Free Trade vs.Protectionism A attempt to analyse the significance of International Trade and its ideologies in the 21st Century Srinivas Atreya • 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. 2 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 3 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 21 st 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, 4 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. 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 cooperative. 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. 5 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 19th 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 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. 6 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." 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. 7 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. 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 8 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 represented by bullion held 9 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 18 th 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 10 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 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 11 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 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. 12 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 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 13 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 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. 14 Conclusion Why Free Trade is more popular that Protectionism in the 21st 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. 15 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 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. 16 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. to achieve economic freedom and greater prosperity. Globalization has presented the world with an unprecedented level of opportunity for people References The Concise Guide to Economics by Jim Cox MIT Open Courseware The World Bank Resource Centre FPIF.org (Foreign Policy in Focus) Economic Policy Institute The 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 17 Protectionism by Jadish Bhagwati The High Price of ‘free’ trade by Robert E. Scott Macroeconomics in the Global Economy by Jeffrey Sachs 18