Free Trade: Advantages and Disadvantages | Essay

3696 words (15 pages) Essay

24th Nov 2017 Economics Reference this




  • Lauren Heffernan

Free Trade in the Modern World

Free trade can be described as the trade which occurs when left to its own resources without any restriction placed upon it by the government. Trade barriers though are often used to protect domestic producers from the more competitive international markets. These redirect and lessen trade flows rather than create them.

Benefits of Free Trade

Countries which trade freely can experience a number of benefits and these are felt by both the companies and consumers. They have the potential to greatly improve production in their country as there is now the opportunity to concentrate on the goods where they believe they have an advantage when compared with other areas. In modern times not many people have the time or resources to make their own clothes and grow their own food, these items can be bought with relative ease, it has always made more sense when thinking economically to acquire certain items from the people who have the talent and skills to specialise in their making. There is then a mutual benefit between two countries as they are each more efficient at producing their favoured item and can import those items they are less skilled at. A firm which produces in a country that trades internationally has a larger market to work with. They have more consumers who are able to buy their goods and services, this also them to grow. With this expansion they have the new asset of being able to take advantage of economies of scale. They can improve their efficiency in production through this and may end up with falling costs and higher productivity. As the firm is now competing with other companies on an international level they must try to be more efficient with their resources so they can lower prices and be more competitive. As the firm becomes more and more efficient they have the ability to product more goods and services therefore expanding their business even more. As the try to compete with a larger market, firms may also need to become more innovative, they must come up with new and better ideas so they can keep their place in the market secure.[1] Better, faster, cheaper products must be developed as companies fight to hold their market share. We can see this in the recent competition to produce the newest most high quality laptop at the lowest cost. Free trade encourage ideas and knowledge to move between countries, new firms can take note of the failures of older firms, use this knowledge to their advantage and so become more efficient.[2]

As the domestic firms benefit so does the consumer. Firms must become more innovative and also may have to try and lower prices so they can keep their customers happy in the larger market. As firms cut their costs to maintain competitiveness they must become as efficient as they can, this could lead to more effective distribution of goods and more informative advertisements all to the benefit of the consumer. Firms must keep on improving themselves so they can keep up with the leaders, either that or create their own niche area but either way the consumer benefits. As the countries trade expands to international levels consumers have a larger variety of goods and services to choose from. Along with these advantages there is also less fear of the consumer being taken advantage of my monopolies, they can no longer charge extravagant prices as there is less chance they actually hold monopoly over something in the larger international market. And the issue of employment cannot be ignored. People who work for companies involved in international trade often have better prospects. In 2008 international trade was seen to have generated around one fifth of the total employment of the world, around 605 million jobs.[3] This fact is further backed up by the claim that trade barriers hinder employment. This can be seen when trade barriers are set up, their purpose is to protect jobs at home but they ultimately just make domestic products more expensive for consumers, when this occurs fewer goods are sold and there is the possibility that jobs will be lost.[4] Trade has been named one of the largest contributors to economic growth since the mid 20th century due to its enticements for efficiency and lowered prices.[5] Due to this there is an increase in living standards experience by all involved, real income may rise and with this the economy expands.[6]

Main Obstacles for Free Trade

The government has the power to restrict the flow of goods and services. This can be done through something called a tariff which is the most common and is a tax on imports[7]. When a tariff is added to an imported good it raises the price of this good when compared to the domestic equivalent. The government also has the power to give a subsidy to a specific domestic industry, allowing them to produce goods and sell them at a cheaper price. These restrictions both exist so that imported goods from foreign countries are more expensive when compared to goods made at home and are used to protect the domestic industry.[8] Domestic industries may sometimes need protection from the increased competition they face when working within a larger international market, as when put under pressure these firms may be forced to fire employees to cut costs or even completely move their production to another country and all of this would result in higher unemployment. This form of “protection” is especially needed in the case of infant industries. In a situation where the government wishes to help a new industry develop it will place tariffs on possible substitutable imported goods, this allows the infant industry to grow. This allows a country to grow its own domestic market and strengthen its industries without them being extinguished due to more competitively prices imported goods. “Protection” has been criticized though as industries that grow in a situation without competition it may produce lower quality goods, also subsidies have the power to lesson economic growth.

There are also other kinds of barriers. A license is one for example this is something that is given to a firm, giving them permission to bring specific goods into a country. As only certain firms are given licenses this decreases the amount of a good that can be imported and so curbs competition at the expense of the consumer as prices can easily be raised in a less competitive environment. A quota is definitely another barrier used by the government in this context. This is a constraint on the actual physical amount of goods that are allowed to be brought into the country. Also found within the same bracket as the license and quota is the Local Content Requirement. This is a stipulation made by the government which means that a specific percentage of goods sold must be made domestically. It can be a restraint on the amount or its value.


