The Impacts of Free Trade Agreements on Global Political Economy

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Global Political Economy

Table of Contents
Introduction............................................................................................................................. 3
Conclusion.............................................................................................................................. 10
Reference List.........................................................................................................................11
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Introduction
The open trading relationship or free trade can be defined as a trade policy that doesn't
have any restriction over export and import between the involved parties. In the case of
international free trade, the involved parties are different countries. In most cases, the
international free trade is governed by the world trade organisation or WTO multilateral
trade agreements. Apart from being a matter of inter-governmental contention, free trade
is also a big issue within the domestic political landscape. In spite of this complication, the
common consensus among the economists is that open trading relation between countries
makes all the involved parties better off (Yarbrough and Yarbrough, 2014). The essay will
focus on different aspects of free trade and its impact on the countries involved in free
trade. The essay will also consider both positive and negative aspects of free trade
relationship on nations involved in inter-country open trade. To analyse and assess the
impact of international free trade or open trade we will be considering the interrelationship
of political and economic facets of international interdependence or globalisation.
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The query as to why the countries get involved in free trade can be answered by considering
the principle of comparative advantage proposed by David Ricardo in 1817 (Levchenko and
Zhang, 2016). David Ricardo surmises that comparative advantage is the basis of
international open trade. The principle of comparative advantage states that the goods with
comparative advantage are produced more and consumed less. The countries engage in
importing goods without comparative advantage while exporting goods with a comparative
advantage when there’s a difference in labour productivity in countries engaged in open
trade. The comparative advantage given by David Ricardo is dependent on the lower
opportunity cost of goods prior to their export. The concept given by David Ricardo indicates
that by engaging in export of goods with comparative advantage and importing other goods
the exporting country can divert its labour to the production of goods being exported
thereby increasing its production. This will lead to increased consumption of both the goods
being exported and imported in the countries engaged in trading while using the available
labour in better ways (Levchenko and Zhang, 2016).
The free trade agreements are contended to be harmful to developing or underdeveloped
trade partners but the economists contend this view. The economists believe irrespective of
the lack of any absolute advantage, a developing or underdeveloped economy will have a
comparative advantage in producing certain goods. They can freely engage in open trade
with advanced or developed economies on the basis of these goods and benefit from the
increasing living standards and economic benefits associated with free trade. The free trade
among countries bring in the fore the efficient organisations or businesses and cause
contraction of inefficient firms. This results in an adjustment within and across the
businesses of the trading countries. This results in access to better technologies and the
production of more types of goods. This also enhances the intra-industry trade (Levchenko
and Zhang, 2016).
The global institutions that are involved in the promotion of free trade include organisations
like the world trade organisation, International Monetary fund, and World Bank. These
organisations work in different ways to promote free trade by either facilitating the
economic growth of developing or underdeveloped countries or by promoting international
trade agreements and governing them. The free trade agreements can be of different types
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such as bilateral, multilateral, and regional. Multilateral agreements are the agreements
between a number of countries; the bilateral agreements involve two countries while
regional agreements have two or more countries of a reason as parties to the agreement
(Yarbrough and Yarbrough, 2014). The World Trade organisation promotes the multilateral
free trade agreements due to its scope of operations and the benefits associated with them.
Certain prominent international trade agreements include NAFTA or North American Free
Trade agreement, COMESA or Common Market for Eastern and Southern Africa, AFTA or
ASEAN Free Trade Area, SADC or Southern African Development Community (SADC), CEFTA
or Central European Free Trade Agreement, and GAFTA or Greater Arab Free Trade Area
(Yarbrough and Yarbrough, 2014).
There are various opportunities to various businesses offered by the free trade agreements.
The minimal government control, access to new markets, lowering of trade barriers,
availability of government procurement contracts, free flow of labour, capital, and good, etc
are some of the prominent opportunities made available by open trade (Lake, 2018). The
advantages and disadvantages associated with free trade are many that exhibit themselves
in different aspects that are both global and domestic. The countries and their respective
businesses engage in importing products that are cheaper than the similar product being
produced domestically. As a result of such a transaction between two countries or
businesses based in these countries, the living standards are enhanced in both the involved
countries. Another cause of import could be unavailability of a similar good or lower quality
of domestically produced goods (Lake, 2018). This transaction helps the seller of goods gain
more sales while earning in foreign currency that can then be utilised by them for their use
or to procure more goods. These benefits are enjoyed by the country or society as a whole
while the disadvantages impact the individuals or individual organisations. The domestic
produce whether individual or organization losses when a good is imported at a cheaper
price and due to various domestic issues such as higher labour or raw material costs the
domestic producer is unable to price its good competitively. It can be contended that
countries could be better off when they purchase goods manufactured elsewhere with
better efficiency (Lake, 2018). Although such an argument does not consider the costs such
as social costs like pollution that results from increased industrial activity. There many
factions in every country that either support or oppose free trade, especially the political
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factions. Apart from political factions, the most vocal and stringent opposition to free trade
comes from people that are adversely affected by free trade (Lake, 2018). Thomas B.
