Free trade involves the exchange of goods between countries without restrictions like tariffs or quotas. Early economic theories like mercantilism supported government control over trade to accumulate wealth, while later theorists like Adam Smith and David Ricardo argued that free trade allows countries to specialize and benefit from comparative advantage. While classical theories supported free trade, many countries adopted protectionist policies due to arguments around infant industries, national defense, and unemployment. Since WWII, organizations like GATT and the WTO have worked to gradually reduce trade barriers, but free trade remains a controversial issue.

1. Free Trade
I INTRODUCTION
Free Trade, interchange of commodities across political boundaries without
restrictions such as tariffs, quotas, or foreign exchange controls. This economic
policy contrasts with protectionist policies that use trade restrictions to protect or
stimulate domestic industries.
II EARLY TRADE DOCTRINES
Foreign trade doctrines began to develop during the 1400s. One early form of
economic policy, known as mercantilism, dominated Western Europe from about
1500 to about 1800. Supporters of this policy worked to promote national unity and
to increase the strength of the nation-state. They considered wealth a necessary
condition of power, and the accumulation of gold and silver specie, or coins, a
necessary condition of wealth. Countries without gold or silver mines acquired
specie by maintaining a surplus of exports over imports throughstrictgovernmental
control of foreign trade.
A reaction against such control occurred in France in the 1700s. This led to the
formulation of the first theory of free trade by a group of economic philosophers
known as the physiocrats, who were followers of the French economist François
Quesnay. The physiocrats maintained that the free movement of goods was in
accordance with the principles of natural liberty. Although their ideas had little
effect in France, they influenced the Scottish economist Adam Smith, whose free
trade theories contributed to the later development of trade policy in Britain.
Smith refuted the protectionist conclusions of mercantilist thought. He pointed out
that wealth consisted not in specie itself but in the material that specie could
purchase. Governmental regulation of trade actually reduced the wealth of nations,
because it prevented them from purchasing the maximum amount of commodities
at the lowest possible price. With freetrade, each nation could increase its wealth by

2. exporting the goods it produced most cheaply and importing goods that were
produced cheaper elsewhere.
According to Smith, each country would specialize in the production and export of
goods in which it had an absolute advantage—that is, it could produce the goods
more cheaply than any of its trading partners. Another British economist, David
Ricardo, extended that analysis early in the 19th century to encompass the more
general case of comparative advantage. Ricardo noted that some nations lack an
absolute advantage in the production of any commodity. However, even these
nations could gain from free trade if they concentrated on producing commodities
in which they had the smallest disadvantage. This enables the nation to trade goods
that are easiest to producefor goods that aremore difficult to produce. Whennations
practice the principle of comparative advantage, more goods are produced between
the trading countries, and the wealth of both countries increases. The principle of
comparative advantage forms the theoretical basis of the argument for free trade.
Ricardo assumed that all nations would share in the gains from free trade. The
British philosopher and economist John Stuart Mill later demonstrated that such
gains depend on the strength of reciprocal demand for imports and exports. The
stronger the demand for the exports of a country relative to its demand for imports,
the greater its gain from free trade. The gain would be reflected in an improvement
in the international terms of trade for the country, as expressed by the ratio of its
export prices to its import prices.
III MODERN TRADE THEORY
The classical theory of trade developed by Smith, Ricardo, and Mill was concerned
primarily with the analysis of the gains fromtrade. Modern trade theory, by contrast,
takes the principle of comparative advantage for granted. It is mainly concerned
with the analysis of the basis for trade and with accounting for differences in
comparative advantage.
Classical theorists assumed that differences in comparative advantage resultedfrom
differences in the productivity of resources, reflecting the unequal distribution of
technologies and labor skills among nations. A more complete explanation was
offered by several 20th-century economists, who noted that differences in the prices

