Advantages and threats to developing nations

MANAGEMENT DEVELOPMENT INSTITUTE OF SINGAPORE IN TASHKENT (MDIST)

 

Course          : BSc in Accounting and Finance

 

Module          : Global Business Environment

 

Lecturer           : Dr.Venkataraman

 

Assignment Type  :  Individual 

 

Due Date:   14.12.2012

 

Student Name	ID Number	Student Signature
Abdujabborov Humoyunmirzo	B 09004534

 

 

 

Submitted on Due Date (Yes/No): Yes

Word Count     2530

 

 

 

 

 

 

 

 

 

 

 

Free Trade – Liberalization of international trade policies: Advantages and threats to developing nations 

Introduction

Development of international economic relations is the most important feature of the global economy in the second half of the 20th century. During this period substantial increase in the extent of relations between states, groups, national and international organizations were observed.

Shift from national economical growth model to global model poses in front of economic theory the question of in what extent in the national economy benefits from the country's participation in international economic relations. Will country win or lose involving yourself in the international division of labor? Economics became interested in finding answer to questions about the benefits of international trade and international specialization for a long time, referring to one of the fundamental questions of economic theory.

 

Protectionism and free trade: historical aspects, current trends.

 

Mercantilism should be considered as one of the early economic principles analyzing interstate economic relations. Mercantilist’s ideas dominated for nearly three centuries, between late XV and XVIII centuries. Mercantilists believed that the country should to sell on the international market as much as possible and to buy as little as possible, in addition government should accumulate gold as the basis of wealth. Nowadays their point of view looks inadequate. However, today their thoughts resonate with the ideas of protectionism - one of the two key concepts of our contemporary international economic relations, so mercantilist principles might be called as pre-capitalist protectionism.

 

In debate with concept of mercantilism, which was classical political economy, Adam Smith and David Ricardo established the opposite of protectionist approach-the concept of free trade that assesses the benefits of international trade.

 

The history of international economic relations is a history of the struggle between two concepts of the above approach to international relations and, accordingly, the two trends in international trade policy of the state. Protectionists argue for government protection of their country's industry from foreign competition and adversely free traders believe that, actually, nor government, neither market should form the structure of exports and imports, trade should be developed on the basis of market forces of demand and supply. The combination of these two approaches varying in proportions distinguishes external trade policy of states at different stages of their development.

 

For national economies more openness and trade liberalization is typical during the period of high economic growth and while having strong export potential (e.g. England during XIX and XX centuries, United States after World War II). Conversely, in periods of economic downturn, weakening export potentials government tends to listen to the arguments for protectionism more.

 

Protectionist have several arguments approving their principals, such as the need to protect domestic producers from foreign competition, maintain jobs in domestic industries competing with imports, protect industries related to national defense, increase the income of the state budget, create measures responding trade barriers developed by trading partners.

 

Theoretical studies of the benefits of free trade

 

Free trade - is the policy of the government, based on the principle of comparative costs, aimed at creating a favorable trade and economic environment for the effective allocation of resources and wealth of the country. Movement of Free trade is originated in England during the last third decades of the XVIII century and was associated with the industrial revolution happened there. Struggle of the British free traders was directed against agricultural duties, supporting high prices for agricultural products, which held back the development of factory production, as well as the reduction of customs duties in mutual trade with other countries, which would help to increase the export of British goods abroad. Under pressure of free trade in the 1820s, in England customs system was reformed, consequently tariffs on many goods had been abolished or significantly reduced. In the middle of XIX century free trade won a landslide victory in England, which has greatly contributed to country in becoming to one of the most developed countries of the world by this time. In the second half of the XIX century trends of free trade became apparent in the trade policy of France and other countries.

For the first time the most consistent rationale benefits of free trade has been presented in the writings of Adam Smith and David Ricardo.

One of the main ideas of Adam Smith is that the growth of wealth of nations is largely due to the deepening division of labor, including international divisions. According to Adam Smith each country should specialize in the production of the commodity, where it has an absolute advantage, i.e. the ability to produce the goods at a lower cost (volume of production factors involved) than in countries with which it enters into trade. The invisible hand of competition is asked to provide tackling cross-country specialization, and government intervention is to be reduced to a minimum.

