Does unilateral free trade serve a nation’s economic interests?
I wrote this essay back in 2020 for the John Locke Essay competition. Disclaimer: this does not represent my actual views on unilateral free trade - I stuck with a position for the sake of the essay and run with it (so much for good epistemics…). Anyway, I hope it still makes for interesting reading.
Since the late 1980s, international trade has become ever freer. The average global tariff rate has fallen dramatically over this period, from over 10% in 1988 to just above 2% in 2015.1 The majority of these tariff reductions have been unilateral: two-thirds of them between 1983-2003.2 The concept of unilateral free trade is an extension of this global trend, as it is the complete removal of all tariffs and other trade distortions by one country without necessary reciprocation by others. There is an ongoing debate surrounding the efficacy of unilateral free trade, as with free trade more generally. I aim to show that unilateral free trade does ultimately serve a nation’s economic interests, but can be disruptive in the short term.
Among economists, there is a strong consensus that free trade is good. 94% of experts agree that free trade raises productivity and offers greater consumer choice.3 Research shows that unilateral free trade is economically beneficial. Anderson et al. (2006) calculate that removing all trade distortions would improve world income by 0.7%, but this figure is likely to be a low estimate as it does not account for an increased variety of goods nor improved productivity.4 The OECD estimates that a 50% reduction in barriers to trade by G20 countries would lead to the UK’s GDP rising by 6.6% in the long run.5 The Resolution Foundation and UK Trade Policy Observatory (2017) estimated that if the UK were to pursue unilateral free trade, the average household would save £130 per year in the short run alone, with prices falling by 0.5% on average. This does not include the potential price reductions in the long run, which would occur due to companies becoming more competitive and efficient.6
The economic theory behind the power of free trade is that of comparative advantage: like individuals, countries can specialise in the goods and services they are best at producing. Even if one country has an absolute advantage over another, they can mutually gain from trade via specialisation. Countries should, by this logic, dismantle their barriers to trade, to maximise their economic well-being by buying and selling a greater number of both domestic and international goods at lower prices. Free trade raises a country’s GDP and hence its living standards, by diverting resources to where they are more allocatively efficient.
Unilateral free trade is beneficial for firms, as well as for a country’s overall business environment and productivity. Unilateral free trade reduces the price of imports, which means firms’ raw material costs are lower, and hence aggregate supply will increase, raising GDP and boosting the economy. Currently, parts, raw materials and machinery account for 75% of world trade.7 Unilateral free trade gives more freedom in this regard than other types of trade agreement, as it enables domestic firms to source the lowest-cost inputs from any other country in the world. Unilateral free trade also increases a country’s productivity and competitiveness. Exposure to international rivals will force domestic businesses to be more competitive and will divert resources away from unproductive sectors. If a country were to unilaterally remove tariffs, firms would no longer be able to lobby the government for protection against international competition. Instead, they would be encouraged to lobby for a better overall business policy environment.8 Also, smaller domestic firms can grow by selling to an international market, which increases their efficiency as they become larger and so develop economies of scale.
The above phenomena are especially relevant for international development. If a developed nation pursues unilateral free trade, it supports the development of their poorer trading partners, as the export industries in those poorer countries grow and benefit from economies of scale. As poor countries are generally labour-rich, they specialise in labour-intensive goods. Demand for those goods in the developed country with unilateral free trade boosts demand for labour in those developing nations, causing workers’ wages and average living standards in those countries to rise, and thus inequality to fall. This occurred in several Latin American countries following trade liberalisation.9 In addition, regulatory alignment can improve workers’ rights in the developing countries and provide mutual intellectual property protection.10 In the long run, the developing economies provide a growing market for exporters in the developed country. Also, the economic cooperation between these nations is likely to have a positive impact on their political relations.
Unilateral free trade encourages foreign firms (like multinationals) to set up in a country because of the low tariff barriers. This leads to inflows of foreign direct investment (FDI). These firms support domestic companies in their supply chains and boost domestic growth by exporting their products. They create jobs and bring skills, wealth and inflows of foreign currency. For example, foreign-owned firms in the UK are 50% more productive than domestically-owned companies11, indicating that, by attracting foreign firms, unilateral free trade would boost domestic productivity. Multinationals invest more in R&D and encourage domestic innovation through the diffusion of new ideas.12 Also, the size of multinationals means they have economies of scale. This increases efficiency, boosting productivity and reducing the price of goods, which benefits consumers.
