Srinivas Atreya
Free Trade vs. ProtectionismA attempt to analyse the significance of International Trade and its ideologies in the 21st Century
Introduction
What is Free Trade?
o The History and development of Free Trade.o The Advantages of Free Trade.
What is Protectionism?
o The History and development of Protectionism. o The Advantages of Protectionism.
The Distinction between Free Trade and Protectionism
India: Its Trade Policies
o The Development of International Trade Policy in India.o India’s current stance on Free Trade and how the present economic policy
helps in creating better trade relations with other countries of the world.
The Global Perspective: How the countries of the world tune their trade policies
o How the large economies of the world such as the United States, Japan and China manage their trade policies.
Why Free trade is more popular than Protectionism in the 21st century
o An analysis as to why more and more countries are turning towards Free Trade.
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Introduction
Trade has right from the creation of an organized market been an integral part of the
economy of a Nation or Business. No economy beginning with the early Mesopotamian
civilisation has survived and prospered without actively taking part in Trade both internally
and with other foreign economies. International trade has not just helped nations to
develop economically but also grow socially and culturally. Exposure of various foreign social
cultures and practices brought forward by International trade has in many instances helped
economies develop as a whole. However this concept of gaining mutual benefit from
exchange of goods and service had held two contrasting ideologies regarding the level of
control placed on trade. They are Free Trade and Protectionism. Both concepts have been in
use in one form or another from times immemorial and each hold their advantages and
downfalls. There continues to be a debate as to which trade policy is better suited in helping
in the growth of an economy. However, like any economic ideology, Both Free Trade and
Protectionism are dynamic concepts and each of them has had its place in history and with
changing times and economic situations, policies of both ideologies have helped nations
move ahead. In contemporary times, with rapid globalization and the unprecedented
growth of the world economy in a short period of time, Free Trade policies are preferred as
they help in maintaining a steady stream of resource both intellectual and material to be
exchanged and mutually benefitted upon. An attempt to try and understand each aspect of
these ideologies will never cease to exist and with changing situations, the applicability and
usage of each of these concepts will continue to develop and change.
What is Free Trade?
“It is the maxim of every prudent master of a family, never to attempt to make at home
what it will cost him more to make than to buy...If a foreign country can supply us with a
commodity cheaper than we ourselves can make it, better buy it of them with some part of
the produce of our own industry, employed in a way in which we have some advantage”. It
was this insight by the 18th century economist Adam Smith which concisely explains the
seminal principle of Free Trade. Trade is one of the most essential economic activities in the
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21st century and no state can effectively stand to develop without actively taking part in it.
Globalization, especially after the Second World War has allowed businesses and nations
across the world to market their products and services with other economies leading to a
rapid growth in international trade. The development of communication and travel has
ushered in an era of countless new trends, services and commodities all with endless
possibilities. All this has resulted in a rise in human interaction and has lead to the opening
up of world economy. Trade without restrictions has brought in the era of globalization and
human advancement.
The main idea of free trade is that it follows a laissez-faire approach, with no restrictions on
trade and it is a type of policy that allows traders to act and transact without interference
from the government. Countries which engage in trade internationally without trade
barriers form the fundamental basis for free trade. It is an established fact that Global trade
allows countries to use their resources be it labour, technology or capital more efficiently.
Free Trade encourages greater efficiency among local establishments, leads to greater
product choice, and price reductions while encouraging local firms to expand and export.
The main purpose of free trade agreements is to allow faster and more business between
the two economies so that they maintain the stream of mutual benefit.
Free Trade as a concept bases itself on the two theories of the Classical theory of Absolute
advantage by Adam Smith and the Comparative Advantage Theory by David Ricardo.
Smith, in his study recognized that fewer the impediments to trade, the richer everyone
would become. He criticized the royal charters, tariffs, cartels, monopolies and his
opposition to restraints on trade made Smith the progenitor of Free Trade. Ricardo
expanded on the free-trade idea of Adam Smith by explaining why international trade is
essential. According to him, each nation has a competitive advantage as everyone has
something they do best and if they trade with each other, both parties will live better.
Free Trade today is essential for any economy’s growth and survival. Maintaining
international trade relations not only brings economic benefit but also brings that economy
closer to the rest of the world both socially and culturally and almost all economies in the
world today are dependent on other economies for resources both human and material.
