Financial Control

UNIVERSITY OF SUNDERLAND

                                ASSESSMENT COVER SHEET / FEEDBACK FORM

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TableofContents:

1. Explain why governments may advocate free trade whilst at the same time resort to protectionism to protect their domestic industries                                                3
2. Explain what types of barriers may be used and what impact they have on consumers and producers                                                                                        9

 Part1:Explain why governments may advocate free trade whilst at the same time resort to protectionism

to protect their domestic industries.

Introduction

Free trade has been growing the last three decades due to market globalization, industrialization and growing number of developing countries. According to free trade, countries do not restrict imports and exports, and they establish open markets in own areas. Therefore, foreign investors and producers can enter the market freely and trade their goods and services without any trade barriers or taxes. Free trade is exercised between countries based on their agreements with each other. Free trade fosters economic development of developing and poor countries, as well as enable consumers to have access to variety of products and services at lower prices. Increased investment leads to better living standards as well as increases competition in the market which nurtures innovation and better products. Although obvious advantages of free trade can be seen, countries initiate trade protectionism in order to protect their markets and domestic industries. As mentioned above, free trade increases competition, and countries put some trade barriers to importers in order to lower competition and give companies an opportunity to grow. This report analyzes advantages and disadvantages of both free trade and trade protectionism.

Body

There are a number of benefits that developing countries can receive from promoting free trade within their markets. Firstly, open markets generate more and better economic progression within a country. According to Arnold Harberger, an economist of the University of California, Los Angeles, free trade has supported an economic growth and therefore, living standards around the world has risen in the last 3 decades (Harberger, 2006). We can associate open trade with higher GDP per capita since reduced tariffs, regulations and restrictions allow countries to benefit from its existing resources by increasing the level of output (See Appendix A). As producers cut the real costs, they can exploit resources and areas in which they obtain a comparative advantage over foreign producers. Through comparative advantage resources can offer more value and that can lead to increased economic output. According to the comparative advantage theory, which was developed by David Ricardo, if two countries produce two types of products and have different production costs, yet specialize to only one which they have a comparative advantage over another, they can receive benefits of producing one product more, therefore, receiving more benefit (Suranovic, 2012). There is also the Ricardian Model that explains the win-win situation of free trade through comparative advantage. As the model assumes, if two countries produce some amount of one product in autarky, yet they have difference in technological advances, the country with better technological developments can have higher production rate. That leads to higher comparative advantage of the developed country, hence, higher wages and better living standards compared to another. In the next step, Ricardian assumes that if free trade is set up by these two countries, both countries realize what they have a comparative advantage in, and accordingly, they can start exporting the good which they have the most comparative advantage. This leads to decreased price of goods to the level of the exporting country has, and eventually, the export of comparative advantage product rises, whereas, the import of comparative disadvantage product declines (Irwin, 2007). For instance, China has a comparative advantage of producing shirts, whereas, Italy has a comparative advantage of bicycle manufacturing. If both countries specialize in production of those goods that they are efficient in producing, and trade with each other, China can benefit from exporting shirts, and importing bicycles, whereas, Italy, otherwise ( The Levin Institute, 2014).