Over the past two centuries, free trade has been one of the most heavily discussed topics in both economics and the field of politics. However, arguments have intensified in the past half century as globalisation has occurred at a pace never seen before and issues such as trade become increasingly important. Political scientists discuss economic, socio-political and moral arguments, and although the prevailing belief is currently in favour of free trade there remain strong arguments against the notion.
Although this essay will focus on the effect free trade has on developing states, it must be noted that there are other factors involved when considering whether the concept of free trade is a positive one. This essay will examine the impact of free trade on developing economies through the increased competition brought about by it, as well as its promotion of undiversified economies, its impact on the standard of living of people in developing states and the effect on the environment.
The most obvious effect of free trade on developing nations is the huge increase in competitiveness. Due to the absence of trade barriers, local firms are competing with overseas markets and must adjust their businesses accordingly. The effect this has on individual states depends on many factors such as the type of businesses operating in the country and the comparative advantage or disadvantage that the state may face when competing with the rest of the world.
Developing states generally have lower labour costs and cheaper raw materials than more developed economies, meaning that they can operate at a lower average cost and thus undercut the prices set by foreign firms in developed states, enabling their businesses to maintain a high level of demand from the global market. However, it is inevitable that some businesses will be worse off when operating with no trade barriers than they would under a protectionist policy.
For example, if a firm in Indonesia was trying to grow bananas it would be unable to compete with firms in Jamaica, where the climate is more suited to banana growing, thus the Indonesian business would probably have to shut down whereas under protectionism they could have maintained a high level of demand within the domestic market. That said, as far as the global economy is concerned, increased competition is certainly a positive outcome of free trade as it will lead to greater efficiency being achieved and in the long term global output of both goods and services will increase substantially as a result.
An example of a country that has benefited from free trade and increased competition in particular is China, who has in recent years risen to become one of the world’s strongest economies. The Chinese economy has benefited from extremely low labour costs, a centralised government, cheap raw materials and the sheer size of the population, which in 2009 was 1. 3 billion strong with almost 1 billion of these being economically active. Although comparative advantage has positive effects, there are also negative aspects arising from the notion.
One key issue is the fact that when countries follow their comparative advantage they must specialise in certain industries, which may lead to a world of many undiversified economies. Often, when countries choose to specialise they become highly dependent upon certain industries and resources which are often limited in availability. This is known as resource curse theory or the paradox of plenty and can be seen around the world today.
One example is the Middle East, where oil-rich countries have economies based around this increasingly scarce resource, putting them in a dangerous position as reserves are severely limited and their economy has not been diversified. In other cases, industries may decline over a relatively short period of time, such as the shipping and fishing industries in Northern England, which has left cities like Hull in economic deprivation when compared to the rest of the country as their economies were focused upon these industries alone.
Nevertheless, this danger represents a negative effect that many believe would be outweighed by the positives. As already discussed, free trade leads to countries focusing on goods and services that they are efficient at producing. Combined with the absence of tariffs on imports and near perfect competition, this means lower prices for consumers as goods and services are provided at the lowest possible cost. This is clearly a positive for consumers who are able to improve their standard of living as they are now relatively richer than they were while paying higher prices.
Consumers in Indonesia would benefit from Jamaica’s comparative advantage in banana growing as they would be able to buy Jamaican bananas cheaper than they could previously buy Indonesian bananas, thus they have more disposable income than they would under a protectionist policy, despite having to import the bananas from overseas. Although this benefits consumers, it highlights two other key issues associated with free trade: standard of living from the supply-side of free trade and the environmental issues with a global market, which I will now look at in more detail.
Firstly, free trade gives rise to environmental implications as it gives rise to a global market where goods can be purchased from any state. Going back to the example of bananas, if Jamaica had the optimal climatic conditions for growing bananas and were able to undercut domestic firms all over the world after taking into account the cost of shipping there would be a huge issue with food miles as people all over the world would be buying Jamaican bananas. Although this is an economically ideal position to be in as it leads to an increased global output, there are externalities that are not taken into account by the markets.
As well as the use of scarce fossil fuels in the long distance storage and transportation of food, there is also the issue of pollution. This would not just be an issue for bananas, but all kinds of food as well as other products. Even in the world today which has a long way to go on the road to a single global market, many examples can be found where free trade has led to an increase in transportation of goods. For example, in New Zealand fish are caught from local waters but are then sent to Japan and China for thawing and processing before being exported back to New Zealand for consumption.
Although this may be economically justifiable, as far as the environment is concerned it is a waste of fossil fuels as well as unnecessary pollution. This is just one of several environmental concerns raised by the removal of trade barriers across the world; there is much research into the environmental impacts of free trade, especially in North America where it has become clear that the arrival of NAFTA has brought with it many environmental issues which must now be addressed. Secondly, there is the problem of low prices leading to poverty in sectors such as agriculture.
