Free trade in economic theories

Authored by the Exploring-Economics-Team

According to the World Bank global trade in goods (merchandise) amounted to roughly 19 trillion US $ (2016 US $) in exports and about the same sum in imports in 2014. The sum of these two divided by World GDP, which in 2014 stood at around 78 trillion US $ gives a figure of around 49,8% trade share of GDP.¹ If services are included it amounts to 59,2%.²

In comparison in 1960 world trade stood at 629 billion US $ (in 1995 US $) only. This means that the world now is trading more goods in absolute $ values than ever before. However, as a historical observation reveals, in relative terms, international trade has experienced its ups and downs from a high tide at the end of the 19th century through relatively modest levels for most time of the 20th century and then again rising to high levels over the last 40 to 50 years. While international trade had been a topic already in ancient societies, it was one of the most pressing concerns for the first economists in Europe in the era of industrialization. In 18th century Europe figures such as Adam Smith, David Ricardo, Friedrich List and Jean Baptiste Colbert developed theories regarding international trade, which either embraced free trade seeing it as a positive sum game or recommended more cautious and strategic approaches to trade seeing it as a potential danger and a rivalry and often as a zero-sum game.

Classical and Neoclassical

Classical Political Economy, as well as Neoclassical theory, embraces free trade. This is mostly because of the theory of comparative advantage first developed by David Ricardo. Broadly speaking, Ricardo’s theory postulates that free trade is advantageous as it allows nations to specialize in production that requires relatively fewer factor inputs. This reasoning is based on the concept of opportunity cost and postulates that even nations that are worse in producing any good stand to gain something from trade. As a consequence of trade, nations would be able to reach consumption (and thereby utility) that goes beyond the possibilities that could be reached by producing all required goods in an autarch manner. The neoclassical theory later refined Ricardo’s assumptions by introducing increasing marginal costs when shifting production factors from one good to another, thereby explaining why there is no complete specialization in countries.

A theory that seeks to explain why different countries specialize in different goods is the Heckscher-Ohlin theory. This theory says that countries will tend to export goods that require more inputs from a production factor (capital, land, labour) they have in abundance and vice versa import goods that require more input from a production factor that is scarce. Also, due to trade both the prices of goods as well as the returns to production factors will reach an equilibrium or a world price.

The political implications of these insights are to repeal restrictions on trade such as quotas, tariffs or national subsidies wherever possible, since they reduce the overall welfare of the world and lead to inefficient production. Historically, free trade proponents’ first great victory was the mobilization against the “Corn Laws” in 19th century Britain. Contemporarily the different rounds of the GATT and the WTO are promoting trade by reducing tariffs as well as non-tariff barriers (such as regulations and bans on certain goods).

Institutionalist

Institutionalists have a more ambiguous stance about free trade. This is mostly because they embrace a more active role for state management of economic development and fear that opening up national economies to world trade (too soon) might interfere with those plans. Also, most of the times a different normative metric for welfare or goodness is applied. Friedrich List, in particular, eschewed the classicals’ preoccupation with the utility of individuals or welfare of the world as a whole. Instead, he places an emphasis on the nation as the locus of collective identity. Consequently, national indicators like, for example, the balance of payment, the share of the manufacturing (or any other nationally relevant) industry or the exchange rate of the nation’s currency would become more important issues than consumers’ welfare gains. Another prominent contribution of List is the “kicking away the ladder” metaphor. He argued that the British economy had actually relied on protectionist tariffs and interventionist policies before embracing free trade and that prescribing other nations to go directly from underdevelopment to free trade would be the equivalent of kicking away the ladder. Contemporary institutionalists might not necessarily share List’s strong attachment to economic nationalism. Still, institutionalists are wary of the consequences for political and cultural consequences that might arise due to free trade i.e. when production patterns are shifted.

Marxian and Developmentalist

Marx did stress the necessity of international trade for the sake of capital accumulation in his analysis. Others working in the Marxian tradition such as Karl Kautsky, Rosa Luxemburg, J.A. Hobson and V.I. Lenin subsequently developed theories of imperialism whereby the conquest of new markets was a function of the capitalist mode of production in the industrialized economies. Consequently, capital needed to expand ruthlessly and violently in order to realize its surplus value and therefore bring all parts of the world not yet subjected to capitalist production under its aegis. It is noteworthy that free trade here is seen as a zero sum game, where value is transferred from the powerless to the powerful, often under the use of (physical) force i.e. in the form of colonial armies, foreign backed dictators or economic and financial pressure.

A variant of imperialist theorizing is World Systems Theory developed by Immanuel Wallerstein, in which a “core” set of nations exploits the “periphery.” In this model, the core imports cheap raw materials from the periphery and sells expensive manufactured goods back to the periphery market. As a consequence of this structure, the core is able to maintain its wealth by keeping the most profitable sectors of economic production within its boundaries, while the periphery is unable to move out of impoverishment (even though transitions towards a semi-periphery are possible).

Somewhat connected to this strand of thinking is the developmentalist school. Developmentalists, however, instead of embracing revolution against capitalism as a policy prescription are closer to the early institutionalists in the sense that they advocate for national strategies such as infant industry protection or the development of import substitution industries that are seen to be able to increase their power in the world trade system in the long term. The political implications from this theory were, for example, the proposal of the New International Economic Organization (NIEO) in the UN in the 1970s, which however failed, and national economic strategies pursued by various states in Latin America roughly from the 1930s until the 1970s.

Ecological

Ecological economists take issue with free trade for a variety of reasons. Firstly, they contend that the negative externalities from the shipping of goods around the globe are not sufficiently accounted for (i.e. CO2 emissions from transport, environmental damages from shipwrecks, destruction of the biosphere for transport routes, …). So from an environmentalist view, it might actually be preferably to produce and consume locally sidestepping global production chains, which have a high and often not even clearly measurable impact on the environment. Secondly, free trade agreements are criticized as a means to break local or national environmental protection laws. This concern is related to the reduction of non-tariff barriers, which might include environmental protection laws and also the inclusion of international trade arbitration courts, which could fine states for introducing future protection laws. Yet another concern related to trade is that states might “green” their economies not by altering production and consumption patterns but by outsourcing environmentally harmful production to other parts of the world and then import goods, whose production entails, for example, high levels of CO2.3

Sources

Frieden, J. A. (2007). Global capitalism: its fall and rise in the twentieth century (1. publ. as a Norton paperback ed). New York, NY: Norton.

Helleiner, E. (2002). Economic nationalism as a challenge to economic liberalism? Lessons from the 19th century. International Studies Quarterly, 46(3), 307–329.

Jäger, Johannes, and Elisabeth Springler (2012). Ökonomie der internationalen Entwicklung. Eine kritische Einführung in die Volkswirtschaftslehre. Wien: Mandelbaum.

Pugel, T. A. (2009). International economics (14. ed., internat. student ed). Boston, Mass.: McGraw-Hill/Irwin.

Further reading

http://www.hetwebsite.net/het/

3^http://www.theguardian.com/environment/2014/jan/19/co2-emissions-outsourced-rich-nations-rising-economies