Sample Essay on Free Trade, Written for My MBA Students (1997), by Sean Gabb

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"In international trade,
countries may gain and cannot lose."
Show why this is, and discuss briefly why despite this
there are objections to free trade.

Note: In the late 1990s, I taught the economics module in the MBA course at a university in London. Many of the foreign students had never before had to write an essay. Therefore, I wrote a series of sample essays to show them what was expected. Here is one of them. It does not necessarily represent my own views on trade policy, but was the sort of balanced discussion I wanted students to attempt within the word limits I had set. I am publishing it now because I feel profoundly uninspired to writing anything new!

Part A:  The Case for Free Trade

Though trade has existed for thousands of years, it was only in 19th century, that David Ricardo (1772-1823) explained how countries benefit from it.  Earlier economists had spoken about absolute advantage - that countries could gain from trade where they were able to produce a range of goods more cheaply than anywhere else in the world.  But it was Ricardo who showed that a country does not need to have an absolute advantage in producing any good to realise gains from trade.

It goes against common sense to claim that a country can still gain from trade even when it can be undercut in everything it produces.  So let us illustrate Ricardian claim with an example.

Suppose there are just two countries in the world, England and Portugal and just two commodities, wine and cloth.  Suppose further that each country is closed to trade with the other, and must produce all that it needs with its own resources.  Now suppose that England can in one day produce either 30 units of wine or 90 units of cloth, or some combination of the two.  And suppose that Portugal can in one day produce either 100 units of cloth or 100 units of wine, or some combination of the two.

Here, it looks as if there is no basis for trade, Portugal having absolute advantage in both commodities.  However, it is the ratios of exchange that are important here.  Consider:

In England, one unit of wine exchanges for three units of cloth; and one unit of cloth exchanges for one third of a unit of wine.

In Portugal, one unit of wine exchanges for one unit of cloth; and vice versa.

Therefore, if both countries are opened to trade with each other, there will be a basis for trade.  On the one hand, a Portuguese wine merchant will find that one unit of wine buys three times as much English cloth as Portuguese.  On the other, an English cloth merchant will find that one unit of cloth buys three times as much Portuguese wine as English.  Of course, if both sides were to insist on these ratios of exchange, there would be no basis for trade.  But there is plenty of room for compromise - so that, perhaps, one unit of wine will exchange for two units of cloth, at which ratio an English merchant will get 50 per cent more wine than before, and a Portuguese merchant will get 100 per cent more cloth than before.

The effect of this will be to create an international division of labour, with England and Portugal both specialising in the production in which it has a comparative advantage.  This will bring about a large increase in production.  We can see this best in tabular form.

In Table 1, we see the production possibilities while both economies are closed.

Country

Exchange Ratio

Wine Produced

Wine Consumed

Wine Imported (-) or exported (+)

Cloth Produced

Cloth Consumed

Cloth Imported (-) or Exported (+)

Portugal

1:1

70

70

0

30

30

0

England

1:3

20

20

0

30

30

0

World

None

90

90

0

60

60

0

In Table 2, we see the production possibilities after both economies have been opened.

Country

Exchange Ratio

Wine Produced

Wine Consumed

Wine Imported (-) or exported (+)

Cloth Produced

Cloth Consumed

Cloth Imported (-) or Exported (+)

Portugal

1:2

100

75

+25

0

50

-50

England

1:2

0

25

-25

90

40

+50

World

1:2

100

100

0

90

90

0

In this case, it can be seen that both England and Portugal gain from speicialisation.  Certainly, the case is greatly simplified.  But the outcome is not really changed when all the complications have been reintroduced.

Part B:  Objections to Free Trade

Even so, free trade has hardly ever been fully practised.  The reason is because of difficulties, real or imagined, in the Ricardian model shown above.  These are briefly listed.

1.The model assumes perfect labour mobility.  It assumes that the English wine industry and the Portuguese cloth industry both collapse, and that all the workers there move into the other industries.  This is not realistic.  At the moment, for example, countries like China have a comparative advantage in textiles, and England has a comparative advantage in financial services.  But there are few unemployed textile workers able to travel down from Bradford to find work in London as merchant bankers.  Therefore, it is feared that the gains from free trade will be confined to one section of the population, with another reduced to unemployment or starvation wages.

2.The model assumes international peace and security.  In fact, war is common.  Therefore, it would be unwise for any country to let its steel or other "strategic" industries collapse in line with international market forces.  There is a short term advantage for any country to rely on financial services, and let poorer countries rely on industry.  But in the long term, it may leave that country unable to defend its wealth against attack by other countries now able to produce plenty of tanks and planes.

3.The model ignores humanitarian considerations.  For example, Columbia has a comparative advantage in coal.  But that advantage relies on the use of child labour in the mines.  Many people think it immoral to take advantage of such specialisation.

4.Then there are the special interests that benefit from protection.  There may be no risk of unemployment or reduced military security.  It may be that opening a particular market to free trade will produce the kind of benefits described above.  Even so, the businessmen or unions in that market will resist by all means available.  Though success for them will reduce the overall wealth of the country, they will be rewarded by getting or keeping an absolutely larger share of the remaining wealth.  An example of this would be European farmers, protected by the Common Agricultural Policy.

Conclusion:

From the above discussion, it can be seen that countries do gain from trade and cannot lose, although particular groups within each country can be differently affected.  Since this essay is required to be brief, I have not space to look in any detail at the objections mentioned above.  However, my feeling is that either they are all based on misunderstandings of economic laws, or they are special cases that do not affect the general truth of Ricardo's argument.

Bibliography

Ricardo, D., Principles of Political Economy and Taxation (1817), Everyman's Library, London, 1911.

Heffernan, S. and Sinclair, P., Modern International Economics, Blackwell, Oxford, 1993. 

References:

"The miracle of trade", The Economist, London, January 27th - February 2nd 1996.

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