A trade policy of placing no restrictions on the movement of goods between countries is known as the policy of 'Free Trade.' Such a policy permits the flow of international commerce in its natural environment, free of artificial impediments.
According to Adam Smith, the term 'free trade' is used to denote 'that system of commercial policy which draws no distinction between domestic and foreign commodities and, therefore, neither imposes additional burdens on the latter, nor grants any special favour to the former.' In other words, free trade implies complete freedom of international exchange. Under such policy, there are no barriers to the movement of goods between countries and exchange can take its perfectly natural course.
The policy of free trade, however, does not require the removal of all sorts of duties on commodities in international exchange. It insists that duties may be imposed exclusively for revenue and not at all for protection.
Classical economists like Adam Smith, Ricardo etc., were enamoured of the policy of free trade, as a reaction against mercantilism dominating England and other continental countries in the sixteenth and seventeenth centuries. They argued that free trade was economically advantageous on the following counts:
1. It permits an allocation of resources and manpower in accordance with the principle of comparative advantage, which is just an extension of the principle of division of labour. Because of natural and other facilities, each country is suited for the production of some particular commodities.
When countries are freely engaged in trade, the price mechanism under competition automatically ensures that each country specialises in producing those commodities which it is relatively best suited to produce and imports those commodities which it can obtain more cheaply than by producing them itself. Further, when there is specialisation, the labour and capital of a country tend to move into those channels of industry where they have optimum use and can produce maximum.
Thus, the production of goods cart be enormously increased by an international division of labour rendered possible by free trade. Such territorial specialisation brings gain to all concerned and maximises national products, when there is free 'international trade. Classicists, therefore, argued that any obstacle to free transactions of goods between countries curtails the possibilities of specialisation and to that extent reduces the national product.
Ellsworth hence, writes: "Therefore, since the income of any community or nation is large just in proportion to the extent to which it specialises, the greatest possible freedom of trade is justified."
In short, according to the classical economists, the gain from free international trade would be the largest due to international specialisation based on comparative advantage. Free trade leads to the most efficient conduct of economic affairs. In a plea for free trade, they also said that even if some countries do not follow the policy of free trade, an industrial country should follow it unilaterally as it will gain thereby.
2. Under free trade, factors of production also will be able to earn more, as they will be employed for better use. Hence, wages, interest and rent will be higher under free trade than otherwise.
3. Free trade procures imports at cheap rate. It seems to be an attractive argument in favour of free trade at least from the consumer's point of view. However, it ignores the question of employment and the interests of producers in the importing country. Here it has been pointed out that under free trade, when consumers gain through lower price, producers also gain as the factors of production are directed to more gainful and specialised production which gives better earnings.
4. Free trade widens the size of the market as a result of which greater specialisation and a more complex division of labour become possible. This brings about optimum production with costs reduced everywhere, benefiting the world as a whole. Restrictions on free trade reduce the scope of specialisation and in consequence there is a reduction of the total world supply, thereby, making the world as a whole so much the poorer economically.
5. Free trade also widens the area of competition as a result of which the industrial techniques of the trading countries tend to be improved. Home producers are spurred by foreign competition to become more efficient and to adopt quickly any improvement in methods of production. In this way free trade has an educative effect.
6. Another incidental advantage of free trade is that it prevents, or at least makes more difficult, the establishment of injurious monopolies by preserving competition.
Experience, however, shows that free trade cannot provide a complete safeguard against the formation of monopolies; international as well as local. The local monopolies owe their existence to transport costs involved in international exchange.
Despite the clamour of the classical economists about the advantages of free trade, the policy has either not been adopted by many countries or abandoned by those who already adopted it. Economic history indicates that since the last two centuries, international trade has developed with the protection policy.
Free trade policy has been abandoned by all countries for the following reasons:
1. Under the system of free trade, the underdeveloped countries suffer very much in competition with the advanced countries. Free trade, policy in India adopted by the British Government has proved that, the one-time flourishing industries (handicrafts) of India were completely wiped out due to foreign competition. On the continent of Europe also, the people knew the dangers of free trade, and they hastened to erect strong tariff walls to protect their industries.
2. On account of economic interdependence in implementing free trade policy, many governments experienced political handicaps, especially during war times. Hence, for maintaining political independence, it was thought desirable to seek economic independence with the abandonment of free trade.
3. Countries cannot allow free import of injurious and harmful products; hence, trade restrictions become necessary.
4. Free trade led to cut-throat competition in the world market, so that, exporters resorted to dumping, which no government can allow beyond a limit; thus, restrictions became inevitable.
5. Free entry of goods produced by powerful combines inflicts a permanent injury on the economic interests of a country. Hence, restrictions on such items were thought inevitable.
6. Backward countries have to protect their infant industries and hence, cannot adopt the policy of free trade.
Thus, though, in theory free trade looked better, in practice protection got the upper hand.
Protection refers to the foreign trade policy of encouraging home industries by paying bounties (or giving subsidies) to domestic producers, or more usually by imposing customs duties on foreignproducts.
The term protection usually carries in a very loose sense the connotation of a tariff on imports; but it may refer to any policy that raises the price of import substitutes and safeguards the interest of domestic producers against foreign competition.
Tariff system, i.e., customs duties, is an important and most common method of protection. By tariff barriers we mean only those taxes which are intended to restrict international trade.
Protection is an established creed of modern trade policy. Yet it remains to be examined whether, protection is a healthy policy leading to an economic millenium or a policy abounding in hidden dangers.