The Economic Argument for Trade

Introduction

The concept of free trade has been in existence since pre-historic times. According to O’Brien, different geographic locations have different natural endowments (172). Similarly, different people have different skills and expertise that defines what they can produce. In the early days, people would exchange what they produced in excess for what they did not produce but was of significant value to them. The modernization introduced the monetary system that helped in eliminating barter trade.

Then technology simplified the movement of goods and people and enhanced communication. It also promoted international integration, as the world became a global village where people could trade with ease. As the world leaders came to appreciate the need for a free and fair trade, various organizations emerged to help facilitate the process.

One of the earliest legal agreements that were signed to promote multilateral trade was the General Agreement on Tariffs and Trade (GATT). It was signed on October 30, 1947, to help regulate tariffs and eliminate other barriers. The North American Free Trade Agreement is another major economic block that seeks to promote trilateral trade among North American nations (Canada, Mexico, and the United States)1.

The World Trade Organization currently is one of the most influential organizations that promote global free trade. It was founded in January 1995 following the collapse of the General Agreement on Tariffs and Trade (GATT). Other economic and political blocks such as the European Union and the African Union are all geared towards promoting free trade among countries. It is a clear indication that free trade is very important to nations across the world. In this paper, the researcher seeks to provide an argument for fair trade and to outline factors that may hinder it.

Economic Argument

According to Mishan, trade is always one of the central concerns for every regime that come to power (29). Every government wants to ensure that its people are gainfully employed and that all their materials needs are made available. Success or lack of it thereof, of every government, is often determined on how the economy of a country performs, besides other socio-political factors. That is why every regime often works tirelessly to come up with the best trade agreements, which are suitable for the country.

To understand the economic argument for trade, it is important to look at some of the works of the earliest economists. The philosophies of Adams Smith may help explain the relevance and importance of free trade. One of his magnum opus was the inquiry into the wealth of nations2. Smith believed that economic success of a country relied on her ability to empower its people. When wealth is in the hands of the common people, then the economy will grow. They will spend more within the economy, and as such, boost trade. It means that in this philosophy, Smith argues that economic success of a nation depends on how well it can facilitate trade.

David Ricardo is another economist whose philosophies strongly support free trade. For instance, in his Theory of Diminishing Returns, he argues that if one input is increased while others remain constant in the production of a commodity, a point will be reached eventually where progressive increase leads to reduced yields (Mishan 68). It means that when an entity has the capacity to produce more of such input but not others, it is economically advisable for it to sell the excess of that input to purchase what it needs most. Ricardo’s Iron Law of Wages, which talks about the concept of minimum wages, strongly advocates for trade.

It argues that a firm must find a way of sustaining its operations by lowering its costs and exploring new markets, some of which may be outside the border of the parent country. Marxian economics can also help in explaining argument for trade. The Marxian Class Theory holds that in capitalistic economies, people of different social classes have varying interest, always keen on climbing the ladder3. In his theory, the proletariats are always in a constant race to become bourgeoisie, and the only platform that can make that happen is through trading, assuming that there is the rule of law and that one cannot use force to grab unfairly the wealth of others.

Market liberalism as a concept started gaining popularity in Europe during the period of industrialization. As technology improved means of transport and communication, nations realized that they needed to liberalize the market. Trade of good without taxes and with as minimal barriers as possible became necessary. Although the regional and world leaders agreed that, it was necessary to have regulatory policies to guide international trade, they also acknowledged the need to eliminate unnecessary barriers.

Several trade organizations started emerging soon after the First World War. The General Agreement on Tariffs and Trade (GATT), the North American Free Trade Agreement (NAFTA), and the World Trade Organization (WTO) are some of the geopolitical and economic organizations that the United States has signed in the recent past. The European Union is another economic block that promotes free trade, a clear sign that the world is increasingly appreciating the need for the free trade.

Factor endowment is another concept that helps in explaining the importance of trade at a global scale. The concept explains that countries are endowed differently in terms of land, labor, entrepreneurship, and capital4. It means that the capacity to produce different products varies. America’s culture of entrepreneurship, skilled labor, and ease of availability of capital makes it one of the world’s leading manufacturers. On the other hand, Saudi Arabia’s rich oil reserves make it one of the world’s top producers of petroleum products. The United States sells what it produces in excess, just like Saudi Arabia and other countries, to get what it lacks in terms of factor endowment.

The concept is closely related to the Heckscher–Ohlin theorem, which states that a country often imports products that use its scarce factors intensively, exports products that use its abundant factors intensively5. It means that a country that is capital-abundant (such as the United States) will always export goods, which are capital-intensive, while a country, which is labor-intensive (such as China), will export goods which are labor-intensive. Whatever a country has in abundance is what defines its exports.

Factors That Can Enforce Fair Trade

It is important to appreciate that a number of factors help in enforcing fair trade. According to O’Brien, the establishment of socio-political and economic blocks around the world is instrumental in enforcing fair trade (174). The World Trade Organization came up with the concept of the Generalized System of Preferences (GSP) that seeks to ensure that all members treat imports from other member states equally in terms of tariffs and other regulatory policies.

It also came up with the principle of the Most Favored Nations (MFN) to help developing countries compete fairly against developed nations (Mishan 94). The MFN concept appreciates that some countries, such as those in Sub-Sahara Africa, lack the capital, technology, and technical-knowhow to compete with developed countries in Europe and North America. As such, they are granted more relief than other developed countries to help them export their products, which in most of the cases are raw materials.

