International trade – Free trade, Protectionism, WTO and Trading groupings

Protectionism

Globalisation has led to a massive increase in world trade and world trade has led to a massive increase in globalisation. These two synoptic elements both help one another to increase in scale and efficiency. And from human’s very beginnings with tribes like the Minoans (a civilisation on the land of Crete) who were master traders, shipping olive oil to Egypt and pottery to Italy, to modern day in which New Zealand Lamb is shipped and flown 11,426 miles to the UK.

The pattern of world trade

This has changed over the years as well, with most goods and services being traded in the west up until the 1960’s, where there was a shift to developing countries such as China and India in the east. This is partly due to untapped markets and low labour costs.

Another major influence affecting world trade is booms and busts, for example since 1970 world trade has grown by 6% per annum but when the 2008/2009 recession took place world trade fell by over 9%

Free Trade

Definition : The unrestricted purchase and sale of goods and services between countries without the imposition of constraints such as tariffs, duties and quotas. (taken from Investopedia)

Benefits

  • By specialising in goods where countries have a lower opportunity cost, there can be an increase in economic welfare for all countries. This manipulation of the comparative advantage causes increased employment, higher incomes and trade account surplus’ which establish a higher standard of living.
  • Specialisation creates economies of scale which lowers the average cost in the long run. This means money can be redistributed into other areas such as wages or employment of staff.
  • Increased competition due to new markets forces firms to cut costs and increase efficiency, benefiting the consumer.
  • Trade is a factor which influences growth and therefore the expansion in trade of about 7% per year from 1945 has helped economic growth across the world.
  •  Trade creation, when consumption switches from high cost producers to low cost producers.

Protectionism

Definition: Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local businesses and jobs from foreign competition. Typical methods of protectionism are import tariffs, quotas, subsidies or tax cuts to local businesses and direct state intervention. (taken from Investopedia)

Reasons for protectionism

  • Protecting Infant industries (businesses that have just entered the world markets).
  • Protecting geriatric industries (industries that may need time to restructure and rationalise in order to compete again).
  • Ensures employment protection.
  • Prevent dumping    –  Refers to exported goods sold at a price below the average cost of                                       production. (Form of predatory pricing and is illegal under WTO).                                   –  One of the few arguments supporting protectionism that can be                                         justified by economic theory due to unfairly distorting the                                                    comparative advantage.
  • Correcting balance of payments by reducing imports and promoting exports.
  • Health and safety laws in developing countries are non-existent therefore giving them a competitive advantage, protectionism benefits the domestic market with a side effect of reducing damage to environment.
  • In times of war, countries do not want to be reliant on imports as it could cause famine and the reason why they lose the war.
  • Tariffs made may be a source of tax revenue for the government.
  • Retaliation may take place due to restricted imports being held against a trade partner. 

Protectionism and Free trade are forever competing against one another and up until 2008 free trade was storming ahead. This was partly due to the work of the World Trade Organization (WTO).

World Trade Organization

Primary aim of the WTO is to liberalise trade. To do this they provide a forum for negotiating trade agreements to lower trade barriers. Since 1947 when the General Agreement on Tariffs and Trade (GATT) was created (predecessor of WTO) there have been eight rounds of talks with the ninth round (Doha Development Agenda) still being negotiated (since 2001).

WTO also performs the settlement of disputes between member countries and the provision of system trade rules. When agreeing to joining the establishment you agree to its principles:

  • Most-favoured nation principle: Implying countries cannot discriminate betwwen their trade partners.
  • National treatment: imported and locally produced products must be treated equally once foreign goods have entered the market.

Has the WTO been successful?

It has massively reduced tariffs on manufactured goods (in industrialised countries tariffs just averaged 4% on industrial goods by mid 1990’s).

However it has been less successful in the reduction of trade barriers in services and there has been an increase in non-tariff barriers such as administrative regulations. These factors could be seen to have offset the reduction in tariffs on goods.

4 types of economic groupings

Free trade areas:

  • Barriers are removed between member countries but individual members can still impose tariffs on countries outside the area
  • Example is North Atlantic Free Trade Area (NAFTA) which consists of free trade between USA, Canada and Mexico

Customs unions:

  • Characteristics include free trade between members and also a common external tariff on goods imported from outside the bloc.
  • Example is European Union which has 28 members.

Common markets:

  • Like customs unions but also factors of production (especially labour) may also move freely across borders.
  • Possibly what the European Union is turning into especially with the increased movement of labour from Eastern European countries such as Bulgaria and Romania.

Monetary unions:

  • Customs unions that have common markets (possibly) and adopt a common currency.
  • Example is Euro zone which has 18 members and has the same currency of the Euro which is regulated by European Monetary Policy.

Consequences of trading blocs – Trade creation and trade diversion

Trade creation:

Occurs due to the reduction in trade barriers which in turn promote specialisation and economic welfare by utilising the comparative advantage.

Trade diversion:

Occurs due to member countries now purchasing goods and services from other member countries rather than non-members due to the lack of tariffs. Therefore there is an inefficient allocation of resources.

International trade is all around us, just look at at any object in your house and see where it is made. It’s incredible how connected the world is not just economically but also socially and politically.

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