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Robert Longley is a U.S. government and history expert with over 30 years of experience in municipal government and urban planning.
Updated on December 05, 2018In the simplest of terms, free trade is the total absence of government policies restricting the import and export of goods and services. While economists have long argued that trade among nations is the key to maintaining a healthy global economy, few efforts to actually implement pure free-trade policies have ever succeeded. What exactly is free trade, and why do economists and the general public view it so differently?
Free trade is a largely theoretical policy under which governments impose absolutely no tariffs, taxes, or duties on imports, or quotas on exports. In this sense, free trade is the opposite of protectionism, a defensive trade policy intended to eliminate the possibility of foreign competition.
In reality, however, governments with generally free-trade policies still impose some measures to control imports and exports. Like the United States, most industrialized nations negotiate “free trade agreements,” or FTAs with other nations which determine the tariffs, duties, and subsidies the countries can impose on their imports and exports. For example, the North American Free Trade Agreement (NAFTA), between the United States, Canada, and Mexico is one of the best-known FTAs. Now common in international trade, FTA’s rarely result in pure, unrestricted free trade.
In 1948, the United States along with more than 100 other countries agreed to the General Agreement on Tariffs and Trade (GATT), a pact that reduced tariffs and other barriers to trade between the signatory countries. In 1995, GATT was replaced by the World Trade Organization (WTO). Today, 164 countries, accounting for 98% of all world trade belong to the WTO.
Despite their participation in FTAs and global trade organizations like the WTO, most governments still impose some protectionist-like trade restrictions such as tariffs and subsidies to protect local employment. For example, the so-called “Chicken Tax,” a 25% tariff on certain imported cars, light trucks, and vans imposed by President Lyndon Johnson in 1963 to protect U.S. automakers remains in effect today.
Since the days of the Ancient Greeks, economists have studied and debated the theories and effects of international trade policy. Do trade restrictions help or hurt the countries that impose them? And which trade policy, from strict protectionism to totally free trade is best for a given country? Through the years of debates over the benefits versus the costs of free trade policies to domestic industries, two predominant theories of free trade have emerged: mercantilism and comparative advantage.
Mercantilism is the theory of maximizing revenue through exporting goods and services. The goal of mercantilism is a favorable balance of trade, in which the value of the goods a country exports exceeds the value of goods it imports. High tariffs on imported manufactured goods are a common characteristic of mercantilist policy. Advocates argue that mercantilist policy helps governments avoid trade deficits, in which expenditures for imports exceeds revenue from exports. For example, the United States, due to its elimination of mercantilist policies over time, has suffered a trade deficit since 1975.
Dominant in Europe from the 16th to the 18th centuries, mercantilism often led to colonial expansion and wars. As a result, it quickly declined in popularity. Today, as multinational organizations such as the WTO work to reduce tariffs globally, free trade agreements and non-tariff trade restrictions are supplanting mercantilist theory.
Comparative advantage holds that all countries will always benefit from cooperation and participation in free trade. Popularly attributed to English economist David Ricardo and his 1817 book “Principles of Political Economy and Taxation,” the law of comparative advantage refers to a country’s ability to produce goods and provide services at a lower cost than other countries. Comparative advantage shares many of the characteristics of globalization, the theory that worldwide openness in trade will improve the standard of living in all countries.
Comparative advantage is the opposite of absolute advantage—a country’s ability to produce more goods at a lower unit cost than other countries. Countries that can charge less for its goods than other countries and still make a profit are said to have an absolute advantage.
Would pure global free trade help or hurt the world? Here are a few issues to consider.
In the final analysis, the goal of business is to realize a higher profit, while the goal of government is to protect its people. Neither unrestricted free trade nor total protectionism will accomplish both. A mixture of the two, as implemented by multinational free trade agreements, has evolved as the best solution.
