Advantages and Disadvantages of Free Trade | FYBA Economics Notes 2022

Advantages and Disadvantages of Free Trade | FYBA Economics Notes 2022

Advantages and Disadvantages of Free Trade


  • Trade policy is also known as a commercial policy that is concerned with international trade between countries of the world. Exports and imports are the two components of international trade. Therefore, trade policy can be categorized into two main policies that are import policy and export policy.
  • Trade policy aims at impacting the volume composition and direction of international trade that is trade between one’s own country and the rest of the world. The volume of trade pertains to the size of imports and exports.
  • The composition of trade refers to the goods and services imported and exported and the direction of trade refers to the countries from which goods and services are imported and the countries to which goods and services are exported.

Explain the instruments of trade policy/INSTRUMENTS OF TRADE POLICY

  1. There are three instruments of trade policy Tariffs, quotas, and non-tariff barriers to trade. Tariffs and quotas are imposed by governments to raise customs income, improve terms of trade, restrict imports and expand exports.
    When government imposes tariffs on imported goods that are not domestically produced, it is aimed at raising revenue from imports. Similarly, tariffs are also imposed on exports in the form of export duties.
  2. In India, tariffs are imposed on imports whereas exports do not carry any tariffs because India has been consistently experiencing a negative trade balance.
    In India, export promotion measures are implemented to encourage exports. For example, Export Oriented Units, Export Processing Zones, Electronic Hardware Technology Park, and Software Technology Parks are set up in India amongst other measures to grow exports.
  3. Tariffs on imports and import quotas known as Quantitative Restrictions are instruments used to protect import-competing domestic industries and to accelerate domestic production. Import duties in particular affect the quantity and direction of international trade through prices. Subsidies on export are offered to encourage exports. Many countries subsidized their exports in a more discreet manner by way of charging low-interest rates on export credit, tax concessions, subsiding production of  export industries, and by giving various other facilities thereby imparting a competitive edge.
  4. Import quotas or Quantitative Restrictions are direct in their effect in terms of restricting imports. A quota is an absolute limit fixed by the government on the quantity of imports of a given commodity.

What is trade policy? Explain the Advantages and Disadvantages of Free Trade Policy/Explain the arguments made in favor of the free trade policy.

  • The policy of free trade was propagated by classical economists like Adam Smith and David Ricardo by stressing the allocative efficiency of free trade. Free trade refers to the free play of market forces of demand for imports and supply of exports.
  • The free trade movement began in 19th Century Great Britain with a heavy emphasis on the distributive efficiency of free trade.
  • David Ricardo had argued that removal of tariffs on corn would increase the real wages of workers in Great Britain on account of reduced prices of corn and also increase the demand for labor on account of higher profits and more investments made by the capitalist class.
  • A free trade regime is however not free from customs duties. Both imports and exports do attract custom duties to the extent they do not affect the competitive advantage of trading nations and sovereign nation are enable to earn tax revenue in the same manner as they would be earning from domestic trade.

Advantages and Disadvantages of Free Trade

Advantages of Free Trade :

  1. Greater Gains from Trade: Free trade maximizes allocation of the efficiency of scarce resources that is resources will be allocated to their most profitable use. According to David Ricardo, a country should specialize in the production of those goods and services in which it either enjoys a comparative cost advantage or has the least comparative cost
  2. Greater Employment, Greater Income, and Greater Consumption: Due to international division of labor and specialization, economies of scale will emerge and the cost of production will be minimized. Markets will be more perfect both nationally and internationally, each firm will be maximizing output and minimizing cost resulting in optimum firms with optimum employment. With the maximization of profits, there will be greater investment, employment, output, income, and consumption.
  3. Cheaper Imports: Under free trade, every country would be specializing in those lines of production in which it has either a comparative cost advantage or a comparative least cost disadvantage. Every country would therefore be producing goods and services at relatively least cost. For instance, let us assume that India emerges as a software giant in the international market, the rest of the world will be in a position to buy the cheapest software from India and India will have the access to the world market for its software exports. Thus free trade not only makes your exports cheaper to the rest of the world but also makes imports cheaper for you.
  4. Greater Competition: Free trade contributes to an unfettered international market wherein factors of production are freely mobile between countries and uses. Free trade can thus obtain maximum allocation and distributive efficiency. Free markets produce the spirit of innovation and invention and to maintain one’s competitive edge in the international market there is no alternative to innovation and invention which are the driving forces of a market economy.
  5. Greater Economic Equality both within and between the Nations: Free trade promotes and rewards economic efficiencies leading to every expanding world GDP through expanding employment, output, income, and demand. Since economic activities will be optimized, there will be little or no scope for inflation.
  6. Economic Integration and Globalization: Free movement of factors of production and free movement of goods and services will bring about rapid economic integration of the world economy. Free movement of labor, capital, and entrepreneurs will bring about both economic and social integration of the world economy and the world society.

Disadvantages of free trade:

  1. Unfavorable Terms of Trade: Terms of trade refer to the relationship between the export price and the import price of a country. Terms of Trade are said to be favorable if the export price of a country is greater than the import price. However, underdeveloped countries mainly export primary commodities and hence have unfavorable terms of trade. Unfavorable terms of trade occur on account of inefficiencies in production and other areas of business activities.
  2. Unfair Competition, Unequal Gains, and the Argument of Dependence: International trade left free to the trading countries and their exporting firms may give rise to unfair trade practices. The creation of artificial scarcity, dumping, misuse of trade-marks and brands, competitive advertising, and misinformation campaigns are all some of the unfair trade practices. competitive advantage and interdependence are the guiding principles of free trade and they need to be protected and upheld by all trading countries.
  3. Anti-competitive Practices amongst the Trading Countries: Unilateral protectionist measures adopted by trading countries would invite counter-imposition of trade barriers. Trade barriers can be either tariff-based or non-tariff-based. As a result, there will be moves and counter-moves leading to an environment of uncertainty and discordance. However, the element of uncertainty and discordance is due to the absence of a regulating mechanism or the lack of effectiveness of the existing trading mechanism.

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