Free Trade and Poor Countries

Why free trade is in the interest of the world’s poorest countries Free trade has been a much discussed topic since the 1770s, when Adam Smith presented his theory on trade and absolute advantages. Most sources argue that free trade will benefit the poor nations in the long run (Anderson et al. 2011; Bussolo et al. 2011; Madely 2000; Winters et al. , 2004). How-ever, the size of the benefits will vary in terms of which trade reforms are made, who the poor are, and how they support themselves (Winters et al. 2004).

The purpose of this paper is to discuss why and how free trade is in the interest of the world’s poorest countries. The essay will commence by a description of the traditional trade theories, followed by a discussion of the advantages and the im-pact free trade has on the poorest nations including different theories and findings. There are two classic elements in the definition of trade. The first is Adam Smith’s rule of ‘mutual gain’, assessing that for two countries trading with each other both must gain.

Furthermore Adam Smith argues that trade is based on ‘absolute advantages’, which means that free trade will benefit all nations, if they specialise in producing the goods in which they are most efficient. The countries will then be able to produce at a lower price and trade the surplus for goods where they are less effective. This will allocate the world’s resources in the best possible way (Dunkley 1997; Irwin 2002; Madely 2000; Smith 1776) The second element to trade is Ricardo’s (1817) argument that trade and specialisation is based on ‘comparative advantages’.

If one country has the absolute advantages in all goods com-pared to another country both nations can still benefit from trading. The country with the absolute disadvantage should specialise in producing the goods in which the absolute disadvantage is small-est and then import the goods in which the absolute disadvantage is largest. In the perspective of comparative advantages, freeing up trade would give the developing countries a chance to specialise in the production of primary goods and export the surplus to the developed countries in exchange of e. g. industrial goods (Salvatore 2012).

However, some sources argue that when the trading is between a poor country trading primary goods and a rich country trading industrial goods the latter will benefit the most, because the poor country will have to export more in order to import a similar amount (Madely 2000). In contrast, Samuelson (1939) argues that any kind of trade is better than no trade and Salvatore (2012) concludes that developing countries should continue trading as long as they gain. The capital they get from the trade should be used to improve their technology, which will change their comparative advantages from primary goods to more refined goods.

This is supported by Winters et al. (2004) who point out that connection be-tween the liberalisation of trade and growth have not yet been completely proven, however there is no proof that trade should be harmful to growth. Moreover, barriers of free trade are not the only factor causing poverty; wars, corruption, diseases, and natural disasters are just a few internal fac-tors that keep the poor countries in poverty (Salvatore 2012). Another argument for free trade is that it would utilise the developing countries unutilised resources, caused by the insufficient national demand, more efficient.

Free trade would give productions in developing countries a chance to sell their surplus on a greater market and with this give the developing countries a vent for their surplus (Salvatore 2012). Furthermore, free trade would increase the efficiency of domestic producers in order for them to compete with foreign companies. In addition, the expanding of the market size would form a basis for division of labour and economies of scale (Salvatore 2012). Advocates of free trade argue that free trade will maximise the world’s welfare (Bussolo et al. 2011).

This is supported by the theory of imposing tariffs in small and large countries (Salvatore 2012). A small country is defined as a country where changes in the domestic market would not affect the international market price and a large country is defined as a country where changes would affect the international market prices (Salvatore 2012). If a small country imposes import tariffs they will experience an overall loss in welfare, because of deadweight loss which is caused by inefficiency in domestic production. If a large country imposes tariffs they will xperience an improvement in welfare because they are able to affect the international market price, the producer’s surplus rise and the government’s revenue increases (Salvatore 2012). However, gains from tariffs are often only short term; when a large country imposes tariffs their trading partners probably will too. This will result in reduced traded volume, which in the long term will cause a decrease in world welfare. Madely (2000) argues that free trade, historically, has raised the welfare of many nations, however, but not for the poorest nations.

He claims that free trade mostly benefits the multinational companies, because the rise of food import has forced the smaller farmers to sell their land to the larger companies. Furthermore, the multinational companies do not have any commitment or loyalty to the country in which they are active, which means that the poorest stay poor. In contrast Dollar (2005) claims, that the fast growth and reduction of poverty has been strongest in the developing countries that have included themselves in the world economy most rapidly.

Furthermore, Salvatore (2012) states that trade will move new technologies, ideas, and managing skills from the developed countries to the developing countries. So even though multinational companies are taking over the small farmer’s land they still provide the producing country with new knowledge and tools that can help the country develop new comparative advantages. Winters et al. (2004) claim, that freeing up trade is one of the easiest ways to reduce poverty.

Agricultural trade reforms would have the largest and most positive impact on poverty, because three-quarters of the world’s poorest people still hinge on farming as their main source of income (Anderson et al. 2011). Furthermore, the poor countries also often have a large number of unskilled workers, which give the poor nations a comparative advantage in exporting labour-intensive goods (Bhagwati & Srinivasan 2002). This paper determines that free trade overall would be in the interest of the poorest countries. Free trade will increase the global welfare and help the poor countries develop their comparative ad-vantages.

Multinational companies’ investments in the poor countries will result in moving of tech-nology, ideas and skills. However, theory is not always consistent with practice, why it is important to examine the different perspectives in each case. Abolishing the world’s trade tariffs would indeed help the world’s poorest countries access a greater market to sell their goods, however, freeing up trade alone would not completely eliminate poverty; wars, diseases, corruption, and catastrophes are also strong influential factors of poverty.