What Gets in the Way of Free Trade?

What is free trade?

Free trade, in theory, is the ideal situation in which individuals and companies in different countries can buy and sell goods to and from each other without any interference from governments. Free trade between countries can increase the variety and reduce the cost of goods, generate job growth, and improve relations between countries.

The benefits of free trade, such as future job growth, are often hard to see at first, and countries sometimes prioritize immediate goals—such as protecting struggling domestic industries—by putting up trade barriers. But most countries agree that free trade is a goal to strive for, which is why 164 of them joined the World Trade Organization (WTO).

The WTO regulates trade between countries.

The WTO is an intergovernmental organization that creates global trade rules and settles disputes between countries that might disagree on how the rules apply. Each WTO agreement is meant to uphold five basic principles.

Trade should be

1. nondiscriminatory between foreign and domestic products and between different countries,
2. predictable and transparent,
3. more competitive,
4. more beneficial for less developed countries, and
5. better for the environment.

While these principles seem fairly straightforward, countries frequently choose to skirt them. Not all trade barriers violate the rules of the WTO. But if you think of the free trade ideal as an open road, they all present some type of roadblock.

Here are some of the barriers to free trade that countries have used in the past, and some examples of what happened as a result:

TARIFFS

Definition: A tax on an import.

Why do countries use them?

To make a foreign product more expensive to buy than a domestically made one. Tariffs are supposed to encourage people to buy from their country’s producers, instead of imports.

How are they used?

Responding to what it viewed as unfair Chinese trade practices that were inconsistent with its WTO commitments, the administration of former U.S. President Donald Trump imposed heavy tariffs on Chinese goods in 2018 in an effort to press China to implement reforms and close the growing bilateral trade deficit. China responded with tariffs of its own on U.S. imports, including agricultural products. The results of the conflict have been costly: in the first half of 2019, Chinese exports to the United States fell by $35 billion. Meanwhile, studies suggest the trade war has cost the U.S. economy hundreds of thousands of jobs and U.S. companies hundreds of billions of dollars. Still, tariffs have remained a major feature of U.S.-China relations. So far, the Biden Administration has maintained or even expanded many Trump-era tariffs on Chinese products.

QUOTAS

Definition: A hard limit on how much of a product a particular country can import. Sometimes instead of stopping all imports above the specified quantity, a quota will put a tariff on every product above a certain limit.

Why do countries use them?

To protect domestic manufacturing, usually. On their own, quotas do not generate government revenue, so they are often combined with tariffs.

How are they used?

After the United States signed the North American Free Trade Agreement in 1992, an existing 33 percent tariff on Mexican brooms made of corn was slashed to 22 percent. This hurt the six hundred-person industry of U.S. broom makers enough that the U.S. government instituted a quota instead. All brooms that exceeded the 2.6 million quota would be subject to the original 33 percent tariff. This resulted in two years of escalating tariffs between the United States and Mexico until, finally, a special panel was convened in 1997 and decided that the corn broom quota had violated free trade rules previously agreed to by the United States and Mexico. U.S. President Bill Clinton removed the quota later that year.

SUBSIDIES

Definition: A broad term that covers various actions a government could take to financially boost an industry. Usually, subsidies are government programs that give money directly to companies in certain industries. They can also come in the form of tax breaks or other financial benefits, benefiting a domestic industry at the expense of foreign competitors.

Why do countries use them?

To support a struggling domestic industry or stabilize prices.

How are they used?

In the 1970s, the U.S. dairy industry experienced dangerously low prices. Farmers were unable to make enough money selling milk, leading to a shortage of dairy products. In 1977, the U.S. government responded with $2 billion in subsidies to boost this major industry. After the influx of cash, dairy farmers started producing as much milk as possible, resulting in an enormous milk surplus that would not sell. The government bought this excess milk and, mindful of milk’s short shelf life, processed it into other products, including cheese. Ultimately, the U.S. government owned a five hundred million-pound stockpile of “government cheese” stored across thirty-five states.

