Free trade within an economy and its features

Develop the following points

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– The advantages and disadvantages of free trade

– Barriers to trade

– Reasons for Protectionism

The aim of my essay is to explain free trade within an economy and its features. I will also assess the advantages and disadvantages associated with free trade. I will then proceed to explain the barriers that can be erected by countries towards trade and the reasons for Protectionism. I will illustrate this by using examples from the global economy.

Free Trade is “where countries remove tariffs and quotas between themselves and the countries they trade with” (Sloman, Essentials of Economics, p 415). Countries participate in trade for a variety of reasons: to develop, to specialise, reduce costs and to achieve comparative advantages. Because of these reasons it makes sense to remove barriers between the countries they trade with to reap all the advantages.

Many countries make a move towards free trade by joining preferential trading arrangements. Preferential trading systems generally are based on the regional grouping of countries and allow countries to remove restrictions between themselves and member countries, but maintain them with the rest of the world. These can take place in three forms: free trade area, customs union and the common market. Examples of preferential trading systems are the European Union and the North American Free Trade Association.

Participating in free trade can bring a multitude of advantages and disadvantages over a strategic period of time. Free trade exposes several advantages. The first of these benefitial features would be economies of scale. Internally countries would benefit from an increase in market size. This would allow the firms within the country to reap the benefits of economies of scale especially for small countries as they would be increasing there market share. Externally because of the increase in trade, there is the possibility the countries infrastructure will improve to handle the increase in trade within the particular field that they have the greatest comparative advantage in.

Another advantage would be that countries would benefit from producing products which they have the greatest comparative advantage of producing. Because they have the lowest opportunity cost they would take over the majority of production allowing specialisation. This would drive the costs of production down and prices as well, resulting in both producers and consumers interests.

Also there would be a reduction in direct costs from barriers (border delays, administration costs etc) between these countries, as they have been eliminated. This would lead to a substantial reduction in costs.

A further advantage of free trade would be greater competition. This would result in companies reducing their profit margins and would encourage them to use resources more efficiently, hence reducing costs. This would also encourage more innovation and better technological information.

Although the creation of free trade with countries can create several disadvantages. Firstly, the essential economic change required to achieve all of the economies of scale can be extremely costly. Examples would be unemployment because production is more efficient in another country, takeovers etc.

Another significant disadvantage which could arise are diseconomies of scale. This could happen if companies became very large in size and as a result become inefficient and bureaucratic.

Free trade may also lead to the development of monopoly and oligopoly powers. This is because there are no restrictions on the movement of capital between free trade countries. This can lead to substantially higher prices against the consumer’s interests, as no competition has the power or finance available to challenge a company of this might to reduce prices.

Even with all the benefits that free trade exhibit countries will for numerous reasons erect barriers to trade. Countries will protect themselves for the following reasons. Firstly, they may do this to stop the development of a foreign monopoly. They may also erect barriers to protect their developing infant industries or to protect declining industries. They may also do this for political/economic reasons such as achieving a macro-economic objective for example reducing unemployment. They may also reject participating in free trade so they can retain their diverse society. They may also do this as a result of another countries actions which have angered them.

The barriers which countries may erect to protect themselves from free trade are firstly, putting taxes on imports this is known as tariffs. An example of this is when the European Union put taxes on bananas being imported from the United States of America so as a result they put 100% tax on all imports. The country may also put a quota on the number of imports of a particular product. The governing body within the country may put a complete ban on imports (embargoes) as a more drastic measure. An example of this is when countries within the European Union rejected Cadbury’s chocolate because it didn’t have a high enough coco content so would not sell it in their countries. As a result the United Kingdom put an embargo on all foreign meat imports from these countries. The county could also restrict the amount of foreign currency available, hence reduce the cost of exports and increase the price imports. Apart from direct actions the country could also introduce complex indirect actions: delays at customs, change product standard regulations and change contract policies.

It can be concluded that free trade unearths a multitude of diverse advantages and disadvantages which a country would undoubtedly want to achieve, it depends on the combination, volume and severity of the advantages and disadvantages they would sustain as to whether or not free trade is benefitial for them. Although from looking at the success that countries have gained from their participation in free trade as an example countries membership in the European Union, I would promote free trade and countries participating in it because of the benefits gained. Although I do realise this may not be the case for all countries.