They are also exempted from a number of non-tariff barriers that may inhibit their ability to trade in the international market. Most of these developing nations have also developed customs union to help them trade amongst themselves. According to Mishan, free trade areas have been created all over the world to enhance free movement of goods and services from one country to another (64). Such economic integration has facilitated the growth of multinational corporations and movement of labor.

The establishment of dispute settlement mechanism is another factor that helps in enforcing fair trade among nations. Rössner says that it is important to appreciate that during the engagement, disputes may arise because of various factors (65). The most important thing is to ensure that such disputes are settled in an amicable manner and within the shortest time possible. Putting in place mechanisms to address such disputes is critical. Political stability is another factor that promotes fair trade among countries.

When a country enjoys a period of political stability, it will be able to increase its production and capacity to trade easily with other states. The Hegemonic Stability Theory helps in explaining the relevance of political stability among member states. The theory, which is popular in international relations, holds that international systems (such as economic blocks) are likely to remain stable when one state is hegemon (the dominant power). The dominance of the United States as a world power, therefore, is beneficial to global economic blocks such as World Trade Organization. It acts as a common factor or a parent to the other member states by addressing disputes and solving major problems that may threaten the existence of the economic block.

Regular engagements between member states of various economic blocks also help in promoting free trade among member states. The Ministerial Conference of WTO that is often held once after every two years helps in addressing concerns among the member states. It also facilitates intergovernmental bargaining power, especially when engaging with non-member states. In North America, the United States and other regional countries have very efficient agreements that facilitate regional trade. Reciprocal Tariff Act (RTA) was enacted specifically to enhance tariff negotiations and agreements among members of regional economic blocks.

According to Mishan, the need for individual corporations to expand and gain economic benefits from global trade also facilitates international trade (84). Multinational corporations such as Coca-Cola Company, General Electric, Samsung, Apple Inc, Toyota, Barclays Bank, and Gucci among others play a critical role in the development of their parent and host country economies. The fig. 1 below shows how they benefit when they trade in the global market.

Gain of producer surplus.
Fig. 1. Gain of producer surplus (Mishan 81).

As shown in the figure above, when the domestic price (without trade) is low compared with the world price, these companies benefit when allowed to trade in the global market. The higher price of their product would translate to higher profits. It helps in promoting the success of the export-oriented sector of the economy.

Factors That Hinder Fair Trade

According to Saether, a number of factors may hinder fair trade in the international market (75). The market bubble is an example of a force that may hinder free trade, especially when the bubble bursts. It creates mistrust among players and legitimizes the need for people to avoid trading in sectors whose growth is fast-paced. The fall of some of the world leading companies in technology and financial sectors from 1998 to 2008 created such mistrust.

Lehman Brothers was flourishing, and it operated in North America, Europe, and the Asia-Pacific. However, because of unethical practices of its top managers and the desire to achieve maximum growth over a very short time led to the engagement in risky ventures, which were not properly calculated (Lacey et al. 22.10). The firm became bankrupt in 2008, leading to loss of investors’ funds. The Bear Stearns Companies Inc. also faced the same fate in 2008 due to global financial crisis.

Rössner says that pure judgment and leadership inefficiencies resulted in a situation where these companies had toxic assets (88). Their fall was unavoidable. Such global crisis makes global trade less desirable, especially when the economy of the world is heavily dependent on that of the dominant state.

Doha Development Round was an ambitious program that was expected to enhance global trade among WTO member states. However, its failure to take effect only fueled mistrust among these states. Several subsequent agreements made to help make it a reality also failed. Such failures tend to frustrate the economic block, more so when they start blaming one another. The free rider problem is another hindrance to fair trade.

Some countries often abuse the privilege offered by the free market to dump cheap products in the global market. Rössner says that a good case is China (31). Being a labor-intensive country that has registered growth in technology, it has been producing substandard products such as electronics and dumping them in the developing markets of Africa and Asia. The effect of such practices is that it hinders fair trade. Companies producing genuine products of good quality and charging fair prices cannot compete in the global market, which is diluted by Chinese products. The protectionism approach to global trade also affects the free flow of products in the global market. Some firms come up with various bottlenecks to limit importation as a means of protecting the local companies.

Conclusion

Free trade is the current global society is increasingly becoming relevant. It is clear from the above analysis that although the need to have free trade through economic blocks is driven by desires for economic success, political goodwill plays a significant role in ensuring that they remain functional.

The member states must remain committed to promoting fairness, and none should feel threatened. Free trade enables countries to sell what they produce in excess while at the same time purchase what they cannot produce locally. It helps in fair redistribution of resources for the benefit of all the parties involved. It is the responsibility of the political leaders to ensure that there is a level ground for a free and fair international trade.

Footnotes

  1. Philipp Rössner, Economic Growth, and the Origins of Modern Political Economy: Economic Reasons of State, 1500-2000, Routledge, 2016, 81.
  2. Arild Saether, Natural Law and the Origin of Political Economy: Samuel Pufendorf and the History of Economics, Routledge, 2017, 57.
  3. Nicola Lacey, et al., “Understanding the Determinants of Penal Policy: Crime, Culture, and Comparative Political Economy,” Annual Review of Criminology, vol. 13, no. 54, 2017, 22.14.
  4. John O’Brien, “Global Political-Economy as Capitalist Hyperspace: Progressive Utopia or Otherwise,” Critical Sociology, vol. 42, no. 1, 2016, 171.
  5. Ezra Mishan, Economic Efficiency and Social Welfare (Routledge Revivals): Selected Essays on Fundamental Aspects of the Economic Theory of Social Welfare, Routledge, 2013, 68.