Does unilateral free trade serve a nation’s economic interests?
The theme of free trade has escalated interest within the world of economics. It is among few ideas that source lively interaction between economic theories and political reality for over two centuries. Adam Smith published The Wealth of Nations in late eighteen century, in which he argued that by giving freedom to produce, exchange goods, open markets to domestic and foreign competition, people’s self-interest would promote greater prosperity than with rigid government regulations, persuading economists Free trade improves overall economic welfare. Free trade is a policy in which two or more governments don’t segregate against imports or interfere with exports by applying trade barriers like tariffs and quotas, or subsidies for exports. Unilateral Free trade, however, is a policy governments serve its own interests by pursuing Free trade regardless of what other nations do.
There are several benefits to Free trade agreements. Increased choice for customers and resources for firms arises from the ability to import commodities from other countries, increasing range of goods available. Producers often achieve economies of scale as they sell to other countries increasing sizes of their markets hence allowing them to achieve lower costs as their size grows. The world economy benefits due to increased flow of better ideas and innovation, enhancing nations’ quality and quantity of output. As products import into a nation, domestic firms experience greater competition forcing them to lower costs of production and increase productivity, firms with high costs are forced out of the market leaving firms that achieve allocative and productive efficiency, this consequently reduces price of goods. (Tragakes, Ellie) This can be linked to the microeconomic concept of perfect competition. Due to the above factors, Free trade can act as an engine for greater and faster economic growth. Unlike companies/bureaucracies, markets don’t run into diseconomies of scale. The larger the extent of markets, the more you harness collective skills and resources.
This is the perspective of a protectionist country X exporting to a unilateral-free-trading country Y. A country can only export to the extent that it imports an equivalent volume of commodities. If X exports to Y, Y needs X’s currency($X) to pay. Y can obtain $Xs by exporting to X. Alternatively, Y must export to a third country that has some $Xs because it has itself exported to X. Thus X ends up importing as much as it exports. With unilateral Free trade, domestic countries allow imports of good X so the domestic market is supplied by foreign and domestic firms. The foreign country remains closed to exports of good X from the domestic country so the foreign market is supplied by foreign firms acting as monopolists. Trade is balanced since it’s assumed that both countries allow Free trade of numeraire goods. Trade will be balanced since the domestic country will have a trade deficit in good X, but a trade surplus in good Y, and vice versa. Under ordinary circumstances, one country on its own can lower tariffs, making international investment easier, lowering taxes, reforming its border customs to attract foreign capital. If foreign capital is attracted, the country can learn from their superior production techniques, while prices for similar products will fall given new competition. Free trade, even if non-reciprocal, can attract capital and ideas into countries.
Some countries, like Britain in the nineteenth century, Chile and Korea in recent decades, have undertaken tariff reductions without reciprocal action by other countries. The advantage of unilateral Free trade includes reaping benefits of Free trade immediately. Gains from trade liberalization are substantial, showing income grows more rapidly in countries open to international trade than in those more closed to trade. Dramatic illustrations of this include China’s rapid climb after 1978 and India’s after 1991, indicating when major trade reforms took place. (Irwin, Douglas A.)
Securing mutual recognition with trading partners may be within interest of nations, like UK due to Brexit and their loss of access to large markets, instead of complete harmonisation that could cut off future deals and slow innovation. Arguments for economies to be open to Free trade are politically more important today than at any time since 1960s. Trade isn’t a zero-sum equation. In the coming years, major economies will diminish their tariffs and open their markets to competition to boost productivity. (Lightfoot, Warwick)
Empirical evidence agrees that trade increases growth. Building off methodologies of Frankel and Romer(1999), professor James Feyrer uses geography and changes in transport technology as statistical instruments to calculate trade’s elasticity on growth of 0.5%-10% rise in trade increases sizes of economies by 5%.
Economist Romain Wacziarg calculated that trade liberalizations in the last half of twentieth century increased growth rates by 1.5%.
There’s little evidence that reciprocity is needed for negotiations, countries that start protected don’t seem to have better records in trade negotiations than those without. Today, countries like Hong Kong and Singapore have unilaterally lowered their tariffs and have still been able to negotiate.
Trying to be self-sufficient may not be viable in today’s economy. Even something simple is challenging to construct by yourself, requiring planned, coherent cooperation of thousands of individuals. Trade barriers aren’t completely eliminated in exchanges of goods between nations. Import tariffs are overwhelmingly paid by consumers, also reducing consumer choice. In the long run, economies become less efficient, blocking industries from international competition and diverting resources to unproductive sectors. The best option may be to remove them, creating a dynamic for firms to administer for good business policy environments. Tariffs may work great in short run; tariffs increase prices of imports causing prices of local products seem lower. This boosts economic growth and creates jobs. Over time though, these advantages disappear. Other nations start to retaliate and add their own tariffs. Domestic companies’ exports fall. As businesses suffer, they fire employees. Global trade drops and everyone suffers. This occurred during the Great Depression. Countries protected domestic jobs by raising import prices through tariffs. This trade protectionism lowered global trade as country after country followed, resulting in global trade plummeting by 65%. (Amadeo, Kimberly)
Unilateral reforms means that other nations are under no obligation to reciprocate. This means that country X can open its markets to country Y, while Y can close its markets to X. This seems inherently unfair since X is open to foreign competition, which might hurt its domestic producers. Y, contrarily, can protect itself from foreign competition. Y gets all the benefits of protection while still taking advantage of labour and natural resources from X. X faces losses of profits and jobs due to increased competition forcing out small and inefficient firms. This causes spikes in unemployment rate, affecting several socioeconomic aspects. Unemployed individuals not only lose income but also face physical and mental issues, causing a domino-effect on lower human development potentially due to lower life expectancy, education and high stress. Social costs include higher rates of crime, and governmental costs for unemployment benefits negatively affecting GDP.