Macaulay, a historian accurately observes the predicament of free trade," Free trade, one of
the greatest blessings which a government can confer on a people, is in almost every
country unpopular".
The economic impact of free trade is a matter of contention between economists. They can
be categorised in terms of their being in favour or being against the free trade owing to
supposed disadvantages on parties of free trade and others (Eicher et al., 2012). The matter
can be further analysed on the basis of theories of trade diversion and trade creation
proposed by Jacob Viner in 1950. Trade creation assumes that the domestic production of
the goods in a country is substituted by the import goods from its trade partner. This is due
to the fact that free trade makes import more profitable than the production of certain
goods. This can be explained as the movement from High-cost domestic source to low-cost
partner source. For example, when a member country of EU or European Union imports a
good from another member country at a price lower than the production cost due to the
lowering of tariff it leads to increase in consumer surplus. This allows efficient utilisation of
available resources leading to the economic welfare of member countries (Eicher et al.,
2012). Trade Diversion occurs when goods import shifts from a non-member country to a
member country in spite of the higher efficiency of a non-member country. This leads to the
movement from a low-cost international source to high-cost regional source. The presence
of import tariff on a good import from non-member country imposed by the European
Union is another aspect of the trade diversion. The trade diversion leads to a reduction in
customer surplus and lower economic welfare. Both Trade Diversion and Trade Creation are
aspects of free trade agreements. When during the formation of a trade agreement the
diversion of the trade exceeds the trade creation, it results in economic and financial
deterioration of member countries as indicated by General Theory of Second Best Principle
by Lipsey and Lancaster. This factor needs to be considered while incorporating a free trade
agreement (Eicher et al., 2012).
The positive impacts of free trade are manifold. It led to an increase in the production of
specific goods in exporting countries that led to a specialisation in producing certain specific
goods for which they had a comparative advantage (Montalbano and Nenci, 2014). This
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resulted in enhanced production output, improvement in industrial scale and efficiency as
well as an enhanced economy. Another positive impact can be its effect on the level of
unemployment especially in developing or underdeveloped countries. Another benefit can
be considered to be its positive impact on the resource distribution quality and efficiency
and the resulting improvement of the domestic economy. The enhanced efficiency in the
resource utilisation leads to better productivity that causes an overall increase in the
domestic output of that specific good. These factors contribute to a further reduction in
production cost and increased exports. The free trade also promotes utilisation of
innovative production methods, advanced technologies as a tool to improve the
productivity and reduce the cost of production, in the long run, resulting in improved
domestic industrial landscape and consolidation of industrial players leading to the
emergence of better equipped large scale players (Montalbano and Nenci, 2014). The
principle benefit of free trade is enjoyed by the consumers in the form of better quality
goods at a much lower price along with a better range of different varieties of available
goods. This leads to an increase in goods consumption within free trade countries. Another
benefit of free trade is the payment of exports in standard foreign currencies such as dollar
or euro or pound that are considered the currencies of international trade that are again
utilised by the exporters to import goods at a much favourable price from other member
countries. The foreign currency being used is usually stable are less likely to suddenly
depreciate financially. The countries with a high rate of export benefit the most with a
major reduction in domestic unemployment rates and enhanced income from exports while
improving the domestic industrial landscape (Montalbano and Nenci, 2014). Their economic
growth is also driven by these factors resulting in better amenities and facilities to its
populace. The free Trade leads to enhanced living standards, increased income, increased
employment levels, reforms in domestic industries, and overall economic growth. Free trade
has another less discussed benefit and it’s the expansion of businesses on a global scale.
Various businesses are expanding to market that was otherwise untouched by them
resulting in improved access to the larger customer base and enhanced business
opportunities (Montalbano and Nenci, 2014).