One of the principal arguments for unilateral free trade is its benefits for consumers. Removing tariff barriers maximises imports, giving consumers access to a greater variety of goods. Also, increased competition between firms lowers prices. This progressively increases purchasing power: poorer people, who have a higher marginal propensity to consume, will benefit the most.13 This boosts economic growth and can reduce inequality. Artuc et al. (2019) examined 54 low- and middle-income countries and found that unilateral tariff liberalisation would be overwhelmingly beneficial, creating income gains for 45 of them, driven mainly by lower food prices. In the other nine countries, reduced tariff revenue explained the drop in income.14
Unilateral free trade is far easier to implement than the alternative: bi- or multilateral negotiated trade agreements. Negotiated agreements between countries inevitably need to respect the special interests of all parties. As a result, the negotiations invariably become complex and lengthy. A key practical implication is that, in order to reach any agreement at all, such negotiations tend to be limited to a few trading partners, to the exclusion of others. This limitation of scope can stymie the intended benefits to consumers and business competitiveness, especially given the highly diverse and dynamic nature of international supply chains. Unilateral free trade avoids these problems, offering a simple solution to any and all potential partners, present and future.
Several arguments are often raised against unilateral free trade, as with free trade in general. The “infant industry argument” suggests that domestic industries may not have the economies of scale needed to compete with larger foreign firms, and so need to be protected via trade barriers until they can develop similar economies of scale. However, in the 21st century, this argument does not hold so much weight. Reduced transport and communication costs mean countries no longer need to develop their own industries from scratch: by unilaterally liberalising trade, countries can join recently internationalised supply chains, and hence rapidly develop sophisticated industry; a phenomenon that has occurred in nations like Thailand and the Philippines.15
Unilateral free trade (as with free trade in general) can also create inequality. For developed countries implementing unilateral free trade, this can arise due to cheaper labour from poorer, labour-rich countries outcompeting domestic, higher-wage workers, while the capital owners in those developed (capital-rich) economies profit from specialisation in capital-intensive goods. Inequality can also increase in developing countries implementing unilateral free trade: lower input prices may result in the owners of larger companies in those countries disproportionately benefiting from trade, thanks to economies of scale. Artuc et al. (2019) showed that, following tariff liberalisation, income inequality would rise in 37 of the 54 countries they analysed, but would actually fall in in the remaining 17. Thus greater inequality is by no means inevitable, and overall, the authors concluded that unilateral liberalisation would vastly improve social welfare in the vast majority of those countries.16
There is also concern about the impact of unilateral free trade on domestic unemployment, as foreign competition could undercut domestic producers, forcing them to cut costs by laying off workers. However, foreign companies create new jobs through FDI and support domestic producers by incorporating them into their supply chain. For many economies, most sectors are currently “unprotected” anyway (i.e.. are not protected by tariff barriers). In the UK, 85-90% of the economy is in such sectors.17 This suggests that unilateral free trade would not have a very damaging impact on employment. In addition, because unilateral free trade encourages specialisation in goods in which the country has a comparative advantage, allocative efficiency in the economy increases, which, in the long run, would actually result in higher employment. The unemployment caused by free trade is an aspect of creative destruction: in some industries, jobs would be lost, whereas in others, new jobs would be created. That said, the unemployment that unilateral free trade might generate is overstated: job losses through normal turnover (“job churn”) far exceed trade-related job losses. The estimate that NAFTA destroyed one million jobs between 1994 and 2014 is the same figure as the number of jobs lost in the US every 18 days on average.18 Overall, at the price of some unemployment in certain sectors, the economy as a whole would see economic growth as a result of unilateral free trade.
