International Economics >> Free Trade, Trade Protection
The pure theory of international trade assumes 'free trade' between the nations. 'Free trade is trade without any direct or indirect restrictions on free movements of goods and services between the nations. The trade restrictions include tariffs, exchange control, quota, taxes and subsidies (open or disguised), and foreign exchange controls. It has been shown in 'the previous' chapters that free trade promotes employment, increases production and consumption, reduces prices of goods 'and services, and raises the level of social welfare. However, the history of world trade in the last three quarters of the 20th century is the history of restricted trade. Why is there a divergence between theory and practice of trade, In fact, the trade policy of nations need not necessarily conform to the theory of trade at least for two reasons.
1. The assumptions of the trade theory do not exist in the real world; and
2. Political, economic and ideological factors not accounted for the trade theories often playa predominant role in the formulation of the trade policy.
However, whether free trade or restricted trade has 'been a controversial policy issue, perhaps, ever since the trade between two nations took place. Economists have debated on the issue over the past two-and-a-half centuries. A section of economists have tirelessly advocated the case for free trade. Another section of the economists have built a case for restricted trade or trade protection. The economists who advocated free trade are called 'free traders' and those who advocate trade restrictions can be called 'trade raiders'.
Trade protection policy
The much advocated free trade policy had hardly ever existed in its form and content on an universal scale. For some political and economic reasons, most countries had adopted a protectionist policy, at some point or the other in the history of their foreign trade, Perhaps, world market never provided the perfect conditions required for free foreign trade on a global scale. One could, however, say that the international economy which 'reasonably approximated' the world of theoretical model existed between 18605 and the outbreak of the First World War.6 Even during this period, tariffs existed in many countries (e.g., in France, Holland, Belgium, the United States and Germany) though at a relatively lower rates. But the growth of free trade itself created conditions for rivalry for market for the growing world industrial output. This along with aftermaths of War revived the economic nationalism, on the one hand, and protectionism, on the other. Consequently, the trend in tariff-reduction was revived, and has stayed as a fact of world economy. For the purpose of regulating foreign trade or protecting the country's interest in the foreign trade, tariff is one of the most important tools. By imposing tariffs, i.e., through the levy on imports and exports. a country can influence the pattern, volume and direction of its trade with the rest of the world. The imposition of tariffs changes the relative price structure which, in its turn, changes the structure and pattern of trade between a country and the rest of the world. For example, if India wants to curb her imports of luxury goods which are cheaper even on comparable quality basis, she will impose tariffs or custom duties on imported luxury goods at a rate which can more than neutralise the price differences. As a result, Indian consumers would divert their demand from foreign to domestic goods and import of foreign luxury goods would decrease. But if even after the imposition of a 100 per cent tariff, Japanese goods remain cheaper than domestic goods while other foreign goods become costlier, India's demand for foreign luxury goods will be diverted from other countries to Japanese goods. This is how tariffs change the direction of trade. An antithesis of tariff is subsidy. While tariffs tend to reduce the volume of international trade, subsidies increase it.
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