Free Trade and Protection

Globalisation is the process by which the world is becoming one market. Globalisation is the
growing interconnection of the world’s economies. Some of the key features of globalisation.
• Goods and services are traded freely across international borders. Example Coca-Cola
can sell its products as easily in Qatar as in the USA
• People can free to live and work in any country they choose. This has resulted in more
and increasingly multicultural societies.
• There is a high level of interdependence between nations. This means events in one
economy are likely to affect other economies. Example recession in one country have
an impact in many economies.
• Capital can flow between different countries. This means that a firm or consumer in
Australia can put their savings in a bank in the USA. Investors can buy shares in foreign
companies
• There is a free exchange of technology and intellectual property across borders.

Reasons for Globalisation

• Fewer tariffs and quotas- An increasing number of economies are more open and many
countries have stopped protecting domestic industries. Many countries have simplified
their monetary and legal systems to make international trading easier.
• Reduced cost of transport- International transport networks have improved in recent
years. In particular, the cost of flying has fallen and the number of flights and
destinations has increased. This means that people can travel to business meetings
more easily and goods can be transported more cheaply.
• Reduced cost of communication- Developments in technology have helped
globalisation to accelerate. Modern computing allows firms to transfer complex data
instantly to any part of the world. It also means that more people can work at home, or
any other location they choose.
• Increased significance of multinationals- Many firms want to sell abroad, perhaps
because domestic markets have been saturated. Large MNCs have a global reach. They
benefit considerably from having international markets and producing goods anywhere
in the world where costs can be minimised.

Advantages of globalisation
• Access to huge markets- Global markets are much higher than domestic markets.
• Lower costs- Firms can enjoy economies of scale as they grow by selling more output
to larger markets.
• Access to labour- People can free to live and work in any country they choose. As a
result, businesses will have access to a larger pool of labour.
 • Reduced taxation- Global businesses can reduce the amount of tax they pay. They can
do this by locating their head office in a country where taxes are low.
• Cheaper and wider variety of goods- Globalisation has resulted in a much wider range
of goods and services for consumers, particularly in developed countries. Multinational
can produce goods more cheaply in foreign countries, prices are likely to be lower.
• Job opportunities- Globalisation creates new jobs, particularly in developing countries
when multinationals open new factories. Greater freedom of movement has allowed
workers from less developed nations to look for jobs in developed countries.
• Tax revenue- The profits made by global companies are taxed by the host nation. This
increases tax revenue for the government, this money can be spent to improve
government services.

Disadvantages of globalisation
• Government can aid globalisation by relaxing laws and regulations that prevent, restrict
or complicate trade and business.
• Some workers lose out as a result of globalisation. This is because global companies
will tend to locate operations where labour costs are low.
• Global economic growth usually means more environmental damage. For example, as
economies grow, more cars are purchased and more flights are taken. Both car and air
transport increase greenhouse gases that cause global warming.

Multinational Companies
A multinational company (MNC) is a business organisation that produces in more than one
country. For example, the Japanese based Toyota has factories in a number of countries.
Reasons for the emergence of MNCs
• Economies of scale -Firms that sell to global markets will produce more than those who
just sell to domestic markets. They can therefore lower costs.
• Access to natural resources/ cheap materials- Many large companies invest overseas
because they need to buy huge quantities of resources. A significant proportion of
foreign direct investment (FDI) is targeted at the mining industry.
• Lower transport and communication costs- Development in transport and
communications have helped to drive the growth in MNC. For example, managers and
other staff of MNCs can travel around the world more easily to discuss and organise
the business activity.
• Access to customers in different regions- MNCs can sell far more goods and services
in global markets than they can in domestic markets.
Advantages of MNCS
• Job creation-MNCs establish factories, warehouses, shops and other business facilities.
When MNCS set up operations overseas, income of host countries rises. Local suppliers
are also likely to get work when a multinational arrives. The extra output and
employment generated by MNCs will increase economic growth and raise living
standards. Jobs created by FDI are good because they pay higher wages.
• Investment in infrastructure- Owing to the attractiveness of MNCs, government are
more likely to invest in infrastructure in order to attract the attention of investors.
Investment in infrastructure benefits everyone.
• Developing skills- MNCs provide training for workers when they locate operations in
foreign countries. Also, governments in less developed countries often spend more on
education to help attract MNCs.
• Developing capital- The arrival of MNCs will help to boost the stock of capital in host
countries. One reason is because when a business sets up a new facility, such as a
factory, it is likely to install up-to-date technology.
• Contributing to taxes- The profits made by MNCs are taxed by the host nation. This
increase tax revenue for the government.

Disadvantages of MNCS
• Tax avoidance- MNCs can avoid paying taxes in countries with less developed legal
systems.
• Environmental damage- MNCs may cause environmental damage. MNCs are heavily
involved in the extraction industries such as coal, oil, and gold mining.
• Moving profits abroad- The profits made by MNCs abroad are often returned to the
country where the MNC is based. As a result, the host country loses out.

Free Trade
Free trade – Situation in which the goods coming into or going out of a country are not
controlled or taxed.

