments. In order to minimize the costs of international trade, an international body (WTO) foresees the activities of international trade.
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