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Home > Economics > The global economy > Free trade and protection: advantages and disadvantages of free trade

Outcomes
Overview
Content
Review exercises
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Outcomes

HSC Topic: The Global Economy is covered in the Board of Studies NSW Stage 6 Economics Syllabus (1999) on pages 31-33. The specific outcomes for this tutorial are:

H1	demonstrates understanding of economic terms, concepts and relationships
H3	explains the role of markets within the global economy
H4	analyses the impact of global markets on the Australian and global economies
H6	analyses the impact of economic policies in theoretical and contemporary Australian contexts
H8	applies appropriate terminology, concepts and theories in contemporary and hypothetical economic contexts.

Overview

Every day Australia and Australians benefit from trade. With a population of only 19 million people trade opens up a global market of more than five billion. Australia has a surplus of resources so we can sell the surplus to other countries and use the export dollars to buy other goods and services. People all around the world are eating Australian food, drinking our wine, using computers with Australian software and riding in Australian fast ferries.

This tutorial introduces the concept of free trade and examines the advantages and disadvantages for trading nations.

Content

1. Advantages of free trade

   Free trade occurs when there are no artificial barriers put in place by governments to restrict the flow of goods and services between trading nations.

   When trade barriers, such as tariffs and subsidies are put in place, they protect domestic producers from international competition and redirect, rather than create trade flows.

   1. Increased production

      Free trade enables the countries to specialise in the production of those commodities in which it had a comparative advantage.

      With specialisation countries are able to take advantage of efficiencies generated from economies of scale and increase output.

      International trade increases the size of a firm’s market, resulting in lower average costs and increased productivity.

   2. Production efficiencies

      Free trade improves the efficiency of resource allocation. The more efficient use of resources leads to higher productivity and increasing total domestic output of goods and services.

      Increased competition promotes innovative production methods, the use of new technology, marketing and distribution methods.

   3. Benefits to consumers

      Consumers benefit in the domestic economy as they can now obtain a greater variety of goods and services.

      The increased competition ensures goods and services, as well as inputs, are supplied at the lowest prices. For example in Australia imported motor vehicles would cost 25% more if the 1998 tariff levels still applied. Clothing and footwear would also cost around 14% more.

   4. Foreign exchange gains

      When Australia sells exports overseas it receives hard currency from the countries that buy the goods. This money is then used to pay for imports such as electrical equipment and cars that are produced more cheaply overseas.

   5. Employment
      

      Trade liberalisation creates losers and winners as resources move to more productive areas of the economy. Employment will increase in exporting industries and workers will be displaced as import competing industries fold in the competitive environment. With free trade many jobs have been created in Australia, especially in manufacturing and service industries.

   6. Economic growth

      The countries involved in free trade experience rising living standards, increased real incomes and higher rates of economic growth.

2. Disadvantages of free trade

   Although free trade has benefits, there are a number of arguments put forward by lobby groups and protestors who oppose free trade and trade liberalisation. These include:

   • With the removal of trade barriers structural unemployment may occur in the short term. The Australian textile industry will face this problem when tariffs are reduced from 25 percent to 7 percent in 2005. However it is interesting to note that when tariffs increased greatly in the period 1974–1984 for textiles and footwear employment in the sector fell by 50 000 for the same period.
   • Increased domestic economic instability from international trade cycles, as economies became dependent on global markets. The Asian economic crisis in 1998 and economic slowdown in the global economy in 2001 illustrate this situation.
   • International markets are not a level playing field as countries with surpluses may dump them on the world markets below cost. Some efficient industries may find it difficult to compete for long periods under such conditions.
   • Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection polices by governments.
   • Free trade can lead to pollution and environmental problems as companies fail to include these costs in the price of goods.

Fact file

 

Review exercises

Exercise 1. Click on the correct response.

Questions	True	False
1. All nations have similar factor endowments.
2. International trade promotes specialisation.
3. A country with an absolute advantage in the production of all goods cannot benefit from free trade.
4. A country that is involved in free trade will typically experience higher living standards.
5. Free trade allows nations to obtain goods and services they cannot produce themselves.
6. Specislisation creates production efficiencies.
7. Structural unemployment is an advantage of free trade.
8. Countries involved in free trade are less likely to be affected by a downturn in global economic activity.
9. Globalisation and free trade has increased the gap between rich and poor nations.
10. Comparative advantage is based on the relative efficiency of production.

Answers

 

Exercise 2

Drag & drop activity      Flash version     HTML version

 

Exercise 3

Figure 1

1) Using figure 1 outline the benefits of free trade for the Australian economy.

Answer

More

The Department of Foreign Affairs and Trade website has current information on global trade and trade in the Asia Pacific region that is very good for research assignments on this unit.

The Austrade Media Centre has a number of case studies of businesses involved in international trade. Gibbens Industries Pty Ltd, established in 1937 is an example of an Australian business that has grown and benefited from free trade. Check on the Austrade web site for more details.