The Case for a free Trade Approach

THE CASE FOR A FREE TRADE APPROACH

The United States reaps significant economic and political advan- tages from expanding international trade opportunities. Adopt- ing a free trade orientation toward China and the WTO would allow the United States to increase the size of these benefits.

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The Economic Case for Freer Trade Trade expansion produces four significant economic benefits for the United States. The principle of comparative advantage gen- erates the most obvious benefit from trade—greater specialization. The idea behind comparative advantage is that even if one coun- try is more productive at making every single good than another country,both economies would benefit from trade,because of improved division of labor. Trade allows the United States to specialize in making the goods in which it is the most productive, relative to other possible uses of resources. Economists from Adam Smith onward have pointed out that the bigger the market created from trade liberalization, the greater the benefits from specialization in areas of comparative advantage. Freer trade permits other coun- tries to specialize as well. With freer trade, economies can increase economic output while holding inputs constant—in other words, trade creates a win-win arrangement for all participating economies.

The second benefit comes from increased competition with- in the same sector of production. Over the past several decades, economists have repeatedly shown that tradable economic sectors— i.e., those areas of the economy that produce goods or services that can be exchanged across borders—are more productive than sec- tors in which cross-border exchange is not possible. An open global economy dramatically expands market opportunities for both importers and exporters. With these opportunities comes greater competition, which forces firms to increase their efficiency. In an expanded market, individual firms—including multinational cor- porations—lack the market power to raise their prices above the market rate. Therefore, increased competition weakens the abil-

 

 

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ity of companies to set prices.That translates into consumers pay- ing lower prices while having more choice of goods.

The dynamic effect on economic growth is the third and per- haps most significant benefit from trade expansion. As available markets expand, the rate of return gained from technological and organizational innovations increases. Economists have long rec- ognized that innovation is the single most important contributor to economic growth. With trade expansion, firms and entrepre- neurs have a greater incentive to make risky investments in research and development (R&D). Trade expansion therefore significantly boosts economic growth. Furthermore, in some industries, such as the production of jumbo-sized commercial air- craft, a global market is necessary for a competitive market to exist.

The combined effect of these three benefits leads to the fourth benefit: the use of more expansionary monetary policies than would otherwise be possible (without triggering inflation). An open market is a significant reason why the United States has recent- ly been able to sustain robust economic growth, dramatic increas- es in labor productivity, low rates of unemployment, modest rates of inflation, and historically low interest rates.

The Political Benefits of Freer Trade The foreign policy benefits of an open trading system are signif- icant. Trade expansion is vital to winning the global war on ter- rorism. Nine days after the September 11, 2001, terrorist attacks, your USTR argued,

Economic strength—at home and abroad—is the founda- tion of America’s hard and soft power. Earlier enemies learned that America is the arsenal of democracy; today’s ene- mies will learn that America is the economic engine for freedom, opportunity, and development. To that end, U.S. leadership in promoting the international economic and trading system is vital. Trade is about more than economic efficiency. It promotes the values at the heart of this protracted struggle.

 

 

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In April 2002, you made the following case in requesting TPA:

Trade creates the habits of freedom. If you welcome trade into your country, it creates the notion of freedom. It gives peo- ple, consumers, the opportunity to demand product, which is part of a free society. It creates an entrepreneurial class, which is a part of a free society.

And the habits of freedom begin to create the expectations of democracy and demands for better democratic institutions. Societies that open to commerce across their borders are more open to democracy within their borders. And for those of us who care about values and believe in values—not just Amer- ican values, but universal values that promote human dignity— trade is a good way to do that.

Your September 2002 National Security Strategy (NSS) stated (and your March 2006 National Security Strategy reaffirmed),

Poverty does not make poor people into terrorists and mur- derers. Yet poverty, weak institutions, and corruption can make weak states vulnerable to terrorist networks and drug cartels within their borders.The United States will stand beside any nation determined to build a better future by seeking the rewards of liberty for its people. Free trade and free markets have proven their ability to lift whole societies out of poverty—so the Unit- ed States will work with individual nations, entire regions, and the entire global trading community to build a world that trades in freedom and therefore grows in prosperity.

A quick glance at the globe affirms these statements. The regions of the world that have embraced trade liberalization—North America, Europe, and East Asia—contain politically stable regimes and few incubators of terrorism.The regions of the world with the most tenuous connection to global markets—Africa and the Middle East—are plagued by unstable regimes and are hotbeds of terrorist activity.

Trade is not a silver bullet for U.S. foreign policy; many other factors affect the rise of terrorism and political instability. Nev-

 

 

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ertheless, trade is a handmaiden to hope and opportunity to indi- viduals in poor countries, offering an improved quality of life for their children. Creating that kind of hope is a powerful weapon in the war against terrorism.