Advantages of free trade

• Lower prices and increased choice for consumers- Consumers get more choice as many
countries both buy and sell the same products. Free trade not only enables the country
to specialize on the basis of comparative advantage but also output of the world will
increase.
• Lower input prices- Through international trade, countries can obtain essential inputs
for its industries at a much lower cost. For example, China imports a lot of raw materials
from Australia and Africa. Australia and Africa have very large deposits of the minerals
coal, iron ore, copper etc.
 • Free trade brings greater competition within a country and between countries. Each firm
will try to improve the quality of its product in order to survive and each country will
try to get a greater share of the global market. As a result, not only quality of the
products improves but also citizens of a country can buy those at a much cheaper price.
• By expanding the size of the market free trade may well generate employment within a
country.
• Free trade encourages FDI inflow into a country. For example, countries like Malaysia,
Singapore and Thailand have been immensely benefited by FDI inflow into those
countries which they received due to free trade.

Disadvantages of free trade

• Increase unemployment: since many economies are less efficient, they may well find
that their jobs are being poached by the foreign companies or by the multinationals.
They argue free trade may shut down infant industries or declining industries.
• Many believe that free trade brings in greater inflow of FDI. However, it is often seen
that such inflows are concentrated in only few countries. Other countries like those in
sub- Saharan Africa region and south Asian have received very little share of FDI flow
across the world.
• Over the years it is found that free trade has generally benefited the rich industrialized
countries and has done little to narrow the gap between the rich and poor countries.
• If free trade is not well monitored by the government, it may well aggravate the current
account deficit of a country.

Means of protection:
Tariff – Tariff is an indirect tax which is imposed on imported goods. Tariff raises the price of
the imported goods and thus makes it less competitive in the domestic market. Tariff brings
revenue to the government. When goods are elastic in demand, tariff is an important way of
reducing import. The tariff raises cost of production, so it shifts the supply curve from S1 to
S2. This leads to prices of the imports rising from P1 to P2, and output falling from Q1 to Q2.
Quota- Quota is a physical restriction on the amount of goods that are allowed to be imported
into a country in a fixed time, usually in a fiscal year. When goods are inelastic in demand,
quota is a better form of trade barrier than tariff. The imposition of a quota at Q2 reduces the
supply of the import from S1 to S2(supply is perfectly price inelastic). This leads to the price
of the import rising from P1 to P2, and output falling from Q1 to Q2

Subsidies - Governments can provide subsidies (lump-sum payments or cheap loans to

domestic producers) to help local firms to compete against foreign imports. Subsidies lower
the costs of production for home firms, thereby helping to protect local jobs. The subsidy
reduces the costs of production, so it shifts the supply curve from S1 to S2. This leads to a fall
in price of the exports from P1 to P2, and output increases from Q1 to Q2.

Embargoes- Embargoes are trade restrictions imposed by one country against another. For
example - complete trade embargoes were imposed on Iraq for invading Kuwait in the 1990’s.
Exchange control- Exporters earn foreign currencies which are surrendered to the bank and
they are paid in the local currency. Importers then can use these foreign currencies to import
necessary goods. The banks can thus control the variety and volume of import by controlling
the issue of foreign currencies.

Excessive custom formalities- Sometimes excessive custom formalities may act as a deterrent
to free trade. For example- in France, all documents must be in French language if some
countries want to make trade. As a result, volume of trade falls especially in the private sector.
Government contract policy- In many countries government prefer putting contract and work
order with the local contractor, in spite of foreign companies offering lower bid. As a result
amount of transaction in International Trade actually decline.
Campaign- Government may launch aggressive campaign publicizing that domestic products
are as good as foreign products, if not better and also cheaper. This may induce many people
to switch over consumption from foreign products to domestic products.

Arguments for protection:

• To protect infant industries- Industries at their infant stage are less competitive. They
do not grow to a size to reap economies of scale and often are driven away if left to
open competition from other countries.
However, there is a problem of this policy- often these industries rely heavily on
government protection and fail to improve their skill and efficiency.

• To protect declining or sunset industries- These are industries which are losing out
today because of fall in the demand of their products- often caused by technological
innovation or change in taste or fashion. For example- jute industry in Bangladesh.

• To safeguard the interest of workers- when goods are imported from countries with low
wages, it often represents unfair competition and threat on the standard of living of
higher paid workers in developed country.

• For strategic reasons- Industries which are strategically important and required during
war time are usually protected by government to reduce its dependence on other
countries for supply of spare parts. For example – defence and telecommunication
industries must be protected.

• To prevent a balance of payment deficit- A country might need to use trade barriers
because it has a very large current account deficit. It may lead to a ‘credit crunch’ when
foreign lenders like IMF may refuse to lend any further amount till the country
improves its current account balance.

• Retaliation- One motive for imposing trade barriers is to retaliate against dumping. If a
foreign business dumps large quantities of goods below cost, a government may feel
obliged to retaliate by imposing heavy taxes on those goods when they come into the
country.

• To prevent the entry of harmful goods- A government might use protectionism if it is

felt that overseas producers are trying to sell goods that are harmful or unwanted. For
example, EU banned all beef from cattle raised using growth hormones.
 • To gain tariff revenue- A government can raise revenue if it imposes tariffs on imports.
This money can be spent on government services to improve living standards.

Arguments against protection:

• Retaliation may occur- If one country protects it industry against foreign competition,
other countries may also protect their industries against the first country.

• Reduction in standard of living- As imports declines through protection, choice gets

reduced and standard of living falls.

• Smuggling may take place- Due to imposition of protection device like tariff, supply of
imported goods may actually fall; their price may well increase thus encouraging people
to bring those through unofficial channel like smuggling.

• Inefficiency may occur- Remain within protective regime; industries may become
inefficient. The country’s export may well decline in the long run and international
competitiveness may fall.

Tanzia Sultana
Economics Faculty