FREE TRADE

 The term free trade refers generally to the free movement of goods, services, labor, and capital
across national borders without the interference of government-imposed economic or regulatory
barriers.
 Free trade is the movement of goods, services, labor, and capital between countries, without
government-imposed trade barriers.
 It also refers to the efforts of the World Trade Organization and various international agreements
to liberalize, or reduce barriers to, trade.
 Free trade, more specifically, refers to the multilateral efforts at the World Trade Organization
(WTO) to liberalize trade by reducing import taxes (tariffs) and removing nontariff barriers
globally. It also refers to the bilateral and regional agreements that liberalize trade between
trading partners.
 In this sense, free trade is the opposite of protectionism, a defensive trade policy intended to
eliminate the possibility of foreign competition.

Three Rules to Free Trade

1. Trade must be voluntary.
2. All trading parties must benefit.
3. Trade moves products from people who value them less, to people who value them more.

Why Do We Trade?
1. Natural Resources – Materials found in nature that is used to make a good or service.
2. Human Capital – Knowledge of making the good/ providing the service.
3. Physical Capital – Objects used to produce the good or service.
4. Economic Activity Patterns – Producing, exchanging, consuming, saving, & investing.
Generally, the more economic activity is happening in a place, the more economically developed
that place is likely to be.
5. Unequal Distribution of Resources – Knowledge of making the good/ providing the service.
6. Need for Trade – Objects used to produce the good or service.
FREE TRADE THEORIES
Since the days of the Ancient Greeks, economists have studied and debated the theories and
effects of international trade policy. Do trade restrictions help or hurt the countries that impose them?
And which trade policy, from strict protectionism to totally free trade is best for a given country?
Through the years of debates over the benefits versus the costs of free trade policies to domestic
industries, two predominant theories of free trade have emerged: mercantilism and comparative
advantage.

1. MERCANTILISM
 Mercantilism is a national economic policy that is designed to maximize the exports, and
minimize the imports, of a nation. These policies aim to reduce a possible current account deficit
or reach a current account surplus.
 Mercantilism is an economic practice by which governments used their economies to augment
state power at the expense of other countries. Governments sought to ensure that exports
exceeded imports and to accumulate wealth in the form of bullion (mostly gold and silver).
Examples:
a) Restrictions on imports – tariff barriers, quotas or non-tariff barriers.
b) Accumulation of foreign currency reserves, plus gold and silver reserves.
c) Granting of state monopolies to firms especially those associated with trade and shipping.

2. COMPARATIVE ADVANTAGE
 Comparative advantage holds that all countries will always benefit from cooperation and
participation in free trade.
 Popularly attributed to English economist David Ricardo and his 1817 book “Principles of
Political Economy and Taxation,” the law of comparative advantage refers to a country’s
ability to produce goods and provide services at a lower cost than other countries.
 Comparative advantage shares many of the characteristics of globalization, the theory that
worldwide openness in trade will improve the standard of living in all countries.
 Having a comparative advantage is not the same as being the best at something. Someone who
is the best at doing something is said to have an absolute advantage.
Examples:
a) A country is said to have a comparative advantage in the production of a good (say cloth) if it
can produce cloth at a lower opportunity cost than another country.
b) The Philippines has a population of over a hundred million people (Philippines Population) and
that is a huge advantage when it comes to the number of highly productive populace. Currently
the median average age is 24. Considering the Philippines has a highly educated population
 where English is widely spoken, this is a comparative advantage in this new millennium for
multinational companies looking for a way to outsource jobs in a foreign country.

3. THE TECHNOLOGICAL GAP OR IMITATION GAP MODEL

 The technology gap theory is a model by Posner 1961, describes an advantage enjoyed by the
country that introduces new goods in a market. The country enjoys the advantage until other
countries have achieved the ability to imitate the new good.
 According to this model, as a firm develops a new product, its first test is in the home market.
After it is proved to be successful in the home market, the efforts are made to introduce it in the
foreign markets. The new products confer a temporary monopoly position upon the producing
firm or exporting country in the world trade. This monopoly position is often protected by the
patents and copyrights. The exporting country enjoys comparative advantage over the rest of the
world until the foreign producers imitate the new varieties of products or learn new processes of
production.
Example:
a) There’s going to be continuous growth on the use of mobile devices in the Philippines and Asia
because the people in these places are quite receptive to the use of mobile technology. Japan
remains the Philippines’ major source of official development assistance (ODA), its main source
of infrastructure support, top export market, and one of its most important trade partners.