CURRENCY MANIPULATION

Definition: When a country deliberately prints more money or uses other tactics to change the exchange rate of its currency.

Why do we use it?

To encourage exports by making domestic products cheaper in foreign currencies, and particularly in the U.S. dollar (USD), since that is the most widely accepted currency. Here’s how it works: if 1 USD is worth 10 Japanese yen, then a product that costs 400 yen is worth 40 dollars. If the yen is devalued compared to the dollar, and 1 USD becomes worth 100 yen, then that same product is now worth only 4 dollars. Japan, the country that made the product, will probably sell more of it in the United States. But this is also a barrier to U.S. trade, since U.S. products then become more expensive to export to the country that manipulated its currency—in this case, Japan.

How is it used?

After its loss in World War II, Japan experienced a rapid period of economic growth, in part because of its increased focus on industrial production and exports. Then, in the beginning of the 1990s, Japan’s economy crashed, leading to a decade of stagnation. A few years later, the yen’s value began rising rapidly against the dollar, and Japan’s Ministry of Finance worried that a strong yen would discourage the exports Japan needed to stimulate its economy. So in 2003, the Japanese Ministry of Finance worked to keep the price of the yen as low as possible. The results were mixed: although exports increased, the intervention also made it harder for people in Japan to buy foreign goods.

DUMPING

Definition: When a foreign company sets the price of a product lower than its normal price.

Why do countries use it?

To get more people abroad to buy a product, and to increase a company’s market share. If the company can control enough of the market for that product, they can start to change the price—and quality—with less competition.

How is it used?

Matches may seem like a small thing, but these little sticks sparked a trade conflict in the early 2000s. In 2003, more than eight in ten matchboxes on the Egyptian market were from Pakistan, leading the Egyptian government to levy additional fees called “anti-dumping duties” on match imports from Pakistan. Pakistan reacted by lodging a complaint with the WTO, and the countries reached a settlement in 2006.

EXPORT CONTROLS

Definition: The regulation of exports the government decides are important for national security, economic security, or foreign policy. These exports include physical technology, but also intellectual property such as software and research. The export control might require a license to export a certain product, or could prevent the export altogether.

Why do countries use them?

To protect the national interests of the home country. Governments sometimes think certain products, such as nuclear materials, secret technology, or medical equipment in the throes of a pandemic should not be traded freely across borders.

How are they used?

In 2020, face masks and other personal protective equipment (PPE) became crucial shields against the spread of COVID-19. But as the highly contagious coronavirus advanced from one country to the next, it soon became clear that this PPE would be in short supply globally. The United States had been responsible for exporting more than 10 percent of the world’s PPE. But in April 2020, the U.S. government placed export controls on several types of this equipment, which was labeled “scarce or threatened materials.”

SANCTIONS

Definition: When a country limits or entirely prevents trade with another country.

Why do countries use them?

To convince another country to take a certain political action, such as stopping human rights abuses or the development of nuclear weapons.

How are they used?

In 1979, the United States banned imports from Iran after a group of Iranian college students took fifty-two American diplomats and citizens hostage in the U.S. embassy in Tehran—the so-called Iran Hostage Crisis. Partly as a result of the ensuing increase in hostilities, in 1992 the U.S. Congress passed the Iran-Iraq Arms Nonproliferation Act, which outlawed transferring goods or technology to Iran if those products could be used to build a nuclear weapon. The European Union supported the United States on some of those sanctions. The effects of the sanctions varied: while Iran has built an economy in resistance to these sanctions, it has experienced serious setbacks. Because of the difficulty in transferring money into and out of the country, for example, Iran experienced shortages of non-sanctioned products such as cancer medications in 2012.

For the most part, countries put up trade barriers to make it easier to sell their goods abroad or at home, and a variety of economic and political developments can make countries prioritize security, politics, or domestic industry over free trade. But these trade barriers almost always come with unintended consequences and do not always accomplish their goals.

In the end, trade is always going to be messier than the open road the WTO is supposed to protect, but as globalization continues to bring markets closer together, every country is going to have to grapple with the implications of free trade and the barriers that come with it.