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The Big Question: What is free trade?

Updated Thursday 12th July 2007

A solution to the world's ills, or a way of keeping poor nations poor?

Coffee beans Copyrighted image Icon Copyright: photos.com

Supporters say free trade encourages economic development around the world, leads to improved living standards and helps to create a more peaceful world - it is simply the best way to do business.

Critics say it gives too much power to rich countries, excludes the poor and it doesn't actually work in practice - they say it's like putting a rabbit in the same cage as a tiger. The Big Question is: What is Free Trade?

 

Look at the labels on the goods at your market or in your local store - where are they made? China? Brazil? Turkey? And do you have a choice of goods?

Free trade, argues Dr Eamonn Butler of the Adam Smith Institute, is good for everyone and is the key to prosperity. Free trade is an economic theory - the sale of products between people without any trade barrier - such as taxes or quotas. The man who came up with the theory was Adam Smith, an 18th century Scottish-born economist. In his book, The Wealth of Nations, he argued that people become wealthy from exchanging goods and services.

Adam Smith Copyright free image Icon Copyright free: Library Of Congress via Wikimedia
Adam Smith

Take the baker and the shoemaker. The baker bakes bread and the shoemaker makes shoes. They are both better at their own profession than at the other's - this is what Smith called an 'absolute advantage'. So it makes sense for them to do what they are good at and trade. The same could be said of nations: if a country is good at producing wine, it should produce wine and import other products from countries that are more efficient at producing them.

"The ideas of Adam Smith", Dr Butler says, "were absolutely sensational... And they led to the great nineteenth century free trade era, where Britain in particular traded around the world, which led to an enormous amount of prosperity all round."

But, free trade theory doesn't end there. It was further developed by David Ricardo, a trader on the London stock exchange, who in 1817 wrote "The Principles of Political Economy and Taxation". He argued that all nations can benefit from free trade, even if they are less efficient than their trading partners. Ricardo came up with the theory of 'comparative advantage'. But this principle confounds even some of the brightest people.

But how about this: David Beckham is very good at football. Let's say, he is also very good at decorating. Beckham makes about US$160,000 a week from playing football but he will never make as much through decorating. He has absolute advantage in playing football.

Imagine Beckham has a friend called Adam. Adam is good at football and at decorating, but Beckham is better at both. But for Beckham, playing football is much more lucrative than decorating. So, Beckham will pay Adam to do his decorating.

The same comparative advantage applied between nations, said Ricardo.

But, as Professor Linda Yueh told The Big Question, the market is much more complicated in practice: "The market is just much more complicated than this basic two country, two goods model. Because it is actually not countries that trade, but it is companies that produce products and then consumers buy those products."

And then there are governments... who protect their industries by levying import taxes and by raising quotas on imported goods. And through paying subsidies to their domestic producers.

Did you know that in Alpine Switzerland, sugar production has been taking place for a hundred years. Swiss farmers grow enough sugar beet for 200,000 tons of sugar every year... But they do this with the help of a 25 million dollar subsidy from the government as well as taxes on any imported sugar.

Sugar is produced much more cheaply in developing countries. It costs 660 dollars per ton to produce sugar in Europe, while Brazilian sugar production costs between 90 and 150 dollars per ton. "If you were talking about perfect free trade and market conditions, not one gram of sugar would be made in Europe," Roberto Azevedo from Brazil's Ministry of Foreign Affairs told The Big Question. Switzerland doesn't export sugar, but European Union sugar production from neighbouring countries does get exported. And that, he says, upsets the global sugar market.

As BBC News reports in Poor countries and trade, rich countries spend US$1billion a day on agricultural subsidies. So, what's the deal with trade? And is it fair?

This edition of The Big Question was first broadcast on 9th October 2004

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