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Free trade and protection: advantages and disadvantages of free trade

This tutorial was written by
Ken Edge
Head Teacher Social Science
Cardiff High School

Outcomes
Overview
Content
Review exercises
More

Outcomes

HSC Topic: The Global Economy is covered in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 31-33. The specific outcomes for this tutorial are:

H1
demonstrates understanding of economic terms, concepts and relationships
H3 explains the role of markets within the global economy
H4 analyses the impact of global markets on the Australian and global economies
H6 analyses the impact of economic policies in theoretical and contemporary Australian contexts
H8 applies appropriate terminology, concepts and theories in contemporary and hypothetical economic contexts.
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Overview

Every day Australia and Australians benefit from trade. With a population of only 22 million people, trade opens up a global market of more than six billion. Australia has a surplus of resources so we can sell the surplus to other countries and use the export dollars to buy other goods and services from overseas. People all around the world are eating Australian food, drinking our wine, using computers with Australian software and riding in Australian fast ferries.

This tutorial introduces the concept of free trade and examines the advantages and disadvantages for trading nations.Whilst many economists and organisations espouse the benefits of free trade, some groups oppose free trade and see it as disadvantageous to many people, particularly in developing countries, where local producers and employees are vulnerable to exploitation. These groups promote the idea of ‘fair trade’ – you can research this concept by going to the websites listed under the section ‘More’.

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Content

  1. Advantages of free trade

    Free trade occurs when there are no artificial barriers put in place by governments to restrict the flow of goods and services between trading nations.

    When trade barriers, such as tariffs and subsidies are put in place, they protect domestic producers from international competition and redirect, rather than create trade flows.

    1. Increased production

      Free trade enables countries to specialise in the production of those commodities in which they have a comparative advantage (external website).

      With specialisation countries are able to take advantage of efficiencies generated from economies of scale and increased output.

      International trade increases the size of a firm’s market, resulting in lower average costs and increased productivity, ultimately leading to increased production.

    2. Production efficiencies

      Free trade improves the efficiency of resource allocation. The more efficient use of resources leads to higher productivity and increasing total domestic output of goods and services.

      Increased competition promotes innovative production methods, the use of new technology, marketing and distribution methods.

    3. Benefits to consumers

      Consumers benefit in the domestic economy as they can now obtain a greater variety of goods and services.

      The increased competition ensures goods and services, as well as inputs, are supplied at the lowest prices. For example in Australia imported motor vehicles would cost 35% more if the 1998 tariff levels still applied. Clothing and footwear would also cost around 24% more.

    4. Foreign exchange gains

      When Australia sells exports overseas it receives hard currency from the countries that buy the goods. This money is then used to pay for imports such as electrical equipment and cars that are produced more cheaply overseas.

    5. Employment

      Trade liberalisation creates losers and winners as resources move to more productive areas of the economy. Employment will increase in exporting industries and workers will be displaced as import competing industries fold (close down) in the competitive environment. With free trade many jobs have been created in Australia, especially in manufacturing and service industries, which can absorb the unemployment created through restructuring as firms close down or downsize their workforce. When tariffs were increased substantially in the period 1974–1984 for textiles and footwear - employment in the sector actually fell by 50 000, adding to overall unemployment.

    6. Economic growth

      The countries involved in free trade experience rising living standards, increased real incomes and higher rates of economic growth. This is created by more competitive industries, increased productivity, efficiency and production levels.

  2. Disadvantages of free trade

    Although free trade has benefits, there are a number of arguments put forward by lobby groups and protestors who oppose free trade and trade liberalisation. These include:

    • With the removal of trade barriers, structural unemployment may occur in the short term. This can impact upon large numbers of workers, their families and local economies. Often it can be difficult for these workers to find employment in growth industries and government assistance is necessary.

    • Increased domestic economic instability from international trade cycles, as economies become dependent on global markets. This means that businesses, employees and consumers are more vulnerable to downturns in the economies of our trading partners, eg. Recession in the USA leads to decreased demand for Australian exports, leading to falling export incomes, lower GDP, lower incomes, lower domestic demand and rising unemployment.

    • International markets are not a level playing field as countries with surplus products may dump them on world markets at below cost. Some efficient industries may find it difficult to compete for long periods under such conditions. Further, countries whose economies are largely agricultural face unfavourable terms of trade (ratio of export prices to import prices) whereby their export income is much smaller than the import payments they make for high value added imports, leading to large CADs and subsequently large foreign debt levels.

    • Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by governments, according to the infant industries argument. It is difficult to develop economies of scale in the face of competition from large foreign TNCs. This can be applied to infant industries or infant economies (developing economies).

    • Free trade can lead to pollution and other environmental problems as companies fail to include these costs in the price of goods in trying to compete with companies operating under weaker environmental legislation in some countries.