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The development of science and technology has made the world smaller in terms of travel
and better informed in terms of information and this has led economies while being fiercely
competitive to also be cordially co-operative. Trade mechanisms like the NAFTA and WTO
have been designed by the major world economist to help in maintaining a healthy trading
relationship between businesses or economies.
A Brief History of Free Trade
The development of trade and its role in the development of the world economy is deep
rooted and goes back to the earliest of civilisations. The need to coexist and maintain trade
relations with other economies for goods and services was realised millennia ago by the
founding fathers of our great civilisations. Trade was a major component of not just the
economy but also the society and much was at stake in order to maintain trade relations
with other nations and economies. Economists who had advocated free trade believed that
trade to be the reason as to why certain civilizations prospered economically. This was
illustrated by Adam Smith when he pointed out that increased trading had helped in the
flourishing of not just the Mediterranean cultures of Egypt, Greece, and Rome, but also of
East India and China.
It was during the medieval ages when European nations such as England, France and
Portugal started competing and building trade empires across Asia. These nations
recognized the potential of the valuable spices and other exotic commodities found in India,
China and other south East Asian countries went after them. These traders and trading
establishments were highly competitive and they aggressively lobbied against trade
restrictions. Most of the European Trade Cartels succeeded in establishing massive trading
ports complete with factories by influencing the small kingdoms and their rulers using
persuasive tactics and politics and amassed huge fortunes in a very short time.
However, Free Trade has held more significance from the beginning of the 19 th century
when trade was the engine of economic growth. The advent of capitalism and
industrialisation along with gold becoming the universal choice of currency led to many
countries dropping restrictions on trade. While Britain maintained its position as the factory
of the world, nations like United States and Germany quickly benefitted from free trade and
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rapidly industrialized around this time. Many liberals in Britain and United States came to
believe that Free Trade promoted peace. The British economist J. M. Keynes suggested that
free trade so long as it was combined with internationally coordinated domestic economic
policies to promote high levels of employment, and international economic institutions
meant that the interests of countries were not pitted against each other. This view was
however temporarily put to rest with the advent of the First World War and the subsequent
collapse of Wall Street which led to collapse of many major world economies. The Great
Depression ushered in a new era of Protectionism with most major world economies
severing their Free Trade policies and reverting back to protectionist measures. This
depression continued into the late 40’s and countries like Japan and Germany were reeling
under severe inflation and economic downturn. This forced comparatively stable economies
like the United States to open up their economies and lower their trade barriers.
The General Agreement on Tariffs and Trade (GATT) was formed in 1948 and it was the
result of 23 countries getting together to sign an agreement to reduce customs tariffs. The
GATT ushered in a new era of globalization and increased trade between the major
economies of the world. This agreement was the first of the many agreements which were
to follow and which made an attempt to reduce trade barriers and protectionist policies and
promote free trade. The Uruguay Rounds from 1986 to 1993 were one of the most
ambitious trade rounds and they are directly related to the establishment of the World
Trade Organization (WTO) in 1994. The WTO super-ceded GATT and is now the highest
international authority which looks after Free Trade across the world. Other more regions
bound free trade policies like the North American Free Trade Agreement or NAFTA were also
created after the 19 to assist in creating better trade
The Advantages of Free Trade
A famous economist providing motivation about free trade accurately summed up the
concept of free trade in the phrase, "If you do something good for me, I will do something
good for you."
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In 1776, Adam Smith while questioning the mercantile assumption that a country’s wealth
depends on its holding treasure (Holding treasure is the amount of gold a country’s treasury
has rather than the amount of goods and services) said that a country had absolute
advantage in the production of a product when it was more efficient than any other country
in producing it. Therefore, Smith reasoned that if trade was restricted each country could
specialize in products that gave it a competitive advantage. This specialization would
increase their efficiency as Labour would be skilled by repeating the same tasks and all and
long term runs would provide incentives for development of more efficient working
methods.
In the 21st century, there are many important reasons as to why voluntary exchange is good
not only for the contracting parties but the world as a whole. The first being that trade
improves global efficiency in resource allocation. A glass of water may be of little value to
someone living near the river but is priceless to a person crossing the Sahara. The bottom
line being that trade delivers goods and services to those who value them most. Next, trade
allows partners to gain from specializing in the producing those goods and services they do
best and when producers create goods they are comparatively skilled at, such as Germans
producing beer and the French producing wine, those goods increase in abundance and
quality. Finally, trade allows consumers to benefit from more efficient production methods.