The Director of the Trade, Equity and Development Program Sandra Polaski and others have found that as many developing economies are based upon the agricultural sector, higher food prices actually have positive overall poverty impacts whereas lower prices have significantly negative impacts on poverty. In her Carnegie Endowment report, “India’s Trade Policy Choices” she finds that based on a 25% decrease in world rice prices: “seventy-eight percent of households would experience real income losses from such a price change, and the distributional impact would be regressive, with the poorest households losing the most.
i Although the Carnegie Endowment report looks at the agricultural sector alone, hypothetically low prices in the face of high competition could lead to many people being worse off, as all firms will theoretically be making minimal profit, thus wages will be at a minimum meaning that although goods and services become cheaper consumers have less income than they would have done previously.
Remaining on the subject of agriculture, it has been argued by some scholars that although free trade may lead to low prices which would harm farmers, this would be fairer than the current situation where subsidies provided by the European Union, namely the Common Agricultural Policy (CAP) work against them. As explained above, agriculture is a staple of many developing countries but most cannot afford to subsidise their agricultural sectors meaning that they are unable to compete with the subsidised exports from Europe which are able to undercut the prices charged by domestic farmers.
The Cairns Group, a trade group of 19 agricultural exporting countries, claim that under free trade and with the removal of subsidies in the agricultural sector developing states would account for a much higher proportion of global trade, which would help in closing the development gap. The Organisation for Economic Co-operation and Development (OECD) amongst others has argued that “Foreign Direct Investment (FDI) is an integral part of an open and effective international economic system and a major catalyst to development”ii.
Many of the Newly Industrialised Countries (NICs) have been able to achieve rapid growth as a result of foreign direct investment into their country. For example, the “Asian Tiger” economies of Hong Kong, Singapore, South Korea and Taiwan have received substantial investment from Japan which has allowed them to rapidly develop into advanced, high-income economies that are now providing similar levels of foreign direct investment to the “Tiger Cub” economies of Indonesia, Malaysia, Philippines and Thailand.
Free markets encourage investment, which allows capital to be transferred to where it is needed for development, leading to an improvement in productivity and thus driving growth. On the other hand, it has been argued that FDI is a risky route to go down in the development process, as an economic crisis may lead to a rapid loss of money from a country as the hosts withdraw their investment in the face of losing it. If this were to occur it would be a huge hindrance to a developing country rather than an aid as the country would have become dependent upon the investment and would struggle to cope after its withdrawal.
Nevertheless, studies have shown that “FDI flows remained relatively robust right through the Mexican peso crisis of 1994-95″iii, therefore if we look at history to determine the future it is fair to say that high levels of FDI could be maintained even in the face of an economic crisis, although there is certainly some element of risk involved. Many scholars who hail free trade as the way forward for developing countries point to the Chinese economic miracle to back up their claim.
Since liberalising their economy in 1978 China has sustained a growth rate constantly above 7% for over 3 decades and are now one of the most powerful economies in the world. Over the same period poverty in the country has also fallen drastically, especially in the 1990s where Ghosh (2010) finds that the proportion of people living on below $1/day fell from 31% to 5. 5%. Furthermore, as a result of the removal of trade barriers FDI into China increased substantially from around $600 million in 1979 to around i??50 billion (i??50000 million) today which is enough to fund about 23,000 development projects across the country.
Clearly, trade liberalisation was crucial for China’s success and although there are other problems in the country such as the issue of human rights, economically China is in a very strong position. Finally, some argue that due to the World Trade Organisation (WTO) being controlled by developed countries there is a bias in trade rules in favour of developed countries and against developing countriesiv. In September 2003 the WTO held a meeting in Cancun, Mexico, where talks were held over how trade could help close the development gap between rich and poor countries.
However, developed countries tended to talk about newer issues that mainly would have benefited them, whereas less developed countries wanted to finish older issues, especially in the field of agriculture as dumping from the US and the EU was having a huge impact on their markets. Consequently, many developing countries walked out of the meeting in order to express their concern as the more developed countries seemed to be interested only in their own issues. Taking this evidence into account, this essay concludes that free trade is on the whole beneficial for developing states.
Although there are issues with completely free trade across the world with no form of regulation, there are ways in which these problems can be overcome so that the benefits of trade liberalisation heavily outweigh the risks and problems. For example, regulation can be introduced to ensure that huge amounts of FDI is not removed from a country over a very short space of time, and rules can be passed to ensure that the environmental externalities involved with international trade are dealt with in some way.
For example, the externality can be internalised by adding shipping charges which can then be used to combat the environmental damage. If problems such as these are dealt with effectively, developing countries have a huge amount to gain from trade liberalisation as China has done in the past few decades. It is already clear that other developing states across the world are following in China and India’s example, with Dornbusch (1992) finding that Mexico, Chile, Korea, Ghana and Botswana had all liberalised their markets by the early 1990s.