Free trade is increasingly under attack across the western world, most notably in America. But why is free trade a good thing anyway? Who really benefits? And who loses out?
Here are five (hopefully convincing) reasons why free trade matters and are sure to make you sound like an expert at any forthcoming dinner party…
- Comparative advantage
Sounds complicated, doesn’t it. But in practice, comparative advantage is a simple and intuitive economic principle. Its basic proposition is that all countries can benefit from trade – even those that are the best (or worst) at producing all types of goods and services.
But why? Take, for example, a hypothetical country that is completely useless (“uncompetitive” in economist jargon) at producing all types of goods and services.
This country can gain from trade by simply only exporting goods and services in which their productivity disadvantage is “least-bad”. In short, they should specialise in producing goods and services which they are least bad at.
The same would be true for a hypothetical country that is the best (most competitive) at producing all types of goods and services.
Still confused? Take David Beckham, for example. During the peak of his career, he was largely considered to be one of the best players in the world. But let’s suppose for one moment that as well as being gifted with a golden right foot, he was also a qualified lawyer, and a talented one at that.
In this case, Beckham would have what economist call an “absolute advantage” in both playing football and practicing law. But does that mean that he should have been both a footballer and a lawyer at the same time?
Well, no. If Beckham had also practiced the law this would have eaten into the time he had available to train and play games. Instead, it would have been far better for Beckham to play to his key strengths and concentrate on playing football. And, if he himself ever required legal advice, he would be much better off simply purchasing it.
This is the theory of comparative advantage: specialising in activities that we are relatively good (or least-bad) at. It is easy to see then, how this analogy applies to trade between countries.
- More bang for your buck
If countries specialise in producing only goods and services in which they have a comparative advantage in, then it follows, that such goods and services should be produced at their lowest possible cost.
Lower costs, all else being equal, mean lower prices. And with lower prices, everyone can have more for less – thanks to trade, every pound in your pocket can buy a lot more than if everything had to be made in the UK.
Whilst this may be good for British consumers, the same cannot necessarily be said for those in developing countries.
Indeed, one of the adverse effects of relatively cheaper imports is the fact that this “worsens” developing countries “terms of trade”, which is simply the ratio of the price of exports against imports. Intuitively, it is easy to see that from the point of view of a developing country, if the price of your exports decreases relative to the price of your imports, you are left worse off in real terms.
- Choice, choice, choice
Writing towards the beginning of the 20th century, the great British economist John Maynard Keynes famously remarked that: “the inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect an early delivery upon his doorstep.”
A huge benefit of free trade – that is perhaps overlooked as we have become so accustomed to choice – is that through free trade, we are able to access almost all of the goods on the earth.
- Growth, stupid
By far the most important long-run benefit of free trade is the so-called “dynamic” boost that it provides to an economy’s growth. What’s more, this is both in terms of the level and the rate of growth.
Indeed, this makes sense. To borrow a football analogy once more, one of the reasons why the premier league is considered the best football league on earth is the fact that each team arguably competes against other teams that draw their talent from a global pool of players – not simply English-born players.
The same notion applies to an economy – more specifically, the businesses that operate within it – when it competes and becomes integrated into a global marketplace. The result is more dynamism, greater competition and ultimately mutually beneficial growth opportunities.
Somewhat paradoxically, a final key reason why free trade matters has nothing to do with economics (at least directly). Free trade amongst nations, by definition, increases countries dependence upon each other. The historical evidence is clear: protectionism – the opposite of free trade – frequently leads to war between nations and classes.
Yet, despite the tremendous benefits free trade brings on both a political and economic level, the gains are not always equally shared.
Targeted government efforts to mitigate the rather punitive side-effects of trade liberalisation – particularly in the labour market or for so-called ‘infant’ industries – are therefore essential. One thing is clear: lest we forget to champion an open and honest debate around the unwavering benefits of free trade, for it is perhaps more important now than ever before.