 

Further development of the theoretical basis of the benefits of free trade associated with the name of David Ricardo and of his theory of comparative advantage, in which the absolute benefits, considered by Adam Smith appeared as a special case of the general rule. The theory of comparative advantage is a universal theory that justifies all the advantages of division of labor, not only between nations but also between regions, enterprises and entrepreneurs in national economies.

It was initially developed by Ricardo in the analysis of trade relations between countries. The theory of comparative advantage is a recognized theoretical framework to explain the causes and trends in international trade.

In modern sense, the issue of free trade is the following realistic conclusion. Thanks to free trade, based on the principle of comparative costs, the global economy can achieve a more efficient allocation of resources and a high level of material well-being. Structure of resources and the level of technological knowledge of each country are different. Therefore, each country can produce certain goods with different production costs. Each country should produce those goods, which have relatively lower production costs compared to other countries; exchange the goods which it is specialized for the products with higher production costs in the country relative to other countries. If every country does so, the world benefits from the full extent of geographic and human expertise. That is, the world and every free trade country can get more real income from the use of the resources at their disposal. Protectionism is barriers to free trade, which reduces or nullifies the gains from specialization. If countries cannot trade freely, they have to transfer resources to effective use to meet their diverse needs.

Incidental benefit of free trade is that it encourages competition and limits the monopoly. Increased competition of foreign firms makes domestic firms to move to production technologies with lower costs. This also forces to innovate and keep abreast of technological progress, improving product quality and using new methods of production, and thereby promote economic growth. Free trade provides consumers the ability to choose from a wider range of products. The reasons favoring free trade, in essence, is same with necessity to stimulate competition. Therefore it is not surprising that the vast majority of economists estimate free trade as an economically sound phenomenon.

The advantages of free trade are complex enough and proved both in theory and practice.

Firstly, free trade improves the welfare of trading nations, since it opens up the possibility of international specialization of production and exchange on the basis of comparative advantage. The growing welfare gain is due to the gain derived from international trade. Classic economists offered to measure this welfare gain as the difference between the rate of profit in the international exchange of goods and the rate of profit in its absence.

Secondly, free trade facilitates the development of competition and support the spirit of innovation, not only among domestic producers, but also in relations with other countries. This ultimately improves the quality of products.

Third, free trade offers opportunities for expanding markets and, therefore, for the international concentration of production and the mass production of goods.

Fourth, free trade is the basis of optimizing the allocation of productive resources between countries and their international combination that increases the effectiveness of their use.

Recommendations by supporters of free trade contributed to economic growth and prosperity of many countries which have embarked on an open economy.

Even without knowledge of economic theory, people understand the importance and necessity of trade, associated with the natural and geographical differences. There is no necessity to explain the need of trading with the countries of Africa and South East Asia to the lover of bananas in Russia. But trade between countries is also beneficial when countries produce the same range of products, and more beneficial, when one country makes all of these products at a lower cost than the other. Ricardo showed that the trade can be beneficial when one of trading country has greater efficiency in all sectors. Conclusions on international exchanges should be done by assessing the comparative costs, in other words, the opportunity costs lost by producers of goods.

 

The principle is true not only for the two goods and two countries, but also for any quantities. Of course, it is abstract, as it ignores inflation and unemployment. But for all its simplicity, it is not only an opportunity to assess the relative efficiency of production in the countries, but also enables us to predict the direction of trade and international specialization. In the example, Ricardo took into neither account neither national labor productivity, nor other quality characteristics of the export industries. Benefits received by countries through specialization, caused the establishment of more efficient industrial structure of production.

 

The assumptions made in the proof of the benefits of specializations: two goods, two countries, constant costs can be removed. The proofs will be complicated, but the final conclusion remains unchanged. This conclusion about the benefits of international exchange, the possibility of increasing consumption in the country compared to the situation when the country relies on its domestic production. In other words, the productive capacity of the country can be increased not only by improving the internal factors, but also by the use of external factors. International specialization and international free trade increase the amount of capital and consumer goods for society. In other words, under certain conditions, international economic relations can lead to the same consequences as the growth of the domestic economy's potential.

 

Why world needs WTO?

World Trade Organization (WTO) an international economic organization, which regulates international trade rules under the principles of liberalism. The main task of the WTO is to promote the smooth international trade. Developed countries, who were initiators of WTO, believe the economic freedom in international trade contributes to economic growth and wealth of society.

