Is Free Trade Good or Bad?

Two sides of the same twenty

Why Free Trade Is Good (In Theory)

The idea that free trade is basically good is widely (though not universally) accepted by today's economic minds. Why? In part because David Ricardo, one of the founders of modern economics, showed that it works--in theory, at least--way back in 1817.

Ricardo was the first to explain in detail "the doctrine of comparative advantage," which says that two nations can both benefit from trade even if one of them is better at producing every type of good than the other. Seem counter-intuitive? Many think so. According to Nobel Prize-winning economist Paul Samuelson, "thousands of important and intelligent men . . . have never been able to grasp the doctrine for themselves or to believe it after it was explained to them." But that doesn't mean you can't get it.

Do What You Do Best--And Trade for the Rest

Suppose there are two countries, Utopia and Dystopia, that produce only two things: fine wine and quality shirts. Now suppose that part of what makes Utopia utopian is that it can make both wine and shirts more efficiently than Dystopia can. In economic terms, Utopia has an "absolute advantage" in both industries.

So why would Utopia ever want to trade with Dystopia? Because unless the advantage Utopia has in winemaking is precisely the same as the advantage it has in shirt making, Utopia can benefit from focusing on what it does best--from seizing its "comparative advantage."

When Utopia Meets Dystopia

Say Utopia can make a shirt in an hour and a bottle of wine in an hour-and-a-half. Dystopia needs an hour-and-a-half to make a shirt and three hours for vino. So, in 15 hours of work, Utopia might turn out 6 bottles of wine and 6 shirts. During the same time, Dystopia might make 3.5 bottles of wine and 3 shirts.

That's 9 shirts and 9.5 bottles of wine between them. But if both countries specialize, producing only what each is comparatively better at making, Utopia can produce 10 bottles of wine, while Dystopia can produce 10 shirts--in the same 15 hours. Assuming Utopia and Dystopia can truly trade freely, both should be better off. No one loses a shirt, and more people can raise a glass to increased productivity.

Of course, you might beg to differ if you're a laid-off Dystopian winemaker or an out-of-work Utopian tailor. Macroeconomics doesn't really address that. That's the realm of politics--where people make decisions about whether overall gain is worth individual pain, or whether individual pain carries the day.

Want to learn more?
Investigate the World Trade Organization
http://www.wto.org/english/thewto_e/whatis_e/whatis_e.htm