Beyond aiding the global war on terrorism, trade advances U.S. foreign policy interests in several ways. The most direct effect comes from poverty alleviation. Poverty, not trade, is the under- lying cause of worker exploitation and environmental degradation in developing countries. These social ills are symptoms of a dis- ease for which trade is the cure, not the cause. In the long run, the single best way to encourage developing countries to enforce workers’ rights and protect the environment is to transform them into middle-income countries. Freer trade is an important mech- anism through which the United States can assist in alleviating global poverty, because it provides an engine for economic growth in the developing world. Trade increases economic growth in developing countries; growth reduces poverty and its concomitant social ills.

Trade expansion directly and indirectly promotes democratic values by pushing countries toward policies that are compatible with democracy. For free trade to yield the greatest economic gain, governments must acquire a healthy respect for economic freedom, the rule of law, and well-defined property rights. These attribut- es are prerequisites of a functioning liberal democracy.Trade also contributes to greater income growth in poorer countries. By increasing economic growth, trade liberalization facilitates democ- ratization, as wealthy countries are more likely to have stable democratic regimes. Among political scientists, it is a truism that freer trade, combined with international organizations and demo- cratic institutions, reduces violent interstate conflict. Some stud- ies go further, arguing that it is economic freedom itself that reduces the likelihood of war.

Trade expansion reduces domestic violence as well as interstate war. In the 1990s, the U.S. government–funded State Failure Task Force concluded that exposure to trade was one of three sig-

 

 

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nificant factors that helped to prevent the collapse of state author- ity. Evaluated according to accepted measures of economic and polit- ical freedoms, countries that are closed to trade are nine times more likely to suppress civil and political liberties. Statistical analysis re- veals that countries agreeing to lower their trade barriers are more likely to respect human rights and labor rights within their borders.

For example, there is little doubt that the enactment of NAFTA locked Mexico onto a course of economic liberalization, but NAFTA also helped Mexico deepen its democratic institutions. The end of the grip of the Institutional Revolutionary Party (PRI) on the government occurred after NAFTA came into effect.The publisher of the newspaper Reforma observed after the fall of the PRI, “As the years have passed, with international mechanisms like NAFTA, the government doesn’t control the newsprint, they don’t have the monopoly on telecommunica- tions, there’s a consciousness among citizens that the president can’t control everybody.”

Even when the United States is not a direct participant in trade expansion, its foreign policy interests are served by the political reori- entation and economic interdependence that trade can generate in other countries.The decision by western European governments to create the European Union has helped to preserve the peace on that continent after centuries of war and violence. Central and east European governments are less nationalist, more democratic, and more respectful of minority rights because they want to reap the economic benefits of EU membership.The Mercosur trade agree- ment helped cement democracy in the Southern Cone (Argenti- na, Brazil, Paraguay, and Uruguay); the agreement’s provisions directly prevented a coup d’état in Paraguay in the late 1990s.The prospect of a South Asia Free Trade Area has caused both India and Pak- istan to ratchet down their enduring geopolitical rivalry.

Trade can have a liberalizing effect even in countries that have yet to make the transition to democracy. China remains an author- itarian state ruled by a communist party, its government stands accused

 

 

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of multiple human rights abuses, and corruption is endemic. Nevertheless, China’s accession to the WTO has helped to strengthen the rule of law in that country. China’s economic openness has created a sizable, urbanized middle class.The Chi- nese Communist Party’s Central Organization Department recently observed, “As the economic standing of the affluent stra- tum has increased, so too has its desire for greater political stand- ing.” This stratum is already lobbying for greater environmental protections—which in other ex-communist countries was a gate- way to demanding greater political reforms. Trade has facilitated a Chinese society that is undeniably more open today than it was two decades ago.

Increasing America’s trade with the rest of the world also gen- erates useful tools of statecraft in the short and long runs. For the near future, freer trade combined with a growing American econ- omy helps to foster export-led growth in other countries. Other countries rely on the U.S. market to sustain their own economic growth—creating opportunities for economic statecraft to advance our national interests. When used judiciously and diplomatical- ly, the linkage between these economic relationships and Amer- ican foreign policy preferences can help to nudge other governments toward policies that benefit the United States.

Over the long term, trade liberalization is a win-win proposi- tion among countries and it therefore promotes American inter- ests and values.Most of the time, trade acts as a foreign policy lubricant. If other countries perceive that the rules of the global economic game benefit all participants—and not merely the United States— these countries will be more favorably disposed toward the Unit- ed States on other foreign policy dimensions. Over the very long term (i.e., the next several decades), U.S.-led trade expansion can cement favorable perceptions of the United States among ris- ing great powers. Both the Central Intelligence Agency and pri- vate-sector analysts project that China and India will have larger economies than most members of the Group of Seven (G7), the world’s leading industrialized nations, by 2030. Decades from

 

 

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now, it would serve American interests if these countries looked upon the United States as a country that aided rather than imped- ed their economic ascent.Trade liberalization with these countries now serves as a down payment for future good relations with ris- ing great powers.

Again, it should be stressed that trade expansion is not a magic bullet that automatically leads to higher economic growth and greater political openness. Freer trade, economic growth, respect for human rights, democratic regimes, and a reduced likelihood of war all move in the same direction, and sometimes these other factors lead to freer trade rather than vice versa. Nevertheless, trade expansion is a useful policy tool.

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