When exchange is voluntary and free, both the buyer and the seller benefit. When you buy milk, the milkman earns money and you have milk without a cow. Voluntary free trade creates assets because it is mutually beneficial. Asset is the total value of everything owned.
In an experiment conducted at the Foundation for Teaching Economics, a group of participants were given random objects and asked to value them. Then the group members freely bought and sold their objects. After a while, the group was again asked to value the objects they owned. The second sum of values was higher than the first. Thanks to voluntary free exchange, asset was created without adding anything new.
International trade generates mutual gain and wealth creation. Before the Second World War, trade agreements between nations were mostly mutual. Private benefits were mutually preserved and trade barriers such as import and export duties were mutual. However, the benefits of free trade were not understood and nations turned to policies of isolation and protection of the domestic economy after the war.
Towards the end of the Second World War, many representatives of the free industrialized world gathered in the town of Bretton Woods in New Hampshire to address economic problems that often cause international disputes. The conference created the International Monetary Fund (IMF) and the World Bank, but did not produce a trade organization to encourage international cooperation. In 1947, many countries, including the United States, came together to form the General Agreement on Tariffs and Trade (GATT). The goal of GATT was to reduce trade barriers so that member countries could benefit equally from free trade.
With the growth in international trade, living standards in the contracting countries have increased. In 1995, GATT became the World Trade Organization (WTO). Under the rule of GATT and then the WTO, more and more countries came to support the reduction of barriers and free trade. As a result, international trade continued to expand and many countries took advantage. For example, Ireland, one of Europe’s poorest countries, joined the EU and became one of the richest thanks to international trade.
Situations Adverse to International Trade
Despite the obvious benefits, there are also those who are against international trade:
• Environmentalists worry that production will increasingly concentrate in countries where there are fewer regulations to protect the environment from pollution and damage to natural habitats.
• Trade unions oppose free trade, arguing that production will be shifted to low-wage countries where there are not many unions, and therefore their members will be negatively affected.
• Human rights activists oppose free trade because of the shift of production to countries where working conditions are very poor and often inhumane, where workers cannot find the same rights and privileges in industrialized countries.
• Politicians and voters concerned about the damage to national sovereignty oppose free trade because decisions affecting the nation are made by an international organization that is not subject directly to the public.
Countries sometimes impose taxes or limits on international trade, or even prohibit it. Why is that? Although voluntary trading is mutually beneficial, sometimes only a certain group carries its costs. The public may be overly interested in protecting their industries, increasing tax revenues, protecting the environment, or even creating social change. Sometimes one country may limit its trade in order to punish another country. Customs duties, quotas, and embargoes are among the tools a country uses to fulfill its various goals.
Customs duty is a trade tax. It can be used to increase government revenues or to benefit a particular sector of the economy. If your industry is facing foreign competition, you can put pressure on Congress to impose customs duties on imports. For example, the US steel industry was protected from foreign competition for years, thanks to tariffs. In 2007, India imposed tariffs on rice exports to avoid famine. The Smoot-Hawley tariff, introduced in 1930, was intended to protect American industry and to increase tax revenue much needed by the state.
Customs tax, on the other hand, has some downsides:
• Customs duty often has anticompetitive effects, supporting waste and inefficiency.
• Customs duties to generate revenue often cannot increase tax revenues because people stop buying expensive imported products.
• Imposing customs duties on exports can give producers a reason not to produce.
Quotas are limits in trade. Rather than imposing a tax on imports, a quota may be applied to limit the number of goods imported. In the 1970s and 1980s, American car manufacturers and labor unions supported government quotas on foreign car imports to limit competition and protect their own businesses. The result was higher price and lower quality.
Ultimately, German and Japanese companies set up their factories in the USA. Thus, domestic producers faced more competition in their own countries. Trade unions also suffered as foreign companies set up their factories in states where the unions were less effective.
Quotas also create other problems:
• They do not bring tax revenue to the state, they bring more responsibility.
• Those who try to avoid quotas encourage smuggling, thus creating a black market.
• Quotas can be manipulated by foreign firms to restrict competition from other foreign firms. For example, if a quota is applied to German cars imported to the USA, the German company that filled the quota first would prevent other German companies from competing in the American market.
An embargo is a ban on trade with another country. The purpose of an embargo is usually to punish a country. The embargo we are most familiar with may be the US embargo on Cuba. After the communist revolution and the Cuban Missile Crisis, the US enacted an embargo banning all trade with the islanders. Even if these events are far behind, the embargo continues. To understand why it still continues, we can think again about who is benefiting from the trade embargo.
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