As you can see in the diagram above, where there is a tariff place on an imported good, domestic producers benefit at the expense of domestic consumers and foreign producers. The green triangles represent the efficiency lost as that is consumer surplus abandoned after the tariff. The yellow rectangle is the revenue gained by the government due to the tariff.[9] Many barriers end up raising the price of some items in relation to others which means that they are generally “pro-producer and anti-consumer”. With higher prices, it can be seen in the short-run, that less imported products are bought, domestic firms will gain a larger profit from this. As many of these barriers are tax related the government will also experience a boost in revenue. This seems like the best possible outcome but if you look at the long-run situation it is not as positive. As time goes on, firms become lax with their efficiency as they have no real competition, they have higher prices and worse quality items which is the perfect environment for new substitutes to develop. As more substitutes are brought into the market, the old firms experience a loss in sales. Also, the government may have to shell out money for better public services, as the population would have less disposable income due to higher prices.[10]

How these Obstacles are used in the EU

The initiation of European economic integration was intended to create a Single European Market by 1993. The euro was introduced in 1999, it was thought that this single currency would help with trade integration by abolishing the ambiguity associated with exchange rates and there would be improved transparency and competition between countries. There have been many barriers between countries which has impeded trade. Along with tariffs and such as mentioned before, there is also a significant use of technical barriers. But it seems most countries accept their usage as the cost of them outweighs the price of being left outside of the euro. Technical barriers create obstacles to trade by crating regulations that restricts on the sale of goods, they do this by requiring the product to have certain characteristic or to have gone through a specific production process, for example a certain package size for food products. Technical barrier are becoming more and more noticeable and are one of the main worries faced by the World Trade Organization. This institution has been trying to make sure that “… technical regulations and standards, including packaging, marking and labelling requirements […] do not create unnecessary obstacles to international trade.” But even with this fear of a more obstacle-ridden trading system it still seems to be apparent that technical barriers are in use throughout the EU and pose significant costs to the member countries.[11]

The goal of the European Union now is to open new markets and to have better trading systems around the globe. To do this they have a variety of policies whose primary function is to lessen and even eliminate barriers to trade between member states and those countries outside the EU. To do this there must be trust and transparency between countries as it involves negotiations focused on the removal of certain “protections”. The Union does understand that not all barriers can be removed, as intellectual property in innovative output must be preserved. So there are no disputes between countries the EU monitors all Protectionism occurring in the world, they do this so as to prevent disputes which could result in trade restrictions. The EU publishes a report every year, this report contains information on the trade and investment barriers used throughout the year. It describes the progress they have achieved in taking down barriers between the six strategic partners which include China, India, Japan, Brazil, Russia and the US.[12]

Example of a Trade Dispute between the EU and another Nation

An example of a trade dispute between the EU and another Nation is that of the banana trade dispute. This has been one of the longest running seen in the trading system since World War II. The main issue of contention in this situation was the preference the EU was seen to be showing towards the import of African, Caribbean and Pacific bananas over those from Latin America.

The conflict began in the early 1990s when the EU wished to begin using a new import regimen and it was thought that this would discriminate against Central American countries. Five main countries were involved, these were Columbia, Costa Rica, Guatemala, Nicaragua and Venezuala. These countries tried to get a consultation with the EU but when this failed they began informal negotiations to find a solution. They argued that the new regime would violate 20% maximum tariff on bananas agreed upon by the EU in 1961. To settle this dispute a panel was put together, they looked at all the evidence and ultimately decided that the new regime would violate a few GATT provisions and could not be justified. The EU then went back to the drawing board and two years later came back with a new and improved regime. The same Latin American countries requested another panel examination and once again they came to the conclusion that it was not to be allowed.

In 1996, five years after the beginning of the dispute, a new complaint was filed against the EU. Ecuador, Guatemala, Honduras, Mexico and the US were all unhappy with the EU’s follow-through after the panal reports. They argued that the EU’S import regime was still discriminatory towards Latin American bananas, this was to be dealt with within the World Trade Organization’s trade dispute system. The Latin American countries once again won the dispute as the WTO decided that the regime was inconsistent with their rules.

The EU lost on the basis of the rule of non-discriminatory administration of quotes, and it was also found that the most favoured nation rule was being broken by the EU’s licensing procedures. The US and Ecuador were then given permission by the World Trade Organization to impose sanctions on the imports they received into their countries from the EU. Finally in 2001 the three countries at the heart of the dispute settled on an agreement. Under the condition that the EU changed its current import regime to a tariff-only system, Ecuador and the US would remove their sanctions. This would mean that there would no longer be a country-specific tariff quota share. The EU began negotiating with all countries from which they imported bananas, to reach agreements on the new system. During 2005 the EU proposed a number of new tariffs all which were ultimately rejected as they would not sustain the existing market for banana suppliers in Latin America. As time went on Latin American lost confidence in their agreement with the EU and made this concern clear, new complaints were filed in 2007. In mid 2008, several Minister met in Geneva discuss various agricultural issue, they also tried to reach a conclusive agreement on the banana dispute but no such deal was reached.[13]

Finally in 2009, nearly two decades after the beginning of the dispute, the four countries reached a conclusive agreement. This occurred when representatives from the EU, US, former EU colonies and the Latin America met once again in Geneva. The EU agreed to reduce its tariffs on bananas from Latin American from €176 per ton to €114 a ton in 2017, and in return the Latin American countries would drop their case. The WTO Director-General Pascal Lamy described this as the end of “one of the most technically complex, politically sensitive and commercially meaningful legal disputes ever brought to the WTO.” Former colonies of the EU would stand to lose money in this situation, around $40 million a year because a portion of the EU banana imports would be coming from Latin America rather than them. But they would still remain receiving basically tariff-free access and also would get a payment of €200 million.[14]


The benefits to trade can clearly be seen in the modern market. Due to international trade countries can benefit from the availability of a larger consumer market, economies of scale and the presence of competition which encourages the lowering of prices and increased production. This leads to increased employment for all countries involved. Though some countries try to protect themselves and their infant industries through tariffs and subsidies it is obvious that the benefits of international trade far surpass the risks.
















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