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Scott Waddell

Everyone is better off with free trade

Is everyone better off with free trade?

The idea of free trade is not a new one; with many theories existing dating back hundreds of years.

Probably the most notable is that ofScottish economist Adam Smith in his Magnum Opus An

Inquiry into the Nature and Causes of the Wealth of Nations, first published in 1776. In his book he

argues that free markets are more productive and beneficial to their societies due to mans natural

tendency towards self-interest (Smith, 2005). This work has provided a vital reference point for

many more economists work and theory surrounding free trade since. So over two centuries later,

how has this changed? What is the modern economists view on free trade? Is everyone really better

off with free trade?

The reason for trade quite simply is because each party values what they are to gain in the trade, if

the parties valued what they were giving up more than what they were gaining they wouldnt go

through with the trade (IMF Center, 2005). The Heckscher-Ohlin Theorem attempts to explain the

reason for countries trading by stating that international markets compensate to the way in which

resources are distributed geographically, and that commodities traded are bundles of factors (land,

labour, and capital) (Leamer, 1997).

One of the main reasons that trade can be so successful is that even a country which is more

efficient (defined by being able to produce goods using fewer inputs i.e. labour and capital) in all of

their produce is able to benefit by focusing more on the products which its absolute advantage was

the greatest. Take the following as a (simplified) example New Zealand with one hour of labour can

produce either three kilograms of milk, or two kilograms of coffee beans. Australia with one hour of

labour can produce either one kilogram of milk, or one kilogram of coffee beans. New Zealand has

an absolute advantage in both products, however if Australia offers to sell New Zealand two

kilograms of coffee beans for 2.5 kilograms of milk, New Zealand can then divert the labour which

would have been used to produce those beans, into producing milk which they are more efficient in.

The end result is that the same amount of coffee beans is produced, however an additional

kilograms of milk is produced in total for the same amount of labour. In the above case, society as a

whole has gained from this trade (McDonald, December 2009).

Many in favour promote China as a great success story of free trade. Through trade liberalisation

China has seen a rapid decrease in poverty over the last 20 years- in 1990 the percentage of China

living on less than US $1 per day was 31.5%, this has been making a steady decline since and as of

2005 this number was sitting at 10.4% (United Nations Development Program, 2008). There is good

reason to believe that this decrease has been a result of an increasing level of openness to trade

(the degree to which foreigners and nationals can transact without government-imposed costs).

Many papers have also shown that the level of openness to trade is a significant variable on the level

of growth of GDP per capita (Berg & Krueger, 2002).

Trade is going to benefit advanced countries like the United States, however it can be argued that

trade is even more important to developing nations in Asia, parts of Africa, and Latin America; lifting

hundreds of millions of people out of poverty. (Bhagwati, 2004). Free trade in developing countries

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especially those with small home markets, can benefit greatly from liberalisation in low-skilled and

agricultural areas, which are likely to be more prevalent in developing countries. Liberalisation tends

to benefit the poor in a country to at least some degree, previous research has shown that on

average the income of the poor generally tends to increase on par with that of the more wealthy

meaning the income distribution does not change. (Berg & Krueger, 2002)

This is not always the case however; take for example China which was mentioned earlier. While the

overall poverty rate has decreased, the inequality has increased. Chinas Gini coefficient (a measure

of income inequality, with 0 being perfect and 1 being complete inequality) has been reasonably

steady in its increase from 1981 through to 2001, starting around 0.32 in 1981 and increasing to

0.412 in 2000 (United Nations Development Program, 2008). Since this figure was released in 2001,

there have been no more official reports of Chinas Gini coefficient from the Chinese Government.

The government insists that this is due to incomplete data on high income groups, however many

experts have criticized this saying that they are trying to de-emphasize the significant wealth gap

(Xuyan & Yu, 2012).

On January 1 1994 a major step forward was taken in free trade with the North American Free Trade

Agreement (NAFTA) coming in to effect. The NAFTA area represents about one-third of the worlds

total GDP (United States, Canada, Mexico) making it the biggest FTA in the world. Since this

agreement has come into place, there have been major economic advances for all partners involved.

Total volume of trade between the NAFTA partners increased from $289.3 billion in 1993 to $623.1

billion in 2003. Throughout the first decade of NAFTA U.S. employment, wages and manufacturing

output rose, wages in export-related industries in Mexico have become 37% higher than in other

industries, agricultural trade has increased 125% between Mexico and U.S., and merchandise

exports from Canada to the U.S. have soared by 250%. (Executive Office of the President, 2004)

Despite all these positive figures NAFTA is constantly under criticism for the effect it is having on

Mexico and U.S. markets, including job losses, supressed wages, and rising income equality. Based

on a report published by Dr. Robert E Scott in November of 2003, the rise in the trade deficit since

NAFTA was signed had resulted in the loss of 879,280 U.S. based jobs mainly in the manufacturing

industry, and has promoted a move of factories away from the U.S. and into Canada and Mexico

(Scott, 2003). Even though the workers displaced in the U.S. are generally able to find work again

their earnings often decrease by as much as 13%. (Mishel, Bernstein, & Schmitt, 2001)

The debate about free trade has been around for many years and will continue to exist for years to

come. Due to the number of different interested parties and countries involved with trade, it is

impossible to conclude that Everyone is better off with free trade as there are always some people

who will do better than average, and some who will do worse. (Berg & Krueger, 2002) However, if

there is a point on which most economist can agree it is that trade among nations makes the world

better off (McDonald, December 2009).

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BibliographyBerg, A., & Krueger, A. (2002, September). Lifting All Boats. Finance & Development, 39(3), 16-21.

Bhagwati, J. (2004). In Defense of Globalization. New York: Oxford University Press.

Executive Office of the President. (2004, July). NAFTA: A Decade of Success. Retrieved April 03, 2012,from Office of the United States Trade Representitive: http://www.ustr.gov/about-us/press-

office/fact-sheets/archives/2004/july/nafta-decade-success

IMF Center. (2005, September 21). International Monetary Fund. Retrieved April 05, 2012, from

http://www.imf.org/external/np/exr/center/students/hs/think/lesson3.pdf

Leamer, E. E. (1997). The Heckscher-Ohlin Model in theory and practice. Princeton Studies in

International Finance, 1.

McDonald, B. (December 2009). Why Countries Trade. Finance & Development, 48-49.

Mishel, L., Bernstein, J., & Schmitt, J. (2001). State of Working America: 2000-01. Ithaca, N.Y.: ILR

Press, an imprint of Cornell University Press.

Scott, R. E. (2003, November 17). The high price of free trade. Retrieved April 3, 2012, from

Economic Policy Institute: http://www.epi.org/publication/briefingpapers_bp147/

Smith, A. (2005).An Inquiry Into the Nature and Causes of the Wealth of Nations. Pennsylvania: The

Pennsylvania State University.

United Nations Development Program. (2008). China Human Development Report. 2007-2008: Basic

Public Services Benefiting 1.3 Billion Chinese People: English. Beijing: China Translation and

Publishing Corporation.

Xuyan, F., & Yu, L. (2012, January 19). China refuses to release Gini coefficient. Retrieved April 2,

2012, from Market Watch: http://articles.marketwatch.com/2012-01-

19/economy/30788275_1_income-gap-china-reform-foundation-gini-coefficient