IMPACT OF FREE TRADE TO DOMESTIC ECONOMY

IMPACT OF FREE TRADE TO DOMESTIC ECONOMY

Introduction

Free trade occurs when countries remove international barriers on all or certain items and allow the free exchange of products. Free trade is, therefore, a consequence of international trade. A country can access goods and services that it cannot assemble or produce locally through international trade. (Gould, Woodbridge & Ruffin, 2015). Some of these goods and services require constant importation, hence the need for free trade, which makes them affordable to the local industries. “A country can get goods and services efficiently by specializing in activities which the country has a comparative advantage through free trade.”( Gould et al., 2015). Comparative advantage occurs when a person or a country produces something at a lower cost than anyone else providing the same thing.

Trade-offs come about when a country increases the cost of a product or service, which is consequently counteracted by reducing the cost of another product or service. A trade-off is essentially a compromise. (Amstel, 2016). In relation to free trade, the U.S. lifts import tariffs for products from another country. As a result, the other country also allows the U.S. to export products duty-free. When making economic trade-offs, countries have to consider the impact of such decisions on the future of the domestic economy.

Gains from trade occur when a country benefits from division of labor and specialization, either at a local or international level. Through free trade, a country can acquire imported goods at a lower price compared to locally producing the products. Since purchasing the goods internationally affects the local industries, the state can compensate through trade-offs. Free trade leads to competition between the local industries and international industries. Free trade mostly affects local manufacturers who produce the same imported products at a higher price. Therefore, consumers prefer to buy imported products.

History and Development of Free Trade in the USA

Free trade agreements were introduced in the USA during the early nineteenth century. The country imposed high tariffs to protect manufacturers and led to the creation of a restrictive act, the “Smoot-Hawley Tariff Act of 1930.”(Destler, 2016). A couple of years later, the then Secretary of State advocated for reversal of the imposed tariffs. Cordell Hull wanted to figure out a way to accommodate foreign trade agreements. Therefore, the U.S. would ask other nations to reduce their duties in exchange for the U.S. reducing its tariffs. ( Destler, 2016). The “Reciprocal Trade Agreements Act of 1934” ensured that the U.S. would enhance lower rates of import duties to its respective partners. (Destler, 2016). The agreements would also highly benefit the USA’s exporting industries since the partner countries would reduce their trade barriers.

In the beginning, the U.S.limited free trade to bilateral agreements and only came to embrace multilateral contracts after the second world war. There was a necessity to create multilateral agreements to stabilize and build the economy after the war. The U.S. initiated the General Agreement on Tariffs and Trade (GATT), which was a union to curtail trade barriers between the trading nations. ( Destler, 2016). The trade-off negotiations resulted in U.S. import tariffs reducing from sixty percent to six percent within fifty years, that is, from 1930 to 1980. The agreements also opened new foreign markets for the United States. It is important to note that the U.S. reduced trade barriers solely for partner countries.

Trade negotiations led to the creation of a free-trade agreement (FTA) in the early 1980s. The creation of the agreement was, however, difficult since the U.S. faced resistance from European countries. The convention began as a bilateral trade policy between Canada and the USA. Mexico later joined the agreement, which led to controversial opinions. Mexico entering the agreement posed as a threat to the USA market due to differing economies. By the late 1990s, other countries joined the FTA.

Problems of Free Trade

Free trade has a few adverse effects on a country’s economy despite the existence of its overwhelming benefits. The discussion below shows some consequences that come about due to free trade.

Free trade cripples the local industries. Local industries produce goods and services at a higher price compared to imports. Products that enter the country without payment of tariffs also enter the market at a lower price. Consequently, consumers prefer to buy such products. In turn, local industries have fewer customers, which can lead to the closure of such sectors. Secondly, free trade seems to promote a monopoly in some areas. Local industries argue that free trade favors giant companies. Due to intellectual property rights, giant corporations get patents for technological innovations. (Bello, 2019). Furthermore, free trade also favors the pharmaceutical sector because a few giant companies get production rights.

Free trade can also lead to job loss for the local communities. Immigration is a result of free trade, and it leads to the creation of cheap labor. Most people from foreign countries accept lower wages than U.S. citizens. Out of every ten jobs lost, free trade leads cause two of those losses. (Teebom, 2019). The WTO director-general acknowledged this factor in a forum. Free trade also leads to an increase in foreign debt. A country like the United States heavily relies on some non-renewable resources such as fuel. (Fletcher, 2010). Overconsumption of such resources leads to borrowing, which increases the national debt.

