Trade between countries and within the countries fall within the fundamental principles of economics (Taylor & Weerapana, 2011, p. 739) and it also forms an indispensable part of our day-to-day life delivering us utility, demand realization of the customers, and profit maximization of the producers. The abolition of the barter system and the introduction of money has neutralized the concept of double coincidence of wants and indivisibility problem with the exchange of goods and services becoming rationalistic and mutually beneficial (Ganßmann, 2012, p.16). In the trade paradigm between different countries, the government plays various roles with interventions like fixing tariffs, quotas, and various restrictions applied to the exchange of goods and services. In this connection, the concept of free trade carries significant importance.
The concept of free trade or unrestricted trade is generally attributed to the exchange of goods and services where zero-intervention policies are implemented by the government of the trading partners (Hajela, 2009, p.55). Now in free trade, there are several benefits and cost emergence within businesses (Hajela, 2009, p.55). To name a few, benefits of free trade include investment in sectors which enjoy a comparative advantage, maximization of output, lower consumer prices, and so on and the costs of free trade are monopoly development, unbalanced development dumping, and so on (Lusztig, 1996, p.2). In this paper, the target will be assessed critically assess the argument that benefits from free trade are outweighed by costs that are generated by it for the business. First of all, we will focus on the formal definition of free trade as proposed by the father of economics, Adam Smith.
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Definition of free trade. Father of economics, Adam Smith who is a staunch supporter of free trade defines it as “that system of commercial policy which draws no distinction between domestic and foreign commodities and therefore neither imposes additional burdens on the latter nor grants any special favors to the former” (Dewett, 2007, p. 439). This definition is crucial as it gives a signal that it is an unbiased policy that reflects the agents engaged in free trade are not vested with undue advantage and operate in an indifferent situation. Now we will explore the benefits and costs of free trade in a little detail. Benefits and costs analysis- Theoretical approach. Potential benefits. One of the most obvious benefits of free trade is a mutual advantage which benefits all the parties engaged in free trade (Niles et al, 1820, p. 354). If no compulsion is present in any countries then the countries will be able to export and import those goods which help in generating maximum profits for the agents.
As a result of international trade, it can be stated that there is the promotion of the welfare of all the countries. The notion of free trade motivates the countries in competing with each other and producing goods as low cost as possible. In such a circumstance, only efficient firms and entrepreneurs remain within the market. In such a situation, less efficient entrepreneurs and firms are forced out of the market. Owing to the efficiency in production, in general, production cost and prices become low. Free trade also helps in extending the market of goods and services and also helps in optimizing consumption. In the absence of free trade, domestic consumption is restricted to the production of those commodities which enables the expansion of the production possibility frontiers of the countries.
Free trade leads to an increase in the income of various factors of production as they are employed in a more efficient manner with more proper and rigorous use. At the extreme macro level, it can be stated that free trade amplifies the economic development of the nations. Haberler states that “substantial free trade with marginal, insubstantial corrections and deviations is the best policy from the point of view of economic development” (Lundahl & Ndulu, 1996, p.436). Particularly benefits are majorly reaped by the developing and less developed countries through stimulation and specialization and division of labor, promotion of healthy competition which leads to the improvement in efficiency dimension within production, enhancing the skills, technical knowledge, and managerial efficiency, helps in availability of raw materials, machinery as well as foreign capital.
The statement of Harberler can be again introduced here which states that “international trade made a tremendous contribution to the development of less developed countries in the nineteenth and twentieth centuries and can be expected to make in the future if it is allowed to proceed freely” (Hajela, 2009, p.56). It is a general impression that the benefits of free trade far outweigh its cost but it needs to be analyzed from a critical angle and the subsequent section which will deal with the cost analysis of free trade will be especially focusing on it.
Association of cost. Now from the point of view of classical theorists and the competitive theory the arguments in favor of free trade encircles around the notion that all the products that are exchanged within the economy are basically homogenous products which signify that the products of different firms including that of imports are basically homogenous. But In the case of the manufactured product also goods also the products are heterogeneous and the notion of homogeneity breaks down and in reality, the goods produced and exchanged are in fact homogenous. For the producers of differentiated products, there automatically generate a market power over the goods which they sell, and extra costs of the trade get applied.
The monopolistic competition which takes into account the attributes of product differentiation takes that the demanders are fully informed about the market. This leads to attempts by the producers to instilling their products with a degree of differentiation and intrinsically leads to advertising. Advertising is costly and trade lead to an increase in the resources spent on it. In absence of trade in a small country, firms might not be able to advertise at all as they face little competition (Deardorff, 1997, p. 16). In this respect, the flaws of a perfectly competitive market can be highlighted bringing the Ricardian theory of rent.
Criticizing the theory of rent by Ricardo. Economist David Ricardo stated that rent emerges from the indestructible power of land and the demand of society exceeds the stock of land. Ricardo stated that rent is a differential return and it is mainly the difference between the yield of a plot and that of a marginal plot. The differential generates at a time when the inferior grades of land are cultivated. If the supply of the superior grades of lend and rent was ample then it would not be necessary for cultivating inferior grades of land and rent would not generate. It can be stated that rent arises when the good quality of land is scarce (Mukherjee, 2007, p.499). The Ricardian theory of rent is based on the unrealistic assumption that there exists one price of an agricultural product in the entire market and it will be equal to the cost of production on the marginal land. In reality, the market is imperfect and the price of the commodity varies with the quality.
The produce of different soils may differ in quality and so helps in fetching different prices. Ricardo’s assumption which states that there will be one price of a given agricultural is synonymous with the concept of price-taking behavior and a perfectly elastic supply curve in free trade can be invalidated (Jain, n.d., p. 301). Thus it can be stated that the benefits, in reality, are not always at least equal to greater than the cost. Now we will focus our discussion towards a psychological dimension of the argument in reference to the prospect theory of behavioral economics.
3.4 Prospect theory. Prospect theory states that a “negative translation of a choice problem such as arises from incomplete adaptation to recent loses, increases risk-seeking in some situations….This analysis suggests that a person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise…a failure to adapt to losses or to attain an expected gain induces risk-seeking” (McDermott, 2001, p.31).
The prospect theory in trade is indeed a more practical way in understanding the public decision on trade in recent years. In this theory, it is observed that in cases where the potential loss outweighs the potential gains, then it is encountered that the decision-makers will be more showing more risk aversion in their actions. In the United States, the concern about the jobs seems to have taken over the focus on opportunities. Countries having free trade agreements like Columbia, Panama, South Korea are kept on the shelf and these point out consumers and producers that would benefit from trade do not gain. Consumers will probably continue in paying higher prices for some goods and the producers who would import goods from those countries will have to find more expensive alternatives. Domestic producers would seem to be protected for some time but not forever (Silvia, 2011, p.87).
Conclusion. The study of the paper reflects that the benefits coming from free trade do not outweigh its cost. Citing the benefits of free trade the paper concentrated on the theoretical approaches of cost-benefit analysis and proved that the underlying assumptions of free trade are based on rather unrealistic assumptions which get reflected in criticizing the competitive theory and the applications of prospect theory with respect to real-life examples of countries having free trade agreements.
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