Multilateral approaches do have advantages over unilateral approaches. Economic gains from international trade are reinforced and enhanced when many nations agree to mutual reductions in trade barriers. Unilateral trade liberalisation yields less welfare gains for domestic countries, since domestic firms don’t export to foreign markets and so there’re no profits from exports under unilateral Free trade.
By broadening markets, multilateral Free trade increases competition and specialization among countries, thus giving a bigger boost to efficiency and incomes. Multilateral reductions in trade barriers reduce political opposition to Free trade in the countries, as groups that otherwise would oppose trade reforms might join campaigns for Free trade if they see opportunities for exporting overseas in that agreement. (Irwin, Douglas A.)
Although trade policies may be used to improve a nation’s terms of trade and raise welfare, it’s unlikely if other large countries retaliate and pursue similar policies. Furthermore, retaliation is likely because maintenance of Free trade policies in light of your trade partner’s protection would only result in aggregate efficiency losses. By increasing global productivity, globalisation has also led to a pro-poor reduction in costs of living in many basic consumer goods, significantly affecting middle classes. Another reason why establishing unilateral trade may be difficult is the variance in elasticity of certain products, increasing complexity of trade and evaluation of whether unilateral trade is the way to go.
Unilateral methods have worked before due to overwhelming wealth and empires which easily self-sustained themselves, but now due to interconnected networks and prominent coexistence in trade, it is challenging for nations to prosper. Nations rely on others to supply them with products/resources which are unable to be produced or are produced at high costs. Metropolitan regions like Singapore and Hong Kong are large developed business hubs, Singapore doesn’t manufacture many products domestically and almost everything is imported. What Singapore offers to businesses and employees through its conducive environment includes low taxes, connections to worldwide companies, strong government support, center of innovation, research and development as well as a vital springboard to rest of South East Asia. Singapore has a pivotal role as a commercial epicenter and unique position in the global economy developing features like infrastructure, skilled workforce, no language barriers, open firm laws, safety and political stability. Nations that don’t have a strong application for investment, high-yield returns, risky state of affairs and limited connections would crumble under unilateral policies.
The rationale for reciprocity relies on the idea of terms-of-trade effects. In theory, countries/industries with power can use tariffs to increase their profits at the expense of other countries by restricting supply to drive up prices, like OPEC has managed to do over few decades. In order to avoid this, countries should negotiate reciprocally to avoid a race to the bottom. The more relevant argument comes over the importance of bargaining power. While it is possible to create a complex game theory model of optimal negotiation strategy, in practice it means something much simpler. Reciprocity is a basic feature of human fairness and negotiations are more likely to be successful if they comply with it.
Moving from autarky to unilateral free trade results in increase in competition in domestic markets causing two effects on domestic welfare. Firstly, the increase in competition results in lower prices in domestic markets and hence an increase in consumer surplus. Secondly, the increase in competition leads to domestic firms reducing output to cut costs/survive, reducing profits of the domestic firm. There are gains from trade if the increase in domestic consumer surplus is larger than the reduction in profits of domestic firms. Unless the domestic firm is sufficiently uncompetitive, the loss of profits for domestic firms exceed gains in consumer surplus for domestic consumers, resulting in a welfare loss.
In models with linear demand, domestic countries gain due to unilateral Free trade if the foreign firm has significant cost advantages. It has been shown that a sufficient condition for there to be gains from unilateral Free trade is that the domestic firm is so uncompetitive that it ceases production under Free trade. With constant elasticity demand, there could be gains from unilateral Free trade whatever the relative costs of the domestic and foreign firms. Demand is assumed as linear to allow explicit comparisons of welfare between autarky and Free trade.
A just economic policy for prosperous nations could be based on pillars of unilateral Free trade. If a trade bloc, like EU, sets import standards different from one’s own domestic standards, each exporting nation/company can decide for itself if rewards for meeting the importing blocs’ standards warrant the extra cost. It isn’t an issue for exporting nations’ government to decide. Furthermore, the exporting nation doesn’t have to concern itself about importing from a country that refuses to accept the exporting nation’s goods in return. After purchasing goods from protectionist nation(s), that nation’s currency will return into its economy through capital investment or export demand from other nations that accept the currency in payment for some commodity. If currencies never find their way back to the nation that adopted unilateral free trade and is held indefinitely in some foreign/central bank, that nation has simply been on the receiving end of a gift.
Bibliography
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