Not to be confused with Free market or Fair trade. An automated process has detected links on this page on the local or global blacklist. Free trade is a free market policy followed by some international markets in international economics thomas pugel pdf countries’ governments do not restrict imports from, or exports to, other countries.
There is a broad consensus among economists that protectionism has a negative effect on economic growth and economic welfare, while free trade and the reduction of trade barriers to trade has a positive effect on economic growth. Trade agreements which encourage free trade. Two simple ways to understand the proposed benefits of free trade are through David Ricardo’s theory of comparative advantage and by analyzing the impact of a tariff or import quota. An economic analysis using the law of supply and demand and the economic effects of a tax can be used to show the theoretical benefits and disadvantages of free trade.
Most economists would recommend that even developing nations should set their tariff rates quite low, but the economist Ha-Joon Chang, a proponent of industrial policy, believes higher levels may be justified in developing nations because the productivity gap between them and developed nations today is much higher than what developed nations faced when they were at a similar level of technological development. If the chief justification for a tariff is to stimulate infant industries, it must be high enough to allow domestic manufactured goods to compete with imported goods in order to be successful. This theory, known as import substitution industrialization, is largely considered ineffective for currently developing nations. The pink regions are the net loss to society caused by the existence of the tariff. The chart at the right analyzes the effect of the imposition of an import tariff on some imaginary good.
The tariff increases the domestic price to Ptariff. The higher price causes domestic production to increase from QS1 to QS2 and causes domestic consumption to decline from QC1 to QC2. This has three main effects on societal welfare. However, the loss to consumers is greater than the gains by producers and the government. The magnitude of this societal loss is shown by the two pink triangles.
An almost identical analysis of this tariff from the perspective of a net producing country yields parallel results. Under similar analysis, export tariffs, import quotas, and export quotas all yield nearly identical results. Sometimes consumers are better off and producers worse off, and sometimes consumers are worse off and producers are better off, but the imposition of trade restrictions causes a net loss to society because the losses from trade restrictions are larger than the gains from trade restrictions. Free trade creates winners and losers, but theory and empirical evidence show that the size of the winnings from free trade are larger than the losses. According to mainstream economic theory, the selective application of free trade agreements to some countries and tariffs on others can lead to economic inefficiency through the process of trade diversion.