The Benefits of Free Trade

The Benefits of Free Trade
Profile photo of Antony Mueller

ship-300x242In a recent study published by the Bertelsmann foundation about the attitude to international trade, the survey found that 42 percent of the US respondents feel that the government is not doing enough to protect them against the negative effects of globalization. This finding is not much different from that in other developed counties. Many people utter the impression that globalization creates more inequality. A majority of the people does not believe that globalization leads to rising wages.

While the majority of the poll believes that ‘in general’ international trade is good and has positive effects, about 39 percent believe that globalization is bad for job security and 61 percent of the respondents in the United States call for stronger protection against international competitors.

When discussing free trade, people favor protectionism because they think this is the way to help ‘our’ industry and to save ‘our’ jobs. What the protectionists fail to see is that international trade leads to higher productivity, and that productivity is the key to rising wages. Resistance to free trade is equal to the opposition against other forms of economic progress as it comes, for example, with technological progress. The opposition to free trade has a lot in common with the storm of the Luddites against the machinery at the onset of the Industrial Revolution and with the modern opponents to technology.

International trade expands the size of the market. The individual firms have more potential customers and the companies can intensify specialization and become more productive. Higher productivity means higher wages. The economies involved in international trade get richer, while the isolated, self-sufficient economies remain poor. For the developing countries, opening up to international trade is a vital instrument of getting out of poverty.

With an expanding market, the structure of the economy changes. The production falls in those areas where there are the greatest competitive disadvantages, while those economic activities where productivity is relatively strong, will increase. In the countries that take part in free trade, the general level of productivity rises because there is a shift of production to those companies that are more productive. The less efficient enterprises focus on activities where the distance in productivity to the companies with the higher performance is lower. In terms of higher productivity, international trade benefits all participants. In each of the countries that trade with one another, a re-allocation takes place according to the comparative advantages.

Not countries specialize but companies. The new trade theory has overcome the error that countries must specialize to get the ‘gains from trade’. At the level of industries and companies, international trade means larger markets for business, and the larger market augments the potential of specialization of companies. The bigger the market becomes, because of global trade, the more the individual companies can specialize and raise their productivity. Besides specialization, those productions, which enjoy economies of scale, can make use of the size effects that come with the extension of the market.

Higher productivity means that one achieves more output with the same amount of input of labor and capital. This way, the increase of productivity leads to rising profits. Higher profits encourage to expand production. The more intense the competition is, and the more companies take part in the competitive process, the faster the productivity gains spread throughout the economy and the more the gains in productivity benefit consumers in the form of lower prices, better quality and a greater variety of products.

The more the companies of a country become part of the world trade, the more these businesses must concentrate their activities on the niches where they can achieve a higher performance. This leads to a rising general level of productivity in the country and then to higher wages.

As the world trade enlarges the markets and intensifies the competition, the market power of national enterprises diminishes as their relative market share falls. Therefore, free trade is a strong antidote against the monopolization of the economy.

Free trade has similar effects as technical progress. The less productive firms make room for the more competitive companies. There is a shift of the factors of production to the sectors of higher productivity at the expense of the less productive sectors. This process lays the foundation for higher incomes. This way, international trade serves the consumer through a wider product variety, lower prices, and better quality of the goods and services.

Like commerce on the local and national level, world trade is an interplay of competition and cooperation. This process of association begins with the individual in the family and continues in the local and regional spheres to extend to the national economy and to international relations and to the global economy. The protectionists take the nation-state as their entity for the limits of free trade. They do not recognize that if their arguments in favor of protectionism were correct, they should also apply regional and local criteria. If protectionism were so good for the nation, why not also impose tariffs for a specific region or city within a country?

What counts in trade is not the city, region, or the nation, but the productivity of the individual companies in a city, in the region and of the nation. International trade means larger markets, and larger markets augment the scope of specialization of the firms. With trade barriers in place, the opposite happens. The degree of specialization must shrink, productivity will fall, and the incomes get lower.

Protectionism is a bad choice that comes with a high price because it blocks the path to rising productivity and to a higher income. In contrast to protectionism, free trade creates wealth. The effect of global trade on wealth comes through specialization, which lifts productivity, which is the key to increase the purchasing power of the people.

Profile photo of Antony Mueller

Antony Mueller is a German professor of economics who currently teaches in Brazil. He has recently published the book "Beyond the State and Politics. Capitalism for the New Millennium".

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