The negative impacts are impacts of free trade that affect some of the trade partners
adversely while having minimal effects on others (Irwin, 2015). These include loss of
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employment and businesses. The businesses that are unable to cope up with the increased
competition that results from free trade either are absorbed by other major players or go
out of existence. Also, the development of new industries sees a decline due to the stiff
competition they have to face and lack of any short term protection that's necessary for
their getting established. The negative impact of open trade is usually visible in developing
and underdeveloped countries that are engaged in free trade with a developed country or
businesses from a developed country as a trade partner (Irwin, 2015). One of the negative
impacts of free trade is the adverse working condition, especially in underdeveloped
countries. The reason for this lies in the pursuit of lower production costs and the negative
impact exhibit themselves as low wages, extreme work hours, and deplorable working
conditions and in certain cases child labour. Another aspect experienced mostly by
developed countries is the loss of employment opportunities due to cheaper imports from
developing or underdeveloped countries. This can be seen by protests of free trade within
the US by its populace due to a fear of losing their jobs. According to WTO, free trade could
be the cause of 20% of total job losses across the world. Another aspect that portrays free
trade negatively is the movement of job opportunities and capital from developed countries
to their trading partners. It’s been a major point of political contention in developed
countries, especially by the left wing politicians (Irwin, 2015). Another contended casualty of
free trade is the global environment. The developing or underdeveloped countries engaged
in mass production use older technology and fuel sources to drive their production while
adversely damaging the global environment. The social and environmental issues can be
another negative impact of free trade between the countries. Although, the source of
environmental issues are usually the developing or underdeveloped trade partners that
employ practices that damage the environment in their pursuit of better production and
lower production cost.
The emerging trend of protectionism by various governments such as the US by imposing
import restrictions is a major detriment to open trade. There are of course benefits of these
measures to the domestic businesses being protected in the form of better sales
opportunity in the domestic market but the disadvantages of such measures are mostly
experienced by the domestic consumer including businesses that lose access to cheaper
alternatives (Irwin, 2015). This damages the businesses that have to buy raw material or
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components from protected businesses at a much higher cost driving up the price of their
own goods leading to loss of market and business. The free trade between the countries
also suffers due to these measures since the international sellers are restricted due to heavy
import restrictions and this may lead to countermeasures by the affected countries resulting
in an escalation of a trade war and damaging the open trade (Irwin, 2015).
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Conclusion
It can be concluded that the open trade between the countries has both positive and
negative impacts on the trading partners. These impacts are usually dependent on their
economic levels such as whether they are developed, developing, or underdeveloped
economies. The effects exhibited by open trade are usually a mixed bag in terms of its
positivity and negativity. The recent actions by certain major trading countries such as the
US in engaging in the protectionism may adversely affect the open trade between the
countries. US have single-handedly withdrawn it from several trade agreements citing its
adverse effect on the US economy and the resulting loss of trade and employment. These
actions put in question the viability of international open trade agreements and their future
prospects. It seems to be a passing phenomenon since the benefits of open trade to
countries mostly outweighs the negative impacts of these trade arrangements (Montalbano
and Nenci, 2014). The benefits gained by the member countries make it difficult for them to
back out from these agreements. This point is especially true for developing and
underdeveloped economies that have seen economic growth, rising economies and
enhanced living standards as a result of free trade. It can also be contended that when a
developed economy like the US backs out from international free trade agreements the
negative impact of these actions is felt the most by the underdeveloped and developing
economies. The US incident being the single such incident currently does not raise many
issues. The even UK while opting out of the European Union has assured the continuation of
open trade with all its members indicating continued importance of free trade for different
countries irrespective of the state of their domestic economy. The impact on the
environment and the working condition of developing and underdeveloped economies sure
raise a few concerns regarding the effects of the free trade (Irwin, 2015).
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Reference List
Eicher, T.S., Henn, C. and Papageorgiou, C., 2012. Trade creation and diversion revisited:
Accounting for model uncertainty and natural trading partner effects. Journal of Applied
Econometrics, 27(2), pp.296-321.
Irwin, D.A., 2015. Free trade under fire. Princeton University Press.
Lake, D.A., 2018. Power, protection, and free trade: International sources of US commercial
strategy, 1887–1939. Cornell University Press.
Levchenko, A.A. and Zhang, J., 2016. The evolution of comparative advantage: Measurement
and welfare implications. Journal of Monetary Economics, 78, pp.96-111.
Montalbano, P. and Nenci, S., 2014. Assessing the trade impact of the European
Neighbourhood Policy on the EU-MED Free Trade Area. Applied Economics, 46(7), pp.730-
740.
Yarbrough, B.V. and Yarbrough, R.M., 2014. Cooperation and governance in international
trade: The strategic organizational approach (Vol. 133). Princeton University Press.
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