McConnel and Brue define free trade as “the absence of artificial (government imposed) barriers to trade among individuals and firms in different nations”. Free trade has long been thought as the desirable model of trade that brings about prosperity to nations practicing it. However, I beg to differ and believe that free trade does not materialize its theoretical promises. Critical analysis of free trade theory reveals that free trade is anything but fair trade.
I have attempted to analyze the classical and neoclassical models of free trade theory and identify inherent problems within the very concept of free trade. Careful analysis reveals that when applied to the contemporary world economy, the very postulates of these theories favor developed countries over the developing countries. David Ricardo has showed that relative cost difference is an important determinant of the theory of international trade.
He founded the principle of comparative advantage, which suggests that under competitive forces, countries will ultimately produce goods, which provide them comparative advantage in terms of cost. This serves as the classical approach towards free trade and implies that countries should specialize in producing those commodities in which they possess a relative cost advantage. They will be more productive in making these goods and can trade them for other goods in which they do not possess a comparative advantage.
On the other hand, neoclassical free trade theory described in the “Heckscher–Ohlin theorem: A country will export the good that uses intensively the factor in which it is relatively abundant”. This model exerts the conclusion that countries differ in their relative productivities because of the difference in factors of production available to them. Countries utilize factors in which they have abundance and produce commodities accordingly. In theory, production and trade would help countries encash such abundant resources because excess output will be exported.
Whereas, goods that require factors scarce in an economy can be imported. In effect, comparative advantage implied that countries possessing advantage in producing agricultural or other simple products should relocate resources within the economy to focus on producing a specialized set of goods and vice versa. Following this dictate, many developing economies that were mostly agrarian channeled their resources to produce food commodities. On the other hand, their developed peers focused efforts on producing value goods, as they were more skilled at it.
This theory had predicted that “trade between dissimilar countries implies a positive welfare effect on both countries since they can exploit their absolute and comparative advantages. Only costs of transporting goods between countries can keep them from exploiting those advantage”. However, in practice developing nations focused themselves on producing goods that had lower international market value. Whereas, developed nations focused on further developing their technologies and produced goods with greater international market value.
Therefore, developing nations stayed at a comparative disadvantage as compared to their developed counterparts. Similarly, factor endowment theory concluded that trade brings gains to countries. It assumed that all countries have similar access to technology. It also predicted that “international real wage rates and capital costs will gradually tend towards equalization” . However, the realities are different, as technology available to the developing and developed nations is different. Therefore, developing nations do not have much to encash on.
The prediction of equalization of real wages and capital costs also never materialized. In effect, the difference between wages of employees of developed countries and developing countries has only increased over the years. Free trade assumes that all countries possess similar factors of production which are fixed within the nations. They are completely utilized and immobile to move beyond borders. However, the reality is different; human capital and technology are dynamic factors and trade in fact increases inequality of production resources between countries.
In context, the developed countries posses an advantage over developing countries because they have superior capital resources and will continue to specialize in research and development to produce more capital goods. Whereas, developing countries are disadvantaged in capital resources and mostly posses labor resources. Therefore, they will continue to specialize in labor intensive goods and the gap of resources will widen. Free trade also assumes that factors of production are internationally immobile. This has been proved wrong by the new world economy.
As capital moves from developed nations to developing countries through outsourcing and other operations. These developed nations, through their multinational corporations, then take advantage of cheap labor force existing in developing countries. They reap the benefits of local markets and channel profits back home. This does no good to the developing nations, as these profits do not add to their GDP, rather, contribute to the GNP of developed nations. Therefore, the prediction of free trade that indicated the benefits of trade gains to nationals, never materialize.
On the other hand, as the trade widens the disparity of incomes between the developing and the developed countries, labor or human capital also relocates itself. Therefore, skilled or knowledge workers in developing countries immigrate to developed countries. This brain drain causes huge losses in human capital of the developing countries, where, such labor force is crucially needed. Yet the developed countries benefit from such movements of skilled workers to their countries. Multinational corporations emerge as the most powerful bodies of the world as the business borders blur and globalization affects trade.
Today the profits of these multinational corporations actually exceed the GDPs of many countries. Therefore, these corporations have become a powerful political entity and can actually influence terms of trade in their favor. Free trade also assumes that customer preferences and consumer demand are independent and influence production of goods. The goods that are preferred by consumers internationally will be produced more as they would satisfy consumer needs and the consumers will get the best quality due to competitive forces.
However, it can be seen that multinational corporations can easily change consumer behavior and preferences through aggressive marketing and advertisements. Today’s competition, is therefore not perfect competition but tilted towards the interests of multinational corporations of the developed nations. Embedded in the concept of free trade is the assumption of internal factor mobility. Internal factor mobility assumes that factors of production within an economy are mobile. This implies that resources can be shifted from one form to another in line with the world market trends.
However, in effect such resource movements are in most cases impossible. Specifically when applied to developing countries, which are mostly agrarian economies. For instance, an agrarian developing economy aiming to specialize itself in agricultural goods might have invested its resources in infrastructural developments. To build road or canals, they cannot pick up the road and place it elsewhere. Therefore, these resources become sunk costs and such resources cannot be relocated.
It also requires regulatory efforts on part of developing nations, and could consume many years before diversification of economy actually takes place. Even when developing countries consume efforts to manufacture labor intensive goods, to break the dependency on agricultural exports, they face resistance from developed countries. Developed countries put barriers in form of tariffs and quotas on such goods coming in from developing countries. Mostly this comes as a protectionist measure to safeguard national goods against the cheaper goods being produced in labor intensive countries.
“The United Nations estimated in 2001 that such trade restrictions cost the LDCs at least $100 billion annually-2% of their GNP”. M. Dunn and J. Mutti defend this strategy of developed countries: “If apparel manufacturers must pay wages that are ten times as high as in India or China, not surprisingly those firms feel that they are at an unreasonable competitive disadvantage. They are likely to argue for tariffs that offset these cost differences, thus putting them on a level playing field in competing with imports.
” However, the postulates of free trade such as factor endowment and comparative advantage encourage countries to pursue this strategy. When the same is necessary to protect economies of developing countries the developed countries neglect their concerns. Therefore, the entire concept of free trade dies by such steps prevalent in the contemporary economy. Free trade in the contemporary world is more or less influenced by the powerful countries that can safeguard their interests on the world forum.
These countries can bully other countries or lobby against them to let their products flow into these countries and yet prevent their cheaper products to invade their own markets. The political muscle of the developed countries puts them in a position to influence economic interests of other countries. Therefore, free trade is anything but fair to all of its counterparties. It favors the block of developed countries and adds to the problems of developing countries. Doctrines of free trade imply that developed countries that have gained superior resources in human capital, technology, and business will continue to dominate trade.Hence, free trade does not fulfill its promise of welfare to all but appears to be a new form of colonialism.
Bjornskov, Christian: Basics of International Economics-Compendium. Falkoner Alle, Ventus Publishers, 2000 Dunn, Robert M. and Mutti, John H. : International Economics, , NewYork, Routledge Taylor& Francis group, 2004 McConnel, Campbell R. and Brue,Stanley L. : Economics. New York. McGraw Hill Irwin, 2005 Todaro, Michael P. and Smith Stephen C. : Economic Development, Addison Wesley, 2002