4. ECONOMIES OF SCALE THEORY

 Economies of scale are cost reductions that occur when companies increase production.
 This means that as a company grows and production units increase, a company will have a better
chance to decrease its costs.
 Governments, non-profits, and even individuals can also benefit from economies of scale. It
occurs whenever an entity produces more, becomes more efficient, and lowers costs as a result.
 Economies of scale not only benefit the organization. Consumers can enjoy lower prices. The
economy grows as lower prices stimulate increased demand.

Examples:
a. Wal-Mart's "everyday low prices" are due to its huge buying power. Managerial economies of
scale occur when large firms can afford specialists. They more effectively manage particular
areas of the company.
b. Supermarkets can benefit from economies of scale because they can buy food in bulk and get
lower average costs. If you had a delivery of just 100 cartons of milk the average cost is quite
high. The marginal cost of delivering 10,000 cartons is quite low. You still need to pay only one
 driver; the fuel costs will be similar. True, you may need a bigger van, but the average cost of
transporting 10,000 is going to be a lot less than transporting 100.

5. REPRESENTATIVE DEMAND THEORY (LINDER HYPOTHESIS)

 The theory was proposed by Staffan Linder in 1961. Linder Hypothesis is an economic
hypothesis that posits countries with similar per capita income will consume similar quality
products, and that this should lead to them trading with each other. The Linder hypothesis
suggests countries will specialize in the production of certain high-quality goods and will trade
these goods with countries that demand these goods.
Example:
a. The rising demand of imported products in the Philippines.
b. For example, a consumer who receives an income raise at work will have more
disposable income to spend on goods in the markets, regardless of whether prices fall,
leading to a shift to the right of the demand curve.

What Are the PROS of Free Trade?

1. Economic growth is encouraged.
 We see that free trade agreements are essential to our nation's prosperity. Without government to
forge trade relationships with other countries, our businesses would not be able to reach foreign
markets and expand the market share through innovation and competition allowing the
consumers and American workforce to benefit from these conditions.

2. It creates opportunities for foreign direct investment.

 When there are fewer barriers to trade agreements in place, foreign businesses form partnerships,
make investments, and even directly enter new markets because there is the chance for higher
profits. This helps isolated countries can develop their economic infrastructure.

3. It offers consumers access to a higher level of expertise.

 Global companies generally have more expertise within their field that local companies that
operate on a domestically regional level. This means specialty work can be completed for a
lower price, more efficiencies can be built into the systems of operation, and fewer resources are
required to produce goods or services. Local companies can even learn from global companies to
improve their best practices by direct observation.

4. It allows for companies to transfer technologies to one another.

  When there is a free trade agreement in place, then the multinational companies make it possible
for local organizations to receive access to the latest technologies from their industry. This
process makes it possible for the local economy to start growing, which means there are
additional job opportunities that begin to develop.

5. It offers a more attractive business climate to organizations.

 Businesses are often protected when countries are trading with one another frequently. When
there is a free trade agreement in place, then these protections begin to disappear. This process
creates more of a free market environment where companies are forced to look for new ways to
innovate as a way to stay competitive in the marketplace. Instead of allowing for stagnation to
occur because there is always a guaranteed income, governments pursuing free trade increase
economic opportunities because they inspire new processes.

What Are the CONS of Free Trade?