    • Pressure to increase protection during the GFC
      During the global financial crisis and recession of 2008-2009, the impact of falling employment meant that protection pressures started to rise in many countries. In New South Wales, for example, the state government was criticised for purchasing imported uniforms for police and firefighters at cheaper prices rather than purchasing Australian made uniforms from Australian companies. Similar pressures were faced by governments in the United States, Britain and other European countries.


Fact file

How Australia has benefitted from free trade

  • Over the 2000s Australia's ratios of exports and imports to GDP have each risen every year. Australia is an open economy, the size of its import and export sectors being greater than 20% of Gross Domestic Product. Australia is one of the countries that has benefitted most from rising international trade. It bought imported goods more cheaply than they could be made in Australia and sold exports overseas that commanded rising prices because they were in international demand.

  • One result of the increase in trade and openness of the Australian economy was has been structural change with a narrowing of the manufacturing and industrial base and a rise in the resources base. China became the world's manufacturing centre and increasingly lower priced manufactured goods made in China were imported into Australia, leading to the closure of inefficient manufacturers. At the same time, demand by China for Australian raw materials such as coal and iron ore increased rapidly, leading to expansion in the minerals sector.

  • Whilst the manufacturing base in Australia has narrowed, manufacturing output has actually increased by 40% and exports have risen by 400%, according to DFAT.

  • Greater access to imports has benefitted consumers and businesses by widening the choice of products available and boosting the living standards for many Australians.

  • Reducing tariffs has resulted in savings estimated to be at least $1000 per year to the average Australian family. For example, without the reductions in tariffs on motor vehicles, Australians would pay around $10,000 extra on a $30,000 car.

  • Having a bigger market to sell to means that a business can sell more, earn more profits and pay higher wages. Exporting businesses in Australia, on average, pay more to workers and sell more per worker than non-exporters.

  • Export growth has been essential to economic growth and job creation in Australia. For example, over 400 000 jobs were created between 1983–84 and 1993-94. By 2010, one in four jobs in Australia were related to exports.

Source: Department of Foreign Affairs and Trade

 

Some current developments in Free Trade Agreements in Australia

  • Thailand.  Australia signed a free trade agreement with Thailand in 2005. The agreement was designed to reduce tariffs on products exported and imported by both countries. By 2010 tariffs on 95% of current trade between both countries were to fall to 0%.

  • The United States. Australia signed a free trade agreement with the United States in 2005. This agreement was designed to increase exports of Australian raw materials and agricultural products and increase imports of US services from the US economy.

  • Singapore. Australia signed a free trade agreement with Singapore in 2003 to increase the import and exports of  banking and education services as well as  other services like environmental and telecommunications services.

  • Chile. Australia signed a free trade agreement with Chile in 2009 to reduce tariffs and boost trade between these two countries. Tariffs on all existing merchandise trade were to be removed by 2015.

  • ASEAN-Australia-New Zealand Free Trade Agreement (AANZFTA). On January 3 2010 the Australian Trade Minister announced the commencement of our largest free trade agreement. This agreement sees the removal of a range of tariffs on Australian exports to ASEAN nations such as Malaysia and the Philippines. It should eliminate tariffs on 96% of our current exports to ASEAN nations by 2020.

  • Future FTAs. Australia is also negotiating with countries including China, Japan, Korea, Malaysia and Gulf countries on possible future FTAs.
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Review exercises

Exercise 1.

True/False activity Interactive version HTML version

Questions True False
1. All nations have similar factor endowments.
2. International trade promotes specialisation.
3. A country with an absolute advantage in the production of all goods cannot benefit from free trade.
4. A country that is involved in free trade will typically experience higher living standards.
5. Free trade allows nations to obtain goods and services they cannot produce themselves.
6. Specialisation creates production efficiencies.
7. Structural unemployment is an advantage of free trade.
8. Countries involved in free trade are less likely to be affected by a downturn in global economic activity.
9. Globalisation and free trade has increased the gap between rich and poor nations.
10. Comparative advantage is based on the relative efficiency of production.

Answers

 

Exercise 2

Drag & drop activity      Flash version     HTML version

 

Exercise 3

Figure 1

Cartoon indicating the benefits of balanced trade

Source: Department of Foreign Affairs and Trade

1) Using Figure 1 outline the benefits of free trade for the Australian economy.

Answer

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More

The Department of Foreign Affairs and Trade (external website) website has current information on global trade and trade in the Asia Pacific region that is very good for research assignments on this unit.

Austrade has a number of case studies of businesses involved in international trade. Check on the Austrade web site for more details.

You can find out more about opposition to free trade in favour of ‘fair trade’ by visiting the following websites:
www.fta.org.au (external website)
www.oxfam.org.au/explore/trade (external website)
www.fairtrade.net/ (external website)

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