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What is Free Trade? - Definition, Pros, Cons & Examples

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  • 0:02 What Is Free Trade?
  • 0:47 Pros of Free Trade
  • 2:18 Cons of Free Trade
  • 3:10 Lesson Summary
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Lesson Transcript
Instructor: Kimberly Winston
Is free trade a good thing? The issue of free trade has been a source of debate for centuries, and in this lesson, we will discuss the pros and cons of free trade that have led to this debate.

What Is Free Trade?

Free trade is a policy formed between two or more nations that permits the unlimited import or export of goods or services between partner nations. However, not all trade is free trade. When nations don't have free trade agreements, which are treaties that outline the parameters of trade between trade partners, tariffs are imposed on goods and services. Tariffs are taxes that nations impose on imports. Tariffs increase the cost of goods, which is passed on to consumers.

Free trade eliminates tariffs and makes corporations more competitive in foreign markets. Many critics of free trade question whether it is beneficial for countries. This lesson will discuss the pros and cons of free trade as well as examples that illustrate these pros and cons.

Pros of Free Trade

There are many benefits of free trade, such as:

  • Giving corporations comparative advantage
  • Generating currency
  • Opening up markets

Adam Smith wrote in his 1776 book The Wealth of Nations that free trade was beneficial to trading partners. Smith noted that when the countries in a free trade agreement made products and provided that product for the other country at a cheaper rate than the receiving country could produce it, both countries benefited. We, as consumers, often apply that concept to our daily lives. We purchase goods or services that we cannot cost-effectively produce ourselves, benefiting both parties.

David Ricardo expanded on Smith's ideas, arguing that countries should do what they do better and cheaper than other countries. This is called comparative advantage. Ricardo further noted that concentrating on core competencies gave nations a comparative advantage.

Free trade also helps countries generate foreign currency that they can use to purchase the things that they need. Japan, for instance, exports cars and computers to China and the United States, generating foreign currency. Japan takes the revenue it earned from exporting and uses it to import needed products, such as food or mineral fuels.

Free trade opens foreign markets and lowers barriers for corporations that otherwise might not be able to compete against local competitors. As previously mentioned, without free trade agreements, foreign corporations must pay tariffs that increase their cost and decrease competitiveness.

Cons of Free Trade

Critics of free trade point out that the cons of free trade outweigh the benefits. Several cons of free trade are:

  • Increased unemployment
  • Stagnating wages
  • Distribution of wealth

One example of free trade is the agreement between the Unites States, Mexico, and Canada, known as the North American Free Trade Agreement (NAFTA). NAFTA was established January 1, 1994, between the United States, Mexico, and Canada. While there were many benefits to all three countries, such as job creation, many U.S. factory workers lost their jobs as factories moved to Mexico, which had cheaper labor. Wages have stagnated as workers are unable to compete in the new economy created by free trade. Furthermore, critics of free trade noted that while revenue is generated from exporting products, it's the richest one percent that benefit, not the workers.

Lesson Summary

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