1. It reduces the tax revenues that are available to the government.
 A free trade agreement creates a shift in how value enters the society. Before there is an
implementation of this contract type, goods and services develop revenues for the government
through the use of tariffs and fees. Once this agreement goes into effect, then the money flows to
the corporations instead. It then becomes the government’s responsibility to collect taxes from
the profits and revenues earned from the new structure. That is why many smaller countries try
to avoid free trade. They often struggle to replace the revenues that import tariffs and
miscellaneous fees generate for them.
2. Free trade can reduce the influence of native cultures.
 As free trade begins to move into the isolated areas of a country, the indigenous cultures which
are present there can sometimes struggle to adapt to the changing realities. There may be a need
to access the resources which are available locally to these tribes for the “greater good” of the
rest of the country. If the decision is made to pursue this need, then it is not unusual for local
communities to be uprooted. Their exposure to new population groups can then result in disease,
suffering, and even death in extreme circumstances.

3. It can begin to degrade the value of domestic natural resources.

 Countries that have already gone through their industrial revolution will typically have fewer
natural resources available to them when compared to the developing world. That creates the
purpose of pursuing a free trade agreement in the first place. These emerging market countries do
not have the same environmental protections in place because they have not experienced the
same pollution challenges as the developed world.
  That is why free trade agreements can often lead to the depletion of natural resources through
mining, timber operations, and mineral extraction. It does not take long for the fields and jungles
of a developing country to be reduced to wasteland because of strip-mining and deforestation
efforts.

4. Free trade can encourage the theft of intellectual property.

 When the United States and China put together a free trade agreement, there was a belief on the
American side that it would be possible to expand business opportunities exponentially with
market access overseas. Then the reality of the situation hit. Chinese companies, which are all
mostly owned by the government, required Americans to sign over their intellectual property
rights as a way to gain access to the market. It created a net win for China and a net loss on the
U.S. side because if the American companies refused, the Chinese ones just stole it anyway.
5. It encourages more urbanization.
 When you look at a map of the United States, you will find an interesting trend. The households
who live in urban areas typically lean to the political left, while those in the rural regions vote
more toward the right. Free trade encourages families to move away from agricultural work
because it is more efficient to let factory farms take care of the food supply. That means more
people move into the cities, encouraging urbanization so that there isn’t any money saved from
the efforts to keep trading lanes open.

GLOBAL TRADE TRENDS

 As trade flows have generally grown faster than income since the Second World War, countries’
openness and their exposure to external developments have increased;
 Global trade collapsed in the global crisis of 2008-2009, recovery remains unfinished and
uneven; the global crisis appears to have left a marked impact on the dynamism of global trade;
 The global crisis has also brought the long-run trend of rising global integration through trade to
a halt, at least temporarily;
 The global crisis and uneven trade recovery have reinforced the ongoing shift in balance in the
world economy, featuring the relative decline of developed countries;
 The shifting global balance is also visible in the changing distribution of exports by destination,
featuring the rising importance of trade among developing countries;
 The rise in South-South trade has been especially pronounced in East Asia;
 LDCs have generally participated in these trends to a lesser extent but recovered some lost
ground in recent years;
  Related to commodity price developments; many countries have experienced sizeable terms-of-
trade changes since 2002, with both winners (especially oil and metal exporters) and losers
(especially food-deficit countries) among developing countries including LDCs;
 Global governance reform needs to make further progress.

WTO: TRENDS IN GLOBAL TRADE 2018

The WTO’s latest World Trade Statistical Review 2019 confirming a continuous uncertainty on
global trade and a rise on trade-restrictive measures. The report highlights that trade continues to be
concentrated.
The volume of world merchandise trade, as measured by the average of exports and imports,
grew by 3.0 per cent in 2018, just above the 2.9 per cent increase in world GDP over the same period.

1. GLOBAL DEVELOPMENTS IN MERCHANDISE VOLUME - 0.0% World merchandise

trade volumes (the average of exports and imports) were flat in the first quarter of 2019 over the
previous quarter, in seasonal adjusted terms.
2. REGIONAL PERFORMANCE, % CHANGE (QUARTER-OVER-QUARTER) - Except
for Europe, all regions showed a decline or slow growth on both exports and imports in
2019Q1(1.0% and 1.5% respectively).
3. MERCHANDISE TRADE VALUES. In 2019Q1, world exports and imports contracted by
2.7% and 3.1% respectively in year on year terms. In particular, trade performance went down in
all regions except for North America.
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