Understanding Free Trade: Benefits, Barriers, and Commercial Policies
Free Trade and Barriers
Free trade (barriers to trade)
- Absolute and Comparative Advantage and Heckscher-Ohlin theory assume free trade and a perfect market (no tariff or differentiated taxes).
- Earnings from trade can be mathematically proven.
- Graphically: points of after-trade consumption are always beyond the PPF.
Gains from Free Trade
- Economic Gains: Increase in the standard of living and economic growth resulting from a country’s engaging in free international trade.
- Political Gains: Increases in well-being that accrue to a country because expanded trade and economic interdependency help reduce international hostility.
Relationship Between International Trade and Economic Growth
- International trade enhances economic growth through imports of capital goods.
- International trade enhances international diffusion of technology.
- International trade promotes competition.
- International trade expands market size if economies of scale exist.
- International trade can enlarge the pool of savings necessary for investment spending.
Dynamic Gains from Free Trade
Increases in economic well-being that accrue to a country because trade expands the country’s productive resources or raises resource productivity.
The “Bad” Side of Free Trade
- Inequality
- Poverty
- Some companies may have to close
- Negative environmental impact
Trade Barriers
Restrictions on the amount of imports or exports from a given country. One of the strongest reasons for barriers is the protection of a country’s internal industry.
Commercial Policy
Actions taken by a government to influence the country’s volume and composition of trade.
Types of Commercial Policy
- Tariff
- Quota
- Subsidy
- Nontariff Barriers
1. Tariffs
A tax imposed by a government on either imports or exports.
Types of Tariffs
- Ad Valorem Tariff: A tax equal to a certain percentage of the good’s selling price.
- Specific Tariff: A tax equal to a fixed amount of money per unit sold.
- Compound Tariff: A tax with both ad valorem and specific components.
2. Quotas
A government-imposed limit on the value or quantity of an import or export good.
3. Subsidies
A government payment to a domestic industry to encourage exports or discourage imports.
4. Nontariff Barriers
A wide range of government policies other than tariffs designed to affect the volume or composition of a country’s international trade. These NTBs include:
- Health and safety standards
- Government procurement policy
- Technical obstacles to trade
Tariffs: Colombian Case
Colombian case:
| Code | Description | Tariff % |
|---|---|---|
| 87.01.90 | Agrimotor (tractor) | 0 |
| 87.08.40 | Gearboxes | 5 |
| 87.08.30 | Brakes | 10 |
| 87.03.21 | Vehicles | 35 |
| 87.06.00 | Chassis and engine | 35 |
Optimal Tariff
The size of a tariff that raises the welfare of a tariff-imposing country by the greatest amount relative to free-trade welfare levels.
Conditions for a Tariff to Raise a Country’s Welfare
- The country must have market power, i.e., it is an important participant in the world market.
- A country’s imposition of a tariff does not lead to retaliation by trading partners.
Trade (or Tariff) War
A general reduction in world trade brought about by retaliation and increases in trade barriers around the world. This can be a post-war reaction.