For example, without large markets for goods and services, large production runs would not
be economical and large production runs, in turn, are instrumental to reducing product
costs therefore Lower production costs lead to cheaper goods and services, which raises real
living standards. Free trade also fosters in a sense of competition and therefore scope for
innovation. These instances along with empirical evidence support the idea that nations
more open to trade tend to be richer than those that are less open. In a study conducted by
prominent economists Jeffery Sachs and Andrew Warner in 1970 to measure the
relationship between economic growth and international trade and how the ‘openness’ of
an economy helps in its economic development, they found that while open economies
grew at a rate of 4.49% per year, closed economies only grew at a rate of 0.69% per year.
This study clearly indicated that free trade seemed to produce higher levels of economic
growth and standards of living.
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However, no idea, policy or concept is complete without its contrast and criticism and no
policy can ever be implemented without understanding the contrasting concept. Each
concept holds true in its own right and therefore it is absolutely necessary to understand
every aspect of it to create a complete picture. Protectionism is held in contrast to Free
Trade and it is important to understand the significance and development of it to help in
increasing the efficiency of an economy.
What is Protectionism?
While Free Trade has helped the world economies to open up and develop, it is not without
criticism and contrasts. The concept of protectionism and protectionist economy does
exactly what Free Trade refrains from doing. Protectionism can be briefly explained as an
economic policy that restrains trade between states to "protect" businesses and workers
within a country by restricting or regulating trade with foreign nations it is designed to
discourage imports, and prevent foreign take-over of local markets and companies. This is
achieved using protectionist policies and methods such as imposing tariffs on imported
goods, restrictive quotas on imports, Anti-Dumping legalisations against dumping by foreign
corporations, Subsidies, both direct or indirect given to local firms to promote their growth
so as to counter foreign encroachments, Export Subsidies, used to increase exports,
Exchange rate manipulations used to lower the value of the currency to achieve an
improved trade balance and a variety of other restrictive government regulations.
A Brief History of Protectionism
Ever since the beginning of organised trade there have existed some economic ideologies
and concepts which even to this day play a vital role in it’s functioning. Protectionism is one
such economic concept that has been used at almost every step of trading history. No
economy has ever avoided using protectionist measures or policies at one time or another
to maintain its internal trade balance. Protectionism is closely related to mercantilism which
holds that the prosperity of a nation is dependent upon its supply of capital and that the
global volume of international trade is "unchangeable". Also economic assets are
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represented by bullion held by the state that is best increased through a positive balance of
trade with other nations. Most European nations during the medieval ages from the 16th to
the 19th century followed mercantilist policies and it fuelled European imperialism and its
many wars. However, by the late 18th century mercantilism began to fade away and it is
today almost rejected as whole by Economists. Protectionism on the other hand is much
more evolved form and it is sometimes used even today by countries to protect their
economies from excessive encroachments by outside businesses and economic influence.
The last time protectionist measures were adopted was during great depression when most
major economies pulled down their trade shutters and focussed more on internal economic
recovery and employment generation. The recent economic downturn has led many
countries to rethink their international trade policies and tighten their trade regulations.
However from past instances in history, free trade regulations and the benefits derived from
it outweigh the benefits derived from being a closed protectionist economy and therefore
trade regulations will be modified only to a certain extent if any.
The Advantages of Protectionism
Protectionism as a concept is fundamental part of trade dynamics and many economies of
the world recognize it potential. However some factors of protectionism stand out in the
present day scenario and still hold a firm place in today’s free trade dominant trade
pavilions. There exist in every economy some aspects which find the need to be protected
from excessive and lenient trade policies. Infant industries may need temporary tariffs and
quotas to survive against established foreign producers if these firms are producing new-
technology goods such as computers and mobile phones. Dumping and Unfair competition
in the form of subsidies and government benefits to foreign firms may result in local
businesses losing out and protectionist measures will help local, small-scale firms build a
base for themselves. Protectionist policies of the government may also help in improving
their balance of payment as there is more export and lesser import. This also protects
declining industries from creating further structural unemployment.
