When trade is both voluntary and free, the buyer and the seller both benefit (if you buy a quart of milk, the dairy farmer gets money and you get milk without having to milk a cow). Because voluntary free trade is mutually beneficial, it creates wealth. Wealth is nothing more than the collective value of all you own. In an interesting experiment from the Foundation for Teaching Economics, a group of participants were each given a random object to which they assigned a value. Then the group traded their objects freely. Soon after, participants were again asked to assign a value to the object in their possession. The sum of the second set of values was greater than the first. Without anything new being added, wealth was (and is) created through the simple act of voluntary free trade.
When you trade with people in other countries, the same results of mutual benefit and wealth creation occur. Prior to World War II, trade agreements between nations were for the most part bilateral, that is, between the two parties, with special interests protected and trade barriers (such as taxes on imports and exports) common. The benefits of free trade were not realized, and nations drifted toward isolationism and protectionism.
Toward the end of World War II, representatives from much of the industrialized free world gathered in Bretton Woods, New Hampshire, to address the economic issues that were often the cause of international conflict. The conference produced the International Monetary Fund (IMF) and the World Bank, but not a trade organization for encouraging international cooperation. In 1947, many nations including the United States came together and formed the General Agreement on Tariffs and Trade (GATT). The goal of GATT was to reduce trade barriers so that member countries could equally enjoy the benefits of free trade.
The growth in international trade was accompanied by a rise in living standards among the members of the agreement. In 1995, the GATT became the World Trade Organization (WTO). Under GATT and later the WTO, more and more countries have become supporters of fewer barriers to trade. As a result, international trade has continued to expand, and many nations have reaped the benefits. For example, since joining the EU and opening itself to international trade, Ireland has gone from being one of Europe’s poorest countries to one of its wealthiest.
Despite its obvious benefits, free international trade has many detractors:
From time to time, countries will seek to tax, limit, or even ban international trade. Why? Even though voluntary trade is mutually beneficial, the benefits are spread out over society, and the costs are sometimes borne directly by a specific group. People might have a strong interest in preserving their industry, raising tax revenue, saving the environment, or even creating social change. At times a country might limit trade in order to punish another country. Tariffs, quotas, and embargoes are a few of the tools that a country will use in order to accomplish these other interests.
A tariff is a tax on trade. Tariffs can be used to raise revenue for the government or in order to benefit a certain segment of the economy. You might pressure Congress to enact a tariff on imports if your industry is subject to foreign competition. For example, for years the U.S. steel industry was protected from cheap foreign competition by protective tariffs. In 2007, India proposed a tariff on rice exports in order to prevent food shortages. The Smoot-Hawley tariff of 1930 was intended to protect American industry and raise much-needed tax revenue for the government.
Tariffs are not without their downsides:
Quotas are limits on trade. Instead of a tax on imports, you might use a quota to limit the number of imported goods coming into your country. In the 1970s and 1980s, U.S. automobile manufacturers and labor unions supported government quotas on foreign car imports to limit competition and preserve American jobs. The result was higher prices and lower quality.
The monetary amount for which consumers and producers buy and sell some quantity of a good or service.
Eventually, Japanese and German firms bypassed the quotas by establishing their factories in the United States. In the end, domestic producers faced more competition at home, and labor unions suffered as foreign firms established their factories in states where unions had less power.
Quotas create other problems as well:
An embargo is a ban on trade with another country. The purpose of an embargo is usually to punish a country for some offense. The embargo you may be most familiar with is America’s embargo against Cuba. In the wake of the communist revolution, and later the Cuban Missile Crisis, the United States enacted an embargo that banned all trade with the island nation. Even though the events are now far in the past, the embargo persists. Once again, you might consider who benefits from the trade embargo in order to understand why it is still in place.