It is now believed that the world trading system must meet the following five principles:

1. No discrimination in trade.

No country shall prejudice any other country, imposing restrictions on the export and import of goods. Ideally, in the domestic market of any country should not be any differences in the conditions of the sale between the foreign and local products.

2. Reduction of trade (protectionist) barriers.

Trade barriers are factors reducing the possibility of penetration of foreign goods on the domestic market of any country. These include the customs duties and import quotas (quantitative restrictions on imports).

3. Stability and predictability in terms of trade.

Foreign companies, investors and governments should ensure that trading conditions (tariff and non-tariff barriers) are not changed suddenly and arbitrarily.

4. Stimulate competitiveness in international trade.

For equal competition of firms from different countries, they must stop "unfair" methods of competition - such as export subsidies (state help exporting firms), the use of dumping (intentionally undervalued) prices to capture new markets.

5. Benefits of international trade for the developing countries.

This principle is somewhat contrary to the previous one, but it is necessary to pull the world economy in the underdeveloped countries of the periphery, which obviously can not initially compete with the developed countries on an equal basis. Therefore it is special privileges considered "fair" representation of developing countries.

In general, the WTO promotes the idea of ​​free trade (free trade), fighting for the removal of protectionist barriers.

Losses and threats to the national economy from adopting free trade rules

On the other hand, joining of any developing country to WTO (in other words, agreeing to adopt free trade concepts) has major impact on the economy of the country, reflecting as a negative impact on the economic security of enterprises and the state.

 

After becoming a member of WTO, country may face with some threats to their national economy. Below there are provided some future threats that should be considered by governments.

• increased import expansion and the resulting destruction of competitive industries and enterprises;
• decrease in revenues and the need to raise taxes as a result of the abolition of export duties;
• reorientation of foreign producers from import of finished goods to move to Russia, new businesses and winning its domestic market due to liberalization of imports;
• Massive social costs (ruin to entities, decreasing job places, migration, etc.) related to the liberalization of access to the market and ousting domestic producers from market.

As result of the loss in industries and the negative impact on domestic production, the ability of country to pursue its national interests and the ability of local entrepreneurs in the implementation of economic activities in the interests of the country will decline

Liberalization of non-competitive sectors of the Russian economy to international competition will lead to the destruction of individual industries and the chain reaction in the whole system of national economy.

In general, the threats appeared in the developing countries economy after becoming member of WTO can be summarized as follows:

1. Absorption by foreign companies: in terms of increased competition inevitably absorption of relatively weak enterprises.

2. Increased competition in domestic markets: foreign companies have greater resources and competitive than the domestic business, and have great potential to capture whole local market.

3. Rising unemployment: cheap imports would lead to the ending of a number of weak industries, consequently increasing unemployment.

4. Outflow of capital from country: profit outflow from operations of subsidiaries of foreign affiliates in the form of dividend payments.

 

Conclusion

To sum up, at a starting point country’s foreign trade policy can not be completely free. In some industries depending on product types there will take place measures to protect domestic producers. Lack of competitiveness of the local products of many poor countries’ enterprises today creates the appeal to close the domestic market to foreign goods and thus facilitate marketing problems to domestic producers.

Undoubtedly, nowadays international trade plays an increasingly important role in the economic development of countries, regions and the world community. In today's world trade, each country faces a choice - in what extent will be open its economy. It is known that that the policy of free trade and protectionism has both advantages and disadvantages. As during the post-war period, the volume of world trade has grown rapidly, and average annual growth rate of global trade 1.5 times exceeded the growth rate of global production, as a consequence, foreign trade has become a powerful driver of economic growth. But on the other hand, there was a noticeable increase in country's dependence on international exchanges.

 

References

Boboev A.D (2008). Economics of International Relations. Tashkent: Sharq. ch 5.

Charles W. L. Hill (2011). International Business : Competing in the Global Marketplace. 8th ed. Boston: Mc Graw-Hill/Irwin. p175-204.

Kamayev V. D (2002). Economic Theory. 8th ed. Moscow: Vlados. ch20.

Shimova O.S (2005). Economics of Natural resources. Moscow: Infra-M. p24-35.

Web Resources

WTO. (2012). About WTO. Available: http://www.wto.com/about/. Last accessed 13 Dec 2012