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Free Trade is Nice in Theory, But …

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Imagine there were no trade borders – it’s easy if you try. Or maybe not. Free trade is one of the most controversial topics in global economics, and recent surveys suggest that most economists are in favour of a more ‘liberal’ view of free trade, with reduced tariffs and global partnerships. Way back in the early 1800s, David Ricardo made a strong case for free trade based on the theory of comparative advantages. The way he saw it, every nation had something which was of value to another, and if every country offered their domestic products freely to others, then everyone would have access to the best prices for the largest variety of goods.S

Ricardo’s theory conjures up utopian images of a peaceful and egalitarian world which John Lennon would be proud of. But of course, it is utterly unrealistic. For a start, it fails to take into account the issues which arise when two or more countries are producing the same product or service. Take the recent oil price rut: when supply was low, oil-rich countries such as Saudi Arabia were able to make a fortune selling their ‘black gold’. But over the past couple of years, increased production in China and the discovery of shale oil reserves in the US have drastically reduced the demand for foreign oil, forcing the Organization of the Petroleum Exporting Countries (OPEC) to reduce their planned production targets in an effort to artificially raise the price of oil again. In a truly ‘free trade’ environment, the global oil surplus would simply be traded at cheaper prices until the supply dwindles again, but this would result in enormous volatility in the economies of oil-producing companies. And that brings us on to the next issue – stability.

History is riddled with examples of economic instability leading to political uprisings – most famously during the French Revolution, and most recently during the Arab Spring. Rulers have a responsibility to protect their citizens, so it is understandable why many countries resort to so-called ‘protectionist’ trade policies which help regulate the cost of imports and exports and therefore minimise the threat of economic volatility.

And then there are the countries which are at an inherent disadvantage. Ricardo assumes that every country has something that is considered valuable to another country, but what if it doesn’t? There are many territories which are unable to compete on a global stage, either because they don’t export many goods of external value (e.g. Western Sahara), or they are unable to maintain their export record due to natural disasters (e.g. Haiti), or because they are geographically distant from the majority of the world’s trading partners (e.g. French Polynesia).

This is the reality of free trade, and it is the reason why protectionist tariffs and laboriously negotiated multi-lateral agreements dictate the majority of global trade today. However, it doesn’t stop the idealists. Ricardo’s theory is still taught to economics students as a sort of ‘parallel universe’ version of globalisation. Over the past two centuries, we have seen the industrial revolution, the end of slavery, the rise of the US and China as two of the world’s most powerful economies, and two world wars. But this doesn’t make Ricardo’s point moot. It just means that we need to redefine the meaning of ‘free trade’ in the modern world.

What is ‘free trade’ in practice?

Protectionist policies are inevitable, especially when countries are going through some form of an industrial revolution or economic devastation. If your markets aren’t protected, you will find that other countries can undercut you on price or quality, or both, stalling your economic development in the long term.

In order to strike the right balance between ‘protectionism’ and ‘free trade’, most countries will draft a series of trade agreements with its nearest and most valuable markets. The US, for instance, currently has 14 trade agreements in place with 20 countries. Almost half (47 per cent) of US exports are sent to these countries, generating approximately $710bn in revenue last year. The Transatlantic Trade and Investment Partnership (TTIP) is currently under discussion and would create a first-of-its-kind trade agreement between the US and the EU.

Trade agreements can also be a useful political tool, with embargoes functioning as a diplomatic alternative to violence during international disputes. Iran and North Korea have been the subject of sanctions in recent years, as a way for the US government to both slow down their nuclear development programmes and express its disapproval for their regimes.

In his essay on the subject, economist George Friedman suggests that we are moving towards anti-globalism, with the rise of right-wing politics and fear of immigration in the US, UK and EU. He points to the “disproportional” influence of the US economy on global politics and concludes that “the post-war trend toward free trade has reached its limits for this cycle”.

Even Ricardo knew that economics and politics were destined to be conjoined for eternity. While free trade may work as an economic solution, it is rarely the answer in the world of politics. For this reason, free trade is likely to remain a nice idea, but nothing more. At least for another couple of centuries.

Related topics:Dynamic EU Financial services Global Markets
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