Free trade benefits

So far, we’ve considered some of the key global forces affecting the global logistics market. We now consider the movement of international trade and its impact.

You might be familiar with the notion of ‘free trade’ – but what does this mean?

Free trade occurs when nations unilaterally do not charge import or export duties on goods that move across borders.

Why would anyone charge for the privilege to cross a border?

Most of the reasons are political and involves protecting national businesses from foreign competition. What this tends to do is reduce competition within a country’s borders and increase prices, which then affects inflation. The economy can then be affected due to the poor allocation of resources. Adam Smith (1789) discusses this in his groundbreaking book The Wealth of Nations and started the move towards market-based economies that are the majority today.

Trade barriers are popular with some national governments because it raises tax revenue, but the direct effect is that imported goods become more expensive.

The hope is that because an imported good is expensive, the consumer will buy a locally produced product instead. This tends not to happen because if consumers had wanted a locally produced item, they would have bought it in the first place.

One of the main reasons imported goods are attractive to consumers is they are often cheaper than nationally made goods. As a country becomes richer, workers’ labour rates increase, and this makes locally made items more expensive. When a country decides to become a protectionist by applying import duties, it is known as mercantilism.

Protectionism often encourages nationally protected industries to become lazy as there is no competition or incentive forcing them to be efficient. There are many examples in history of how mercantilism works. Interestingly, they are between the periods of globalisation expansion.

The most recent was after the first world war and was ended by the second world war. The late 18th and early 19th century was also a turbulent time where some growing European nations practised mercantile policies.

The main benefits of free trade can be summarised as:

  • Cheaper goods and services because of comparative advantage (Ricardo 1817) and specialisation (Smith 1789)
  • A greater demand for goods due to the reduction or elimination of trade barriers
  • Cheaper goods lead to an increase in demand and economic activity

This can help to create more jobs and make the home country attractive to foreign investment, as they envision a return from the growing economy. This leads to savings in foreign exchange as other nations buy and invest in the home currency.

If a country practices free trade through comparative advantage, this will mean greater production and manufacturing activity as other nations will demand the goods you make that they cannot make themselves.

This also leads to increased competition between firms and countries that have similar comparative advantages. It will also result in the improved allocation of resources as competition encourages technological innovation to extract the most from limited resources.

Finally, economies of scale will help keep production costs low. This is especially helpful in industries with high fixed costs, such as transport and warehousing, where vehicles, ships, trains and aircraft have a high capital cost along with buildings for storage.

From a global logistics and distribution network perspective, free trade is one of the main drivers of global distribution activity. Barriers to trade just make operating a global network more time consuming, expensive and difficult.

Your task

Discuss in the comments area:

  • How tariffs harm imports and the country that sets them, not the exporter
  • Why a country would set import tariffs and how the WTO is supposed to settle disputes between trading countries

References

Ricardo D. (1817) On the Principles of Political Economy and Taxation

Smith, A. (1789) The Wealth of Nations. 5th edn

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This article is from the free online course:

Principles of Global Logistics Management

Coventry University