The discussion above shows that the most affected sector is the local industries. Encouraging free trade leads to the entry of cheaper products to a country’s economy. Due to high levels of competition and the availability of low-cost products, imported goods gain a broader market from consumers.

Benefits of Free Trade to the Domestic Economy

Despite the existence of resistance towards free trade, the practice benefits countries in a couple of ways. Local businesses acquire purchasing power from free trade. Due to free trade, some local companies have a variety of products to choose from at a lower price. The local companies can then resell the products to consumers at a profit, hence generating income to the business owners. Secondly, free trade results in lowering the wage gap between genders. In the current economy, a higher percentage of men earn a higher income than women. According to the County Executives of America, countries that have lower tariffs also have a smaller wage gap. (CEA, 2015). A 10% decrease in trade barriers leads to a 1% decrease in the gender wage gap.

Due to FTAs, the U.S. has a diverse export market. The U.S. has free trade agreements with 20 countries. ( Chamber of Commerce, 2015). Partners of the agreement purchase more than 50% of the country’s exports. Therefore, local exporting industries benefit from the investments made by the partners. Overall, free trade leads to export growth. Free trade also leads to an expansion in productivity. Local manufacturers gain access to raw materials, which increases their productivity. The manufacturers gain a competitive advantage in the marketplace due to the production of a broader range of products and services. Buyers will opt to purchase from the manufacturers due to lower prices. Free trade benefits the middle-class bracket. Due to a wide range of products, consumers buy goods at a lower cost leading to an increase in wages. (CEA, 2015). Due to a reduction in budgets, people save up to $ 10,000 annually. (Chamber of Commerce, 2015).

Solution #1

The first solution is adopting the theory of comparative advantage. Most countries embrace free trade due to comparative advantage. Under given circumstances, producing a product locally can prove to be extremely costly compared to importing the same product. “A country can acquire goods and services with higher adequacy and efficacy through free trade.”( Gould, et al., 2015).

Adopting the theory has a few advantages. The founder of the theory is David Ricardo, who tried to advocate for free trade in Great Britain in the 1800s. (Faccarello, 2016). According to the political economist, when a country allows free trade, it can focus on specialization. Specialization means concentrating on producing what the state is good at, which means the country has a comparative advantage when it exports that product. The state also allows importation of goods that they cannot produce, which means that it lacks comparative advantage in supplying that good. Therefore, the theory argues that such practice benefits both countries. Free trade attributes its basis to the theory of comparative advantage.

Comparative Advantage also has a few disadvantages. Some countries lack comparative advantage since they lack the ability to specialize in producing one product. Some countries like China also have a high comparative advantage due to the availability of a cheap labor task force. Third world countries also lack a comparative advantage, which may lead to oppression from developed countries.

Solution #2

The second solution is adopting Trump’s policies. An example is the trade war on China. China is one of America’s biggest importers. “In 2018, imports from China accrued to almost $558 billion while exports amounted to $179.5 billion.” (U.S. Trade Representative, 2018). The deficit is almost $379 billion. China is also one of the USA’s largest export markets, ranging in the top three. One of Trump’s agenda was to increase tariffs on goods from China to reduce unfair trade practices.

The solution has a few advantages because some tariffs increased from 7% to 25% on Chinese goods. However, the disadvantage is that China also increased tariffs and restrictions on USA’s products. The duties imposed by both countries amount to billions of dollars yearly. Most countries around the world accuse China of crippling their domestic economies. Chinese products often range at meager prices hence posing a threat to the local industries. The war on trade between the two countries seems to affect the U.S. compared to China adversely. China has an extensive worldwide export market.

Solution #3

Involving the World Trade Organization is another solution. The WTO is a comprehensive intercontinental organization that governs trade among countries. The organization was formed in 1995 as the replacement for GATT.  Involving WTO has a few advantages. The organization shelters the economy of developing countries from inequitable practices of the trade. Therefore, WTO members grant equal trade opportunities for all countries. The organization also offers a forum for nations to negotiate trade agreements. (Anderson, 2020). The organization has 164 member countries and is in charge of ninety-eight percent of the global trade. The U.S. is one of the organization’s founders as the state advocated for multilateral trade since the mid-1930s.

