13.4. The Argument in Favor of Free Trade

Those favoring free trade (no trade restrictions) among nations feel that it offers several advantages.

Free Trade Benefits Consumers. Trade restric­tions benefit a protected industry at consumers' expense. For example, a tariff on clothing exported from North Carolina to Iowa might help Iowa's clothing manufacturers, but consumers would have to pay more for clothes. So some argue that free trade among nations is as beneficial as free trade among states in the U.S.

Free Trade Avoids Retaliation. Trade restrictions frequently result in some form of retaliation. American tariffs or quotas on imports often prompt other nations to put tariffs on American goods. Our pro­tectionist policy, it is argued, rewards a relatively inefficient American industry by protecting it from foreign competition. Meanwhile, U.S. exporters would be penalized in two ways. Some nations will retaliate directly by placing trade restrictions on U.S goods, and other nations will lack the money they need to purchase U.S. goods because Americans have not been buying their products.

13.5. Promoting Economic Cooperation

Specialization and trade allow nations to acquire more goods and services than if they produced everything on their own. Tariffs and other barriers to trade limit the benefits of specialization and exchange. Recognizing these two facts, more nations are attempting to promote international trade by creating free-trade associations and customs unions.

A free-trade association (FTA) results from an agree­ment among countries to remove the barriers to trade among themselves. The member countries remain free to maintain whatever barriers they choose against nonmember countries. Best known of these is the European Free Trade Association (EFTA) whose members include Austria, Finland, Iceland, Norway, Switzerland and Sweden. For that reason, U.S. goods are subject to different tariffs when they are exported to EFTA countries.

A customs union also promotes free trade among its members, but imposes a common tariff on nonmem­ber countries. So U.S. goods are charged identical tariffs when shipped to France, Belgium or Germany, all of whom belong to the European Community (EC) or Common Market, the best known of the world's customs unions. The EC was created in 1957 when France, Germany, Italy, Belgium, the Netherlands, and Luxembourg signed the Treaty of Rome. Since that time Denmark, Ireland, the United Kingdom, Greece, Spain, and Portugal have joined, bringing the total number of EC nations to 12.

At the present time no tariffs exist between EC nations, but the goods of nonmember nations are subject to a tariff. The EC, however, is not a United States of Europe. Unlike trade between North Carolina and Idaho, trade between member nations of the European Community is slowed by customs inspections as well as differences in sales taxes, health and safety regulations, environmental stan­dards, and banking

practices.

The European Community Plans for a Single Market. In 1986 members of the European Community agreed to eliminate all barriers to the movement of goods, services, people, and capital by

1992. They called their plan Europe 1992. But a sin­gle market for goods and services hasn't been the only goal of the European Community. In 1991 the EC also agreed to create one currency by forming an economic monetary union. Representatives of European countries met in Maastricht, Netherlands, where they developed a plan, the Maastricht Treaty, that would result in a single European currency by 1999.

The citizens of each EC member nation were asked to vote on the treaty. The treaty is controversial because it requires each country to give up some of its sovereignty or independence. Under the Maastricht Treaty, a single European Currency Unit (ECU) and a new European Central Bank replaces individual national currencies and the central banks of EC members. The European Central Bank would make monetary policy for all 12 EC members.

The first step toward one currency "fixed" the value of each European Community member's currency relative to all the others. This means, for example, that if one German mark is worth four French francs, this ratio remains the same, regardless of economic events in Germany, France, any other member of the European Community. (See "Financing International Trade" on page 170.) Naturally, some Europeans worried about losing control of their country's currency and monetary pol­icy. In fact, voters in Denmark rejected the treaty in 1992.

Once the European Community made concessions, Denmark approved the Maastricht Treaty in 1993. Still, other events in 1992 and 1993 stalled plans for a single currency in Europe by the end of the centu­ry. The European economy was slumping in 1993. The general situation was aggravated by events in Germany. Following the unification of East and West Germany, the German government borrowed large sums of money to rebuild its former neighbor. As a result, interest rates in Germany and neighbor­ing countries increased. This, in turn, further slowed economic growth in these countries, and Europeans discovered it was very difficult to have both a cur­rency with a fixed value and an effective national monetary policy.

For now, most European countries are spending more energy strengthening their economies than establishing a European currency. In the years ahead, it will be interesting to see if a single curren­cy and the ECU will become a reality.

The North American Free Trade Agreement

A single currency and common central bank are not goals of the North American Free Trade Agreement (NAFTA). But, like the European Community, NAFTA is an effort to create a single, open market. Stretching from the Yukon to the Yucatan, NAFTA unites Canada, Mexico, and the United States in the world's largest market. It contains more than 360 million consumers and over $6 trillion worth of annual production.

Canada and the United States created the free-trade accord in 1989. Then, in November 1993 after a heated national debate, Congress voted to add Mexico to the agreement. On January 1, 1994, NAFTA eliminated many trade barriers between Mexico and the United States. Most remaining tar­iffs and quotas will be phased out over the next five to 10 years, and the citizens of all three countries will experience important economic benefits.

• Individuals and businesses will have more free­dom to trade industrial and agricultural products, as well as services, such as telecommunications and insurance.

• Patents on Pharmaceuticals and other research-intensive products will be respected, and copy­rights on sound recordings, computer programs, and other so-called intellectual property will also be enforced.

• NAFTA will make it easier for people in one coun­try to invest in the others.

Much of the heated debate about NAFTA centered on jobs and environmental issues. Opponents of NAFTA pointed out that average wages in Mexico are a fraction of those in the United States. They feared that once borders were open, Mexican work­ers would flood U.S. factories, or American and Canadian factories would move to Mexico. Others opposed NAFTA because of concern about the envi­ronment. U.S. and Canadian environmental laws impose costs Mexican firms escape. This gives Mexican businesses a competitive advantage which could attract U.S. and Canadian firms. The compa­nies would pollute more in Mexico and total pollu­tion would increase.

Despite these concerns, Congress agreed with NAFTA's supporters who argued that wage rates and lax environmental laws aren't the only factors in a company's location. Education, skills, and the productivity of workers; infrastructure; and the availability of reliable services like telecommunica­tions are also important. The United States and Canada offer more of these advantages, so NAFTA's supporters didn't expect companies to rush to Mexico.

In addition, NAFTA established a special Commission on Environmental Cooperation to monitor environ­mental abuses in the three countries. The agree­ment provides for trade sanctions and fines if countries don't enforce their environmental laws.

From an economist's perspective, NAFTA and freer trade should shift production toward industries in the three nations that have comparative advantages. The result would be greater efficiency and increased production in all three economies. For example, NAFTA should benefit U.S. industries such as com­puter software, pharmaceutical, entertainment, and farms that produce wheat or corn.

True, freer trade with Mexico may hurt some U.S. businesses and workers with a comparative disadvantage. These industries will probably include household appliances, glassware, apparel, and farms that produce certain vegetables. But by combining U.S. and Canadian capital, skills, technology, and natural resources with Mexican labor, NAFTA will create new opportunities in the global economy.