The free trade system is one of the most efficient forms of global economic integration. This regime is usually established on a contractual basis between the countries having a towering level of trade, and political as well as economic cooperation. This regime avails for the eradication of tariffs, alongside with quantitative limitations in bilateral trade. Exemptions from the free trade system are probable for products that are extra sensitive.
The Cost of Adopting a Free Trade Regime
Nevertheless, as attractive as the free trade regime may look, it has its disadvantages as well. The adoption of this regime has potential costs attached to it. However, the degree of cost of any nation in the free trade zones is directly linked to the technological advancement of the nation. Free trade zones are areas that have no trade restrictions and boundaries. All the members of these areas that constitute the free trade region permit deal freely between them and deploy minimum, or no barriers or tariffs in trade on goods, as well as services that are delivered from any nation within this region.
Once a country adopts the free trade regime, it opens itself to fierce competition from other countries in the similar free trade region. This is because all nations will be competing for the same consumer. Despite competition, working to the advantage of the consumer, as a result of increased product quality, leads to low profit margins for the companies. This is because companies are forced to cut down their prices to remain in the market. Reduced profit margins mean reduced tax collection.
Consequently, countries that produce in excess may dump some of their surplus products in the market at lower prices. It causes some effective firms to find it extremely tricky to compete under such situations. Additionally, nations that largely depend on agriculture face adverse terms of trade (Ratio of the prices of import to that of exports). Such countries have their income on export much smaller than the payments on imports. This leads to extremely large CADs and, consequently, large levels of foreign debts.
Emerging firms may also experience a challenge in coming up to a competitive environment that lacks short-term protection plans by government, as put across by the infant industry argument. It is extremely challenging to come up with economies of scale in the presence of competition from massive foreign corporation. This is applicable to infant industries or economies. Thus, it is extremely hard for a weak economy to survive in a free trade, since its industries cannot grow.
Additionally, free trade may lead to unemployment. For instance, the free trade between two countries, one with higher technological advancement may cause unemployment in the less technologically advanced country. Increased competition leads to some countries gaining some competitive advantage than others. For instance, the levels of unemployment in Mexico are higher comparing to those in America, due to the technological superiority of America over Mexico. Technology allows lower prices for cheaper production. It forces companies in weaker countries to close down. Closure of these companies leads to unemployment. Increasing structural unemployment, resulting from adoption of a free trade regime, affects a vast numbers of employees, their relatives, as well as the domestic economy.
There is always a competition among companies in the free trade zone. However, this competition can cause a restructuring. Companies that are competitive disadvantaged need to restructure their businesses in order to catch up with their competitors. Nevertheless, undertaking a restructure may cost company massive amounts of money and it may incorporate the ownership, management team, or the operational features of the company.
Much of the literature about the potential cost of adopting a free trade region does not touch the issue of pollution, alongside with related environmental problems. Numerous companies do not include the cost of pollution control in the price cost. This is because these companies are trying to compete with others that belong to nations with weak policies on pollution. Environmental pollution leads to environmental degradation, which causes a lot of health matters, and nations spend hefty amounts of money for the treatment of diseases resulting from this.
Free trade leads to elevated local economic instability from global trade cycles, as economies become increasingly dependent on global markets. This translates to increased consumer, alongside with employee vulnerability to downturns in the trading partner’s economies. For instance, recession in America causes a diminishing demand for exports from Australia, thus causing diminishing income from exports, reduced GDP, reduced incomes, reduced local demand, alongside with rising unemployment in Australia.
Disadvantages of High Tariffs
Protectionism is among the commonly debated issue of the global trade. On one side, countries believe that a certain amount of protectionism is required to protect local industries, as well as employment opportunities. On the other hand, protectionism may induce retaliation from partners of trade, foster some more protectionism, and lead in blocks to free trade. A common form of protectionism is the tariff. Nevertheless, despite the protectionism nature of tariffs, which is an advantage, they have plenty of disadvantages, as well.
High tariffs lead to elevated price levels of imports. It disadvantages the consumer of the country that the tariff is in operation, since he, or she, pays more for imported goods, as well as services. In the event of retaliation from trading partners, there is an increase in cost of undertaking business for companies, which deals with exports. Some analysts argue that tariffs can lead to a reduction in the quality of products as firms offset the tariffs imposed on their products.
Elevated tariffs can cause trade wars between countries. For instance, China and the EU were involved in a dispute on trade over textiles. The extremely high U.S tariffs on auto spares are said to be an adhering point in a number of business contract discussions. These arguments harm the earnings of each nation engaged in the conflicts. Trade only works when nations transfer and trade.
In order to reduce the cost of adopting a free trade regime, the government can encourage industries to produce what they can produce at the lowest cost. This will be a formidable breakthrough, as the industries will gain a competitive advantage that will enable them to remain in the market for a long time. The government can also encourage the production of goods that the country has a high relative advantage. This will create a possibility to produce at a lower cost, and trade with other countries in the same free trade region. The government can also put exemptions on goods that it feels are crucial to its economy. Such goods are traded in the terms of the government.
It is, therefore, necessary for the government to understand its comparative and relative advantages in order to adopt a free trade regime. Nevertheless, putting tariffs at high levels may also harm the economy. Therefore, the government should regulate its rates of tariff depending on the type of product. High tariffs can be placed on luxurious goods while minimal, or no tariffs can be placed on basic goods.