However, some countries still complain about the WTO. Removing trade barriers on all members might lead to a higher export market for a country. However, the country lowering the restrictions might not get the same returns on exports. An example is the trade between the USA and China, which seems to favor the Chinese economy as compared to the US economy.

Comparisons of the Solutions

The theory of comparative advantage involves lifting trade barriers among countries and letting the countries enhance specialization. The United States is a significant benefactor of free trade due to comparative advantage. The Free Trade Agreement between the United States and Brazil is one example that benefits the country. Brazil is among the top ten export markets in the United States. (Calder, 2019). The country imports products such as raw materials and animal products to the U.S. since it has a comparative advantage over the products. In turn, the U.S. exports runner and other chemicals, which has a comparative advantage over Brazil. The theory claims that free trade leads to a two-way benefit for trading countries.

The president of the United States also has a few proposals to deal with the adverse effects of free trade. Trump managed to replace NAFTA with the United States-Mexico-Canada agreement, which has seen an increase in fairer trade between the countries. (U.S. Trade Representative, 2018). Some of the economists are of the opinion that free trade benefited the U.S. until the 1970s. Afterward, the activity has a negative impact on the USA’s domestic economy. Some of Trump’s agendas positively benefit the country, such as an increase in wages, the addition of manufacturing jobs, and a decline in the wealth gap. (U.S. Trade Representative, 2018). The future of free trade in the country faces jeopardy. However, the adaption of some policies might have a positive impact on the country’s domestic economy.

Involving the World Trade Organization is also a solution to free trade. The organization tries to bring countries together while trying to boost the economy of every member country. In addition, the organization solves trade problems between member countries. An example is trade problems with Mexico. Initially, the country joined the organization in order to lift the economy and bring it closer to that of the U.S. Mexico also expected to close the living standard gap with the U.S. However, there is a significant disparity between the economies and living standards of these two countries. Mexicans argue that the trade agreement only benefits people close to the border due to the creation of factories around the area. However, Mexico is highly dependent on trade with the U.S. since more than 75% of Mexico’s exports go to the U.S.

Preferred Solution

Adopting the theory of comparative advantage is the preferred solution. The main reason for the preference is that the solution is a two-way benefactor. The solution also has fewer disadvantages compared to the rest. In addition, comparative advantage ensures that both trading countries benefit from the activity. As a result of specialization, both trading countries can gain comparative advantage over specific goods and services. (Faccarello, 2016). A country like Japan can produce goods at a lower opportunity cost than the U.S. Consequently; Japan imports such goods to the U.S. without paying high tariffs. The goods are therefore sold at a low price in the U.S. market. The U.S. can also export goods and services to Japan without paying high duties.

Conclusion

Some economists in the U.S. are of the opinion that free trade has a negative impact on the domestic economy. Free trade can cripple a country’s local industries. However, countries can adopt some solutions to solve the problem. Some of these solutions include; adopting comparative advantage theory, adopting Donald Trump’s policy proposals, and involving the World Trade Organization. Free trade should benefit both trading countries. Therefore, adopting comparative trade theory is the preferred solution. Comparative trade ensures that the countries specialize in what they can produce best, lift trade barriers, and exchange the products through imports and exports.

References

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Anderson, K. (March 18, 2020). World Trade Organization: International Trade. Britannica.

Bello, W. (March 15, 2019). Why Free Trade is Bad For a Country. Foreign Policy in Focus.

Calder, A. (November 4, 2019). Comparative Advantage Revealed: What the U.S. could Gain from an FTA with Brazil. Global Trade Magazine.

Cavin, A. (January 2017). Trade Wars: The Collapse of America’s Free Trade Consensus. Ohio State University & Miami University History Departments. Vol. 10, Issue 4.

CEA. (May 2015). The Economic Benefits of U.S. Trade. Executive Office of the President         of the United States.

Destler, I.M. (April 28, 2016). America’s History with Free Trade. Harvard Business Review.

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Fletcher, I. (April 13, 2010). Problems with Free Trade. Global Policy Forum.

Gould, D.M., Woodbridge, G.L. & Ruffin, R, J. (February 12, 2015). The Theory and       Practice of Free Trade. The University of Houston. Economic and Financial Policy Review.

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Teebom, L. (February 12, 2019). Negative Effects of Free Trade. Chron.

Office of the United States Trade Representative. (2018). The People’s Republic of China.           Retrieved April 4, 2020, from                  https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china