In fact, one of the major advantages of protectionist measures is it helps in maintaining and
generating the employment of the country. Employment opportunities of an economy are
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generally reduced when there is rampant establishment of foreign companies as people
from those foreign economies take away the jobs of this economy. Strict trade restrictions
help in maintaining a balance in the internal economy of the nation and ensure that the
people living in that country are not deprived of their opportunities. Unemployment,
Underemployment due to free trade policies is best highlighted in developing countries
where Workers are under paid and lack any kind of union and legal representation and
protection are forced to take jobs that exploit them. It is no surprise that Global companies
often indulge in exploiting labor in developing nations as they are easily targeted and
influenced and because these nations rely on export based industries for economic
generation.
The Distinction between Free Trade and Protectionism
Observing the various characteristics and trends set by both Free Trade and Protectionism,
we can clearly draw a line between the two concepts. Clear distinctions can be sought
observing the history and advantages of the two concepts and it can be observed that both
concepts contrast one another other and one’s advantage can be pictured as another’s
disadvantage. For instance, while free trade helps in the growth of a developing economy
through foreign investment, Multinational corporations may also exploit the workforce
because of their dependency on job. However, with contrasting principles comes the task of
balancing them. No economy can successfully survive on either of the ends and it needs to
find a suitable middle ground based upon its prevailing internal factors to effectively benefit
and prosper. It is therefore trade policies which help in maintaining this balance that have to
be created to help in the advancement of an economy.
India and its foreign trade policies
India has not been far behind in reaping the benefits of globalization and it has after the
1990’s or the so called “Post Liberalization Era” extensively participated in trade with the
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other economies of the world. Improved Export Import policies along with lower tariffs and
the establishment of Special Economic Zones (SEZ) has attracted a huge amount a foreign
investment and that has led to the rapid development of both rural and urban areas. The IT
boom and India featuring as the most potential investment destination has ushered almost
every major multinational corporation to invest heavily in India. I
However, India while steadily opening up its economy has still maintained restrictive
investment and trade norms. It has retained its power to ‘protect’ when needed and this
has been very effective in cushioning the impact of the recent economic downturn.
Nonetheless, the government’s stand on trade and investment policy, in recent years has
displayed a marked shift from protecting ‘producers’ to benefiting ‘consumers’. This is
reflected in its Foreign Trade Policy for 2004/09 which states that, "For India to become a
major player in world trade ...we have also to facilitate those imports which are required to
stimulate our economy." It is clear that India is now aggressively pushing for a more liberal
global trade regime, especially in services. For instance is that it has assumed a leadership
role among developing nations in global trade negotiations, and has played a critical part in
various trade negotiation rounds including the ever important Doha negotiations.
India has been aggressively moving ahead on the global stage and has signed various trade
agreements with its neighbours and is seeking to establish trade relations with new ones
including many East Asian and European countries. Some of the important existing trade
agreements include the The India-Sri Lanka Free Trade Agreement, India-Nepal Trade
Treaty, and The Comprehensive Economic Cooperation Agreement (CECA) with Singapore
and Framework Agreements with the (ASEAN). Being an active member of the WTO, India
also has trade agreements with China, South Korea, Brazil and many such major economies
of the world. Trade pacts with the European Union and United States are also in the
pipeline. The 123 Agreement with the United States in 2008 can be considered as a founding
stone to renewed trade relationship with the US.
It is therefore evident that India is very much a vital player in world economics and trade
and it has its GDP and growth indicators to back it up. India is one of largest and fastest
growing economies among the developing world and it is considered as one of the largest
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markets for commodities and services from around the world. With reforms to create a
more flexible trade policy, India’s economy is bound to grow at a faster rate and lead the
country to greater heights of economic and social prosperity.
The Global Perspective on International Trade
As highlighted earlier, globalization had enhanced and renewed the will of the economies of
the world to trade and benefit from each other. Major leaders of the world economy like
the United States of America, Japan and Germany have all aggressively participated in world
trade and have benefitted enormously from it. The United States and the European Union
are the most active advocates of Free Trade and they have benefitted enormously by
limiting their trade barriers. Even the latest economic collapse has only acted as a speed
breaker in continuing and expanding trade relations. With signs of recovery around the
corner, the major capitalist economies of the world are beginning to resume their trading
activities with the same pace as was observed before the economic collapse. The European
Union or the EU and the United States with their aggressive trade pacts such as the NAFTA
for the Americas and internal trade pacts and standardization of currency for the EU have
permitted these economies to trade with virtually nonexistent trade barriers that have
allowed these countries to expand their industries and commodities all over the globe.
