Free Trade
Expert reviewed • 21 July 2024 • 14 minute read
What is Free Trade?
Free trade is an economic policy that allows countries to trade goods and services without imposing tariffs, quotas, or other restrictions. Under free trade agreements, countries can specialise in producing goods and services where they have a comparative advantage, leading to increased efficiency and economic growth.
What are the Advantages of Free Trade?
Free trade provides economies with various benefits, including the following:
- Economic Growth: Free trade broadens market access to economies, allowing businesses to scale production to a global scale. This in turn fosters economic growth. As such, countries can specialise in producing goods where they have a comparative advantage—meaning they can produce at lower opportunity costs than others—leading to more efficient international production and trade.
- Lower Prices for Consumers: By eliminating tariffs and reducing barriers, free trade reduces the cost of imports, which can lead to lower consumer prices. This increase in affordability can improve the standard of living.
- Increased Competition: Opening up domestic markets to foreign competitors pushes local businesses to improve efficiency and innovation to maintain market share. This forces inefficiencies in local businesses to be eradicated. This is because they must improve efficiency, or get run out of business.
- Access to a Broader Range of Products: Consumers benefit from a greater variety of goods and services, which might not be produced domestically. For example, the European Union (EU) allows goods to move freely between member states. This ensures that consumers across Europe can enjoy a wide range of products at a competitive price.
- Economic efficiency: Free trade allows countries to specialise in producing goods and services where they have a comparative advantage - meaning the products which they can create more efficiently than other countries at a cheaper rate. This leads to increased efficiency and lower costs for consumers. For example, if Country A can produce cars more efficiently than Country B, while Country B can produce textiles more efficiently than Country A, both countries can benefit by specialising and trading with each other.
What are the Disadvantages of Free Trade?
Although free trade comes with various benefits, there are consequences like any other economic policy. Disadvantages include:
- Job Losses: Free trade can lead to job losses in certain sectors as domestic producers face increased competition from foreign firms. This can be particularly challenging for workers in industries that are less competitive or have higher labour costs. For example, the North American Free Trade Agreement (NAFTA) led to job losses in the U.S. manufacturing sector as firms moved production to Mexico to take advantage of lower labour costs.
The graph below illustrates the impact of the free trade agreement of NAFTA on employment within the US automotive job sector. As we can see from the graph, after the implementation of the NAFTA free trade agreement, there was a decline of approximately 400,000 jobs in automotive jobs in the US.
This graph therefore reflects the typical effects of free trade agreements on industries unable to compete with cheaper labour costs abroad.
- Wage Suppression: In trying to stay competitive against countries with lower labour costs, businesses might cut wages or avoid wage increases. Although this is done to minimise job losses, employees are still negatively impacted by cuts in pay.
Wage suppression therefore leads to bigger problems such as income inequality. Free trade can exacerbate income inequality within countries, as the benefits of trade may accrue disproportionately to skilled workers and owners of capital.
A study by the World Bank found that while free trade reduced poverty in developing countries, it also contributed to increased inequality in some cases. For more information on this case study, visit the World Bank's article page: World Bank Inequality Study
- Loss of Local Industry: Free trade can lead to the disappearance of traditional industries that cannot compete on an international scale. As a result, environmental and labour standards can drop. Critics argue that free trade can lead to the exploitation of workers and environmental degradation in countries with weaker regulations.
- Economic Dependence: Over-reliance on imports for essential goods can make a country vulnerable to external economic shocks or geopolitical tensions. For example, the free trade agreement NAFTA between the US, Canada and Mexico led to significant job losses in the US automotive sector. This came as a result of manufacturing jobs being moved to Mexico, where labour was cheaper.
Examples of Free Trade Agreements:
Across the world there are various free trade agreements, which all have large impacts on the global economy in their own respect. Some of the largest agreements over the last decade are:
European Union (EU)
The European Union is a trade agreement or market that allows the free movement of goods, services, capital and labour among states in Europe. Within these member states, protectionist trade barriers such as tariffs and quotas have been eliminated, leading to increased trade and economic integration.
North American Free Trade Agreement (NAFTA)
The North American Free Trade Agreement (NAFTA) was a free trade agreement between the United States, Canada, and Mexico that eliminated most tariffs and other trade barriers among these countries. While NAFTA increased trade and investment flows, it also led to job losses in some sectors and concerns about labour and environmental standards.
Trans-Pacific Partnership (TPP)
The Trans-Pacific Partnership (TPP) was a proposed free trade agreement among 12 countries in the Asia-Pacific region, including the United States, Japan, and Australia. Like most free trade agreements, it aimed to reduce trade barriers, but it faced criticism over its potential impact on jobs, intellectual property rights, and environmental regulations. The United States withdrew from the TPP in 2017. However, the remaining 11 countries signed a revised agreement known as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).
The Association of Southeast Asian Nations (ASEAN)
The Association of Southeast Asian Nations (ASEAN) is a regional intergovernmental organisation composed of ten Southeast Asian countries. Established on August 8, 1967, by Indonesia, Malaysia, the Philippines, Singapore, and Thailand, the organisation aims to promote political and economic cooperation and regional stability. The bloc has significantly contributed to regional economic growth and is noted for its efforts to create a more stable and cooperative political environment in Southeast Asia.