3. of final goods tend to reflect differences in the prices of resources used to produce
the goods, and that these differences reflect differences in the availability of the
resources. Countries specialize in the production and export of goods requiring
relatively large amounts of those resources that they possess in abundance, and they
import goods requiring relatively large amounts of resources that are scarcewithin
their borders.
IV ARGUMENTS FOR PROTECTION
Despite the arguments of classical trade theory, few countries ever adopted a
thoroughgoing policy of free trade. The major exception was Britain, which, from
the 1840s until the 1930s, levied no import duties of any kind. The historical
prevalence of protectionist policies reflects in part the strong influence of industries
fearful of foreign competition, and in part the strength of various theoretical
arguments for protection. Such arguments include the infant-industry argument,
the national defense argument, the counter-dumping argument, and arguments
focused on protecting domestic employment and income. Under appropriate
circumstances all of these arguments have theoretical validity as well as limitations.
One of the oldestarguments for protectionis the so-called infant-industry argument.
According to this theory, when foreign competition is reduced or eliminated by
import barriers, domestic industries can develop rapidly. After their development is
complete, they should theoretically be able to hold their own in competition with
industries of other nations, and protection should no longer be required. In practice,
however, protection frequently cannot be removed, because the domestic industries
never develop sufficient competitive strength. The limitation of the infant-industry
argument is its inability to identify those industries that are capable of growing to
genuine maturity.
The national defense argument for protection seeks to avoid dependence on foreign
sources for supplies of essential materials or finished products that might be denied
in time of war. The limitation of this argument is that identification of those
industries indispensable for national defense is difficult.
A third instancein which protection is advocated is to counter dumping fromabroad.
Dumping occurs when products are made available as imports at prices lower than

4. the prices prevailing in the exporting country. Protection may be justified in these
circumstances, butonly if the clear intention of foreignsuppliers is to drivedomestic
suppliers out of business.
During periods of high unemployment, protection is often urged as a means of
increasing employment. Withimports reduced, demand for domestic substitutes will
be stimulated, expanding production at home. Economists call this a “beggar-my-
neighbor” policy: The improvement of employment at home is achieved entirely at
the expense of employment elsewhere. The limitation of such a practice is that it
invites retaliation from other nations suffering from similar problems of high
unemployment.
Protection can be used to redistribute income either within nations or between
nations. For example, if a nation finds that the demand for its exports is relatively
strong, it can gain income at the expense of other countries by imposing tariffs or
other import barriers. Foreigners will then find it more difficult to earn the income
to pay for the exports they desire. Consequently, they will be forced to reduce their
prices, thus improving the terms of trade for the protectionist nation. Like the
employment argument, this method invites retaliation from abroad.
V RECENT DEVELOPMENTS
Since World War II ended in 1945 the leading trading nations have generally made
a concerted effort to promote freer trade and remove protectionist barriers. In 1948
the General Agreement on Tariffs and Trade (GATT) went into effect. GATT was a
treaty and international trade organization that worked to reduce or eliminate tariffs
and other barriers to trade. GATT was originally signed by 23 nations, including the
United States. A succession of trade “rounds” or negotiations significantly reduced
tariffs on a large number of manufactured goods. In 1994 Canada, Mexico, and the
United States took a major step toward removing trade barriers by ratifying the
NorthAmerican FreeTrade Agreement (NAFTA). Then in 1995 GATTwas replaced
by the World Trade Organization (WTO). By 2001, 142 nations were members of the
WTO. The trade round that created the WTO further liberalized trade in
manufactured goods and expanded the scope of the international trade agreement.
The WTO began to reduce trade barriers and limit subsidies for agricultural

5. products. It phased out protectionist measures for textiles and apparel, and it
imposed limits on the ability of participating nations to enact or maintain nontariff
trade barriers such as regulatory standards that discriminate against imports. The
WTO also established a more effective system for adjudicating trade disputes.
Despite the apparent role of freetrade in promoting strong economic growthduring
the 1990s, both NAFTA and the WTO proved highly controversial. Large and often
violent demonstrations at a WTO meeting in Seattle, Washington, in 1999 revealed
a substantial public backlash against trade liberalization in the United States,
particularly among trade union and environmental groups. Many critics argued that
freetrade had led to reduced wages, job displacement, and harm to the environment.
Many environmental organizations, for example, objected that domestic regulations
to protect the environment could be overturned under the WTO if they were shown
to restrict imports.
The continuing controversy over free trade agreements appeared to narrow the
support given to new accords. The first free trade pact in more than a decade—the
Central American Free Trade Agreement (CAFTA)—narrowly passed the U.S.
House of Representatives by a vote of 217-215 in July 2005 and required strong
backing by the administration of PresidentGeorge W. Bush. The agreement lowered
trade barriers between the United States and the Central American nations of Costa
Rica, El Salvador, Guatemala, Honduras, and Nicaragua, along with the Dominican
Republic. Critics said the agreement lacked the labor and environmental standards
that were negotiated for NAFTA and would lead to job loss in the United States and
increased exploitation of workers in Central America. Supporters of the pact said it
would “level the playing field” by immediately eliminating tariffs on 80 percent of
U.S. industrial exports and 50 percent of U.S. agricultural exports to those nations.
Prior to CAFTA, imports fromthose nations to the United States were already tariff-
free.