What Is the Definition of Free Trade?
Free trade refers to trade between two or more countries without any interference by their governments in the form of tariffs or other barriers. Although many countries have eased restrictions on trade, completely free trade does not exist yet. There is a fierce debate between those who think that under free trade everyone will be better off and those who claim that it will destroy jobs.
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Theoretical Foundations
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Countries should benefit from focusing on what they produce best and trading surpluses. In the 19th century, British political economist David Ricardo stated in his theory of comparative advantage that if each country specializes in the production of those goods and services in which it is best, everyone will be better off. If country A, for example, produces electronic goods, and country B produces food, each country should make the most efficient use of its resources and trade surplus goods with others. In that way, they will both benefit from unrestricted trade.
History
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Gold was used as global currency in free trade during the 19th century. Although trade between nations existed long before, it was in the 19th century that countries dropped restrictions on trade, while using gold as a substitute for universal currency. After the Wall Street crash in 1929 the world reverted to protectionism, and the struggle for resources contributed to outbreaks of two world wars. After World War II, nations realized once more the importance of world trade. The United States, as the dominant economy by then, was under pressure to open up its markets to imports from other countries. It suited the United States to see other major economies recover, so that they could import more American goods.
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GATT and WTO
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Today, more than 140 countries are members of WTO. To regulate and facilitate trade, nations in 1948 formed the General Agreement on Tariffs and Trade (GATT). Initially, it included 23 countries that agreed on 45,000 tariff reductions. The largest disagreements arose in the 1980s, when negotiations included agriculture and services. GATT in 1995 was superseded by the World Trade Organization, which was given more powers to enforce free trade rules and a clearer mandate to promote free trade.
Benefits of Free Trade
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Free trade helps producers gain access to wider markets. According to a study by the World Bank, the main benefits of free trade come from the increased access of producers to larger, international markets. Domestic producers produce more efficiently due to their international specialization and the pressure that comes from foreign competition, while consumers enjoy a wider variety of domestic and imported goods at lower prices.
Costs of Free Trade
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Increased competition can force less competitive industries out of business. A country involved in free trade runs the risk that some of its less competitive and adaptable industries will be forced out of business. This leads to job losses in certain sectors, which can force politicians to adopt protectionist measures.
Other Considerations
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Countries rich in certain resources tend to trade more. Countries weigh benefits and costs of engaging in free trade based on the size of their domestic market, abundance of natural resources and location. Countries with large domestic markets generally trade less. On the other hand, countries rich in certain natural resources, such as oil, tend to trade more.
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References
Resources
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