2. Economics of free trade and free trade zone
Free trade is a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports) or quotas. According to the law of comparative advantage, the policy permits trading partners mutual gains from trade of goods and services.
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from those that would emerge under deregulation. These governed prices are the result of government intervention in the market through price adjustments or supply restrictions, including protectionist policies. Such government interventions can increase as well as decrease the cost of goods and services to both consumers and producers. Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade. Other barriers, however, that may be equally effective in hindering trade include import quotas, taxes, and diverse means of subsidizing domestic industries. Interventions include subsidies, taxes and tariffs, non-tariff barriers, such as regulatory legislation and import quotas, and even inter-government managed trade agreements such as the North American Free Trade Agreement (NAFTA) and Central America Free Trade Agreement (CAFTA) (contrary to their formal titles) and any governmental market intervention resulting in artificial prices.
Free trade implies the following features:
Trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on imports or subsidies for producers)
Trade in services without taxes or other trade barriers
The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws) that give some firms, households, or factors of production an advantage over others
Free access to markets
Free access to market information
Inability of firms to distort markets through government-imposed monopoly or oligopoly power
Two simple ways to understand the proposed benefits of free trade are through David Ricardo's theory of comparative advantage and by analyzing the impact of a tariff or import quota. An economic analysis using the law of supply and demand and the economic effects of a tax can be used to show the theoretical benefits and disadvantages of free trade.
Advantages of tariffs
Widgets cannot be produced to the right of the Supply curve.
This graph demonstrates the benefits of tariffs to a domestic industry. Assume that Japan wants to protect a domestic industry that is only able to produce and sell widgets at the price Ptariff. Since there are other countries that are exporting the same widgets at a price of Pworld, Japan's industry is threatened to go out of business should widgets be imported into their country without a tariff. This graph also shows that as long as Ptariff does not fall above the intersection of the Supply and Demand lines, then an equilibrium can be reached in which there are no shortages of demand or excesses of supply, and so Japan's industry can produce and sell widgets to the same degree as manufacturers in any other country.
In this case, the higher price would not cause domestic production to increase from QS1 to QS2, since it has already been assumed in our example that Japan cannot afford to enter the widget market below the price Ptariffas the world economy has for price Pworld. The effect of the tariff would limit imports and create a higher demand for domestically produced widgets (QS2 - QS1) but have no effect on consumer prices, since the graph shows that for all quantities to the left of the intersection of the Supply and Demand curves, consumers will buy whatever widgets enter the market. As increasing widget sales allow more widget producers to enter the market and the quantity of imported + domestic widgets in Japan approaches QE then the tariff can be phased out since the market will be at equilibrium (E) and the PE market price will be enough for Japan's widget manufacturers to stay in business.
Currently, the World Bank believes that, at most, rates of 20% can be allowed by developing nations; but Ha-Joon Chang believes higher levels may be justified because the productivity gap between developing and developed nations is much higher than the productivity gap which industrial countries faced. (A general feature is that the underdeveloped nations of today are not in the same position that the developed nations were in when they had a similar level of technology, because they are weak players in a competitive system; the developed nations have always been strong players, although formerly at an overall lower level.
Counter arguments to this point of view are that the developing countries are able to adopt technologies from abroad, whereas developed nations had to create new technologies themselves, and that developing countries have far richer markets to which to export than was the case in the 19th century.) If the main defense of tariffs is to stimulate infant industries, a tariff must be high enough to allow domestic manufactured goods to compete for the tariff to be successful. This theory, known as import substitution industrialization, is largely considered ineffective for currently developing nations.