Effects of Free Trade on Economy

Effects of Free Trade on Economy

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Introduction

Trade has always been recognized as one of the most fundamental aspects of any country’s economy. It is well recognized that it allows countries to obtain goods that are not produced locally, as well as export their surplus thereby benefiting in terms of foreign exchange. In most cases, however, countries impose tariffs, levies and other trade barriers so as to limit importation of goods. These are some of the protectionist efforts to allow for the growth of the domestic industries. Recent times, nevertheless, have seen the introduction of Free Trade Agreements. Free Trade is a term used to underline a situation where two countries eliminate the artificial barriers such as subsidies and tariffs that restrict the free flow of services and goods between the trading nations (Mankiw, 2009). Free trade, undoubtedly, comes with a number of effects on the economy. This has been the source of controversy with a large number of people opining that it has negative effects, while an equal number believes that it has positive effects. Nevertheless, there has been long-standing U.S policy in support of multilateral trade liberalization. This support is in line with well-acknowledged conclusions from empirical evidence and economic reasoning pertaining to the beneficial effects of free trade for the participating countries.

One of the key effects of Free Trade revolves around increased production in the participating countries. Economic models of trade show that there would be increased aggregate production once an economy shifts to free trade from autarky. The increased production results from production efficiency as the two countries would have the capacity to produce more services and goods with similar amounts of resources (Mankiw, 2009). For free trade to improve the production efficiency, it is imperative that resources are shifted between the varied industries in the economy. This underlines the fact that the some industries have to expand their operations while others contract. However, the basis or underlying stimulus for trade between the two countries determines the industries that contract and those that expand. Varied stimuli for trade are emphasized by different scholars or models of trade. These include the variations in technology between the participating countries as the predisposing stimuli for trade, or differences in endowments, as emphasized by Ricardian models and factor proportion models among others. Scholars note that there is likelihood that, in the real world, these stimuli play a role in stimulating the observed trade patterns. In essence, as trade opens between the two countries, each of the countries specializes in products and services in which it has comparative technological advantage, or shifts production to industries where the relatively abundant factors of the country are used most intensively (Mankiw, 2009). Alternatively, production would be shifted to products and services that the country has comparatively less demand in relation to other parts of the world, or the production would be shifted to products that show increased economies of scale in their production. In case the production shift results from any of these reasons as or a combination of them, it follows then that the aggregate production would increase as postulated by the models. There would be an empirical reflection of this through increased Gross Domestic Product of the country. Without free trade, every country would have to manufacture every product that it needs including things that it may not be efficient in their production. However, once free trade is allowed, every country would concentrate on the production of items that it is most efficient in their production relative to the other countries and export a proportion of the output in exchange for imports of items that it is inefficient in their production (Mankiw, 2009). This activity would result in an increase in increased production and output both nationally and globally. Economic output would also increase thanks to the increased usage of economies of scale considering that industries in one country would have the capacity to serve two or more countries instead of one.

In addition, Free Trade would result in an increase in consumption through enhanced consumption efficiency. Improvements in consumption efficiency result in instances where changes or variations in the relative prices of services and goods allow an individual to obtain higher levels of utility. Having in mind that the change in price results in a change in the number of choices hat a consumer has, it is safe to conclude that improvements of consumption efficiency underline the fact that the consumer can access more satisfying choices. The increased production efficiency means that the consumers would be likely to have more choices of products available to them (Masimo, 2001). This is complemented by the fact that the increased number of goods also underlines increased competition, which would underline a reduction in the magnitude of monopolistic pricing, as well as the inefficiency that emanates from it. These, therefore, mean that the consumer would have the capacity to attain consumption efficiency, which, in economic terms, means that the consumer would have to a higher indifference curve through income distribution (Wessels, 2006).

In addition, trade liberalization result in increased employment opportunities in the economy thanks to increased production (Masimo, 2001). It is worth noting that it results in winners and losers as resources are moved to increasingly productive areas of the country’s economy. There would be an increased in employment in the exporting industries, while workers would be displaced due to closedown of the import competing industries (Samuelson & Nordhaus, 2005). However, the industries where there are increased employment opportunities would be likely to have the capacity to absorb the unemployment emanating from restructuring. This is the case for Australia where jobs have been created in the service and manufacturing industries capable of absorbing the unemployment from firms that closed down. Imposition of tariffs between 1974 and 1984 in textile and footwear industries resulted in a decrease in employment in the sector by 50000. A similar scenario can be observed in the United States. The U.S economy had a net gain of more than 20 million new jobs from 1993 to 2002. In fact, the creation of NAFTA (North American Free Trade Agreement) has resulted in a net increase of more than 26 million jobs in the labor market (Samuelson & Nordhaus, 2005).

Needless to say, the overall effect of free trade would be increased economic growth. This is especially considering the increasingly competitive industries, as well as increased efficiency, production and productivity, and consumption levels (Wessels, 2006). On the same note, it is worth noting that the increased productivity would mean that a higher amount of goods would be exported to other countries or rather there would be increased trading between countries. The increased trading would also means that the economy makes foreign exchange gains as it would receive hard currency from the country to which it exports its productions (Samuelson & Nordhaus, 2005). This foreign exchange would then come in handy in purchasing items whose production is done more efficiently in the other countries, in which case they would be offered at a considerably lower cost. This is undoubtedly bound to enhance the economic growth in the participating countries.

However, there are also some negative effects of pertaining to Free Trade on the economy. Scholars note that there would be increased instability in the domestic market emanating from the international trade cycles. This is because the participating economies would become dependent on the global markets (Masimo, 2001). In essence, the businesses, consumers, and employees would become more vulnerable to downturn occurring in the economies of their trading partners. This is the case for USA economic recession, which has reduced the demand for the products of its trading partners such as Australia and African countries, resulting in reduced GDP, export incomes, increased unemployment and reduced domestic demand (Lipsey et al, 2007). On the same note, it is worth noting that the international markets do not always offer a level playing field especially considering that countries that have surplus products may sell them at below cost in the world market. This means that some efficient industries may be unable to compete in the long-term under such conditions (Lipsey et al, 2007). On the same note, countries whose economies are dependent on agricultural production are usually faced by unfavorable terms of trade where the incomes of their products is way lower than the import payments that they would make for value added imports, which may increased the level of foreign debts.

In conclusion, recent times have seen an increase in free trade agreements between different countries. While this may have varied effects, Free trade usually has a positive impact on the economy. It allows for increased output thanks to increased production efficiency, consumption efficiency, increased employment and foreign exchange, which would increase the economic growth (Lipsey et al, 2007). However, it may also result in increased economic vulnerability to international market due to dependency, as well as trade deficits especially in the case of agricultural exporting countries as their products fetch less than the items that they would buy from their trade partners.

References

Lipsey, R. G., Chrystal, K. A., & Lipsey-Chrystal, . (2007). Economics. Oxford [u.a.: Oxford Univ. Press.

Massimo, Ca. (2001) “Investment and the Persistence of Price     Uncertainty,” Research in economics, Vol. 55,

Mankiw, N. G. (2009). Principles of economics. Mason, OH: South-Western Cengage Learning.

Samuelson, P. A., & Nordhaus, W. D. (2005). Economics. New Delhi: Tata mcGraw-Hill.

Wessels, W. J. (2006). Economics. Hauppauge, N.Y: Barron’s.