China, too after its gradual opening to trade has probably the most aggressive participant in
global trade. International Trade has resulted in unprecedented rates of growth and China is
the most important future super power of the world. One of the most significant steps
China had taken towards Free Trade was to finally join the WTO in 2001 after 15 years of
negotiations. This resulted in major economies like the United States, France and Germany
investing heavily in China. China is now the preferred destination for most investor’s and it
stands to overtake the United State as the world’s largest Economy in a few years.
The World leaders at the recent G8 talks at L’Aquila, Italy called for attention towards the
growing Global Food Crisis and suggested a possible review of the current free trade policies
towards the production and trade of food grains. Agricultural development has take centre
stage at world economic summits after severe food shortages in spite of sufficient
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production. Discrepancies in the allocation and unethical trade practices of many business
and economies have come to light following this and a call has been sounded for world
economies to tackle this problem quickly and efficiently. While some call for international
trade and reduction in existing trade barriers to tackle this problem, others argue that
excessive trade and unethical trade practices arising out of free trade such as dumping to be
at the root of the issue. Only a concentrated study of the situation and an honest effort by
the major world economies into this problem can determine and subsequently tackle the
actual cause of the growing crisis.
Conclusion
Why Free Trade is more popular that Protectionism in the 21 st century
Societies that enact free trade policies create their own economic dynamism which help in
fostering a sense of freedom, opportunity, and prosperity that benefits every citizen. In
recent years, many world nations have demonstrated the power of this principle. For
instance, by breaking the cycle of poverty, the most impoverished countries of the world
can begin to create their own dynamic toward prosperity.
Nevertheless, despite all the evidence to the contrary, the opponents of free trade will
continue to espouse the old arguments like that of "the jobs created by globalization are
often less sustaining and secure than the livelihoods abolished by it in developing nations”.
Such claims presuppose that some sort of agrarian utopia previously existed in these
countries and that their peoples will not reap the benefits of economic development. To
argue against the development carried by technology and innovation is akin to arguing that
the United States and Europe, to cite just one example, were better off before the Industrial
Revolution. The Revolution brought freedom of movement and increased opportunity to all
economic levels of society all over the globe. Only, some nation’s derived more benefit
quickly while others took more time to stabilize and reap its benefits. A comparison of the
economic growth between China and it break away neighbour Taiwan illustrates this idea.
The Taiwanese government in the 1960’s chose to institute widespread reforms to
guarantee private property, establish a legal system to protect property rights and enforce
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contracts, reform the banking and financial systems, stabilize taxes, distribute public land to
individuals, and allow the market to flourish. The Real GDP per capita of Taiwan and China
was compared and tracked for the next three decades.
This graph clearly illustrates the astounding record of economic growth of Taiwan because
of the right policies being implemented and adopted by its policy makers. There are steps
every economy can study and implement from successful economic policies like that of
Taiwan’s.
For India, Post Liberalization with reduced trade barriers and increased foreign investment
has set the stage for social and democratic progress of a magnitude that would have been
impossible earlier and although as history suggests that this new era of market globalization
may well be accompanied by new problems for which the solutions will once again lie in the
power of human ingenuity and innovation. Globalization has presented the world with an
unprecedented level of opportunity for people to achieve economic freedom and greater
prosperity.
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References
The Concise Guide to Economics by Jim CoxMIT Open CoursewareThe World Bank Resource CentreFPIF.org (Foreign Policy in Focus)Economic Policy InstituteThe UN Millennium Project Resource Centre
Articles
Free Trade Benefits All by Marian Tupy, CATO Institute
The History of "Free Trade" By Jonathan Larson
The Benefits of Free Trade by Denise H. Froning, Centre for International Trade and Economics
The World Trade Constitution, Harvard Law Review of 2000
Globalization vs. Protectionism by Alan Greenspan, Federal Reserve Board of the USA
Protectionism by Jadish Bhagwati
The High Price of ‘free’ trade by Robert E. Scott
Macroeconomics in the Global Economy by Jeffrey Sachs
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