Another criticism of unilateral free trade is that it eliminates a country’s bargaining power by removing the threat of tariff imposition in trade negotiations. This argument assumes that negotiation happens through tit-for-tat piecemeal concessions, but evidence shows that this is not how negotiations play out.19 In fact, in the long run, it seems that unilateral commitments are eventually reciprocated. For example, the repeal of the Corn Laws in Britain in 1846 set a precedent for Britain to unilaterally liberalise many of its tariffs. In response, the US rapidly reduced their own tariffs20, while France willingly negotiated a trade deal with the UK in 1860 in which both countries lowered their tariff barriers to one another.21
In the modern era, several real-world examples illustrate the benefit of unilateral tariff liberalisation (although these stop short of complete implementation of unilateral free trade). Following India’s trade liberalisation in 1991, firms were able to import new, cheaper and higher-quality inputs, enabling them to produce new products for domestic and international markets.22 This increased productivity, boosted exports, and has contributed to the rapid growth of the Indian economy since the 1990s.
Another illustrative example is Australia. In the 1970s, Australia unilaterally cut its tariffs due to declining commodity prices and the loss of traditional British export markets. The total rate of effective protection declined from 35% to 5% between the early 1970s and 2000.23 This liberalisation is one of the factors that has contributed to Australia’s economic success, with near-uninterrupted growth until the COVID-19 pandemic.
Perhaps the biggest success for unilateral trade liberalisation has been China. From the 1980s, as part of Deng Xiaoping’s economic reforms, China’s tariffs were dramatically reduced: in 1982, the average tariff rate was 56%. This fell to 15% by 2001.24 This unilateral reduction was a vital factor in China’s economic success, becoming the world’s largest exporter by taking advantage of cheap labour.
In conclusion, I believe that economic theory, empirical research and real-world examples all back up the idea that unilateral free trade serves a nation’s economic interests, by lowering prices for consumers, increasing competition, productivity, and innovation, and by increasing growth. As discussed above, the potential effects of unilateral free trade on unemployment and inequality are generally overstated, however there remains a need to protect those who lose out from trade. Government assistance such as welfare benefits, education, and retraining would be necessary to ensure that the gains from trade are properly distributed, so that everyone may enjoy the benefits from unilateral free trade.
Joshua Muthu
https://voxeu.org/article/trump-doctrine-international-trade-part-two. Accessed 11/07/2020.
https://capx.co/deal-or-no-deal-britain-should-pursue-unilateral-free-trade/. Accessed 11/07/2020.
http://www.igmchicago.org/surveys/free-trade/. The percentage was of the panellists that responded. Accessed 11/07/2020.
https://www.resolutionfoundation.org/app/uploads/2017/10/Changing-Lanes.pdf. Accessed 14/07/2020.
UNCTAD, 2017
https://capx.co/deal-or-no-deal-britain-should-pursue-unilateral-free-trade/. Accessed 13/07/2020.
Lopez-Calva, Luis; Lustig, Nora, eds. (2010). “Declining inequality in Latin America: A decade of progress?” New York Washington, D.C: United Nations Development Programme Brookings Institution Press. ISBN 9781282558304.
https://www.thebalance.com/unilateral-trade-agreements-definition-examples-3305904. Accessed 14/07/2020.
https://voxeu.org/article/inequality-and-trade-simulation-evidence-54-developing-nations. Accessed 13/07/2020.
https://voxeu.org/article/unilateral-tariff-liberalisation. Accessed 13/07/2020.
https://voxeu.org/article/inequality-and-trade-simulation-evidence-54-developing-nations. Accessed 13/07/2020.
https://iea.org.uk/blog/post-brexit-britain-should-adopt-unilateral-free-trade. Accessed 13/07/2020.
https://www.nytimes.com/2018/03/28/opinion/trump-tariffs-trade-war.html. Accessed 14/07/2020.
http://www.ir.rochelleterman.com/sites/default/files/james%20and%20lake%201989.pdf. Accessed 14/07/2020.
Pinelopi K. Goldberg, Amit Khandelwal, Nina Pavcnik, and Petia Topalova, “Trade Liberalization and New Imported Inputs,” American Economic Review 99, no. 2 (2009): 494-500.
https://www.imf.org/external/np/apd/seminars/2003/newdelhi/lardy.pdf. Accessed 14/07/2020.