Let’s start from the beginning: free trade is based on the principle of comparative advantage developed by David Ricardo in the early part of the 19th century “that attributed the cause and benefits of international trade to the differences among countries in the relative opportunity costs (costs in terms of other goods given up) of producing the same commodities”. According to John Sloman and Dean Garratt, comparative advantage is when “a country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost: i.e. if it has to forgo less of other goods in order to produce it”. Comparative advantage is different from absolute advantage. Absolute advantage is when a country can make a good much more cheaply than any other country. In this case, the country can produce at the lowest resource cost.
Comparative advantage occurs when a country has the lowest opportunity cost. For example, if China can produce 50 cars in one day of work and the UK can produce 5 cars in the same period of time, China is more productive than the UK. And if China can produce 150 bicycles in a day of work and UK can produce 25 bicycles in the same period of time, China will be again more productive, but will have a greater comparative advantage in cars — the comparative advantage is based in the time of work needed to make a product.
For each car that China produces, the country will spend the same amount of time to produce 3 bicycles. In Britain, for each car that the country produces, it will spend the same amount of time to produce 5 bicycles.
Every time that the UK decides to produce 1 car the country is also choosing to not produce 5 bicycles. For China, every time that the country decides to produce 1 car this means that China is also not producing 3 bicycles. In this case, we can say that the opportunity cost of 1 car for China is 3 bicycles and the opportunity cost of 1 car for the UK is 5 bicycles. Cars are relatively less costly to produce for China then the UK and it will be good for both countries if they agree to trade, for example, 1 Chinese car for 4 British bicycles. This comparative advantage resides on the fact that instead of China choosing not to produce a car to produce 3 bicycles the country can choose to trade 1 car for 4 bicycles with the UK and then this will represent a gain of 1 bicycle for China. For the UK the gain will reside in the fact that the cost to produce 1 car is 5 bicycles, but if the UK can trade 4 bicycles for 1 car with China the advantage it will be 1 bicycle. In this case, both countries win. For David Ricardo, it will be better for both countries if they trade Chinese cars for British bicycles because those are the items that they are more productive.
. In other words, the opportunity cost is the cost of what you don't get to spend the money on because you have to spend it on something else. In that way, if you choose to produce one thing like cars there is an opportunity cost, a loss, for not having done something else, for example, bicycles. This holds true even if China can produce both goods (car and bicycles) more effectively than the UK. Since both countries want to consume both products, the most efficient productive scheme will be China to produce and export cars and the UK to produce and export bicycles. This is known as inter-industry trade.
All the economic decisions of a government include an opportunity cost. If a country chooses to spend billions of pounds in the military industry, military missions, and wars, this means that the same country is also choosing not to put this enormous amount of money into education, health service, and other industrial areas — like the development of technologies to produce green energy. Opportunity cost means that every decision of producing something by an individual, a firm or a government is also a decision to not be doing something else with the time, the work and the capital spend.
Free trade basically means no barriers to buying and selling goods produced in one nation in another country. In reality, this is not what really happens. Today, almost every country in the world has some sort of tariff (tax) collected on imported goods and services. In this case, we can say that that is no free trade in the world.
The idea of free trade seems to be more a product of the mathematization of economics. It seems to be easier to think and create mathematical models of a free market and a free trade version of the world. But, in reality, all markets have their taxes and some kind of protectionism. Historically, the truth about free trade is that there is no developed country in the world today that became developed by practicing free trade. The developed countries had protected themselves to become economically powerful. Then, the developed countries start to try to convince other small or undeveloped countries to practice the free trade that they had never practiced for real. Even Adam Smith had praised the British Navigation Act, which was a major protectionism decision of Britain government in his time. He expressed the view that restrictions on international trade are justified "when some particular industry is necessary for the defense of the country".
In reality, free trade and international trade are two very different things. There is no laissez-faire spread in the world market. For this reason, a government that decides today to base his entire economy only in free trade is making a terrible mistake. The reason is simple: no other country will do the same. The idea of comparative advantage developed by David Ricardo is a fundamental argument used in favor of free trade between countries. For him, nations will be better off if they choose to use their resources for the production of that kind of goods that they are more efficient at doing it. The problem with Ricardo’s theory of comparative advantage is the assumptions that he makes about how the world economy works. For example, his notion of capital mobility had a lot of problems. In Ricardo’s world, there is no capital, factory or production mobility. But, today, world production has been totally globalized. Nowadays, the notion of free trade developed by Ricardo has to face problems production mobility and like the costs of labor.
It is possible also to say that China has today low opportunity costs of labor when compared with most Europeans countries and that make the Chinese economy more competitive. But this model suggests also that any increase in labor costs will make the country less competitive. The Financial Times recently reported that Coach, the big United States accessories brand, “is planning to move up to half its manufacturing out of China to escape rising labor costs”. According to the Financial Times, “Lew Frankfort, Coach’s chief executive, said that over the next five years the company would cut its China production to 40-50 percent of its total from 85 percent at present by opening factories in lower-wage economies including India, Vietnam and the Philippines”.
This means that in a globalized world companies will always try to find where the labor cost less. The search for competitiveness will push companies to countries with lower-paid workers. In this case, the opportunity cost will be linked, in many cases, with low-wage labor.
According to Stephen D. King, “political arrangements can get in the way of economic opportunity and preserve economic rents for the lucky few. They create barriers to free trade, migration and capital flows. Since the 1980s, those barriers have slowly come down. The developed world is now trading with countries that, only a few years ago, were treated as strange lands. In analyzing these new patterns of trade, economists routinely resort to the principles of comparative advantage famously described by David Ricardo in On the Principles of Political Economy and Taxation, published in 1817. Today’s trade patterns, however, are much more a story about outsourcing, off-shoring, upscaling and downsizing. The developed world has increasingly been exporting its factories to emerging economies”.
In Ricardo's theory, countries which choose to practice free trade will be better off. In reality, free trade in Ricardo’s terms could also help to increase productivity abroad, give strength to other economies and it may harm developed countries in the long run by making international competition more and more aggressive. One possible answer for this kind of competition will be the creation of protectionism policies to try to rebuild the industry and resuscitate the productivity.
In general, we can say that international trade is a tool for development, but the most important thing is to comprehend that international trade is not free trade at all. A country with absolutely free trade does not exist in reality. This kind of extremist openness exists only in economist’s minds, not in the reality. Every country has a balance of closure (tariffs) and openness towards the world economy.
John Maynard Keynes once wrote that he “was brought up, like most Englishmen, to respect free trade not only as an economic doctrine which a rational and instructed person could not doubt but almost as a part of the moral law”. This Keynesian notion of free trade — if we look carefully to Ricardo’s ideas — doesn’t apply to international trade today.
In David Ricardo terms, comparative advantage works if land, labor, and capital, called factors of production, were immobile across nations. Unfortunately, this is not what happens in reality. Today, labor and capital are very much mobile. According to Stephen D. King, immobility of labor and capital between nations is “only true under certain strict conditions”, that is almost impossible nowadays. “When Ricardo said that free trade would produce shared gains for all nations, he assumed that the resources used to produce goods – what he called the ‘factors of production’ — would not be easily moved over international borders. Comparative advantage is undermined if the factors of production can relocate to wherever they are most productive: in today's case, to a relatively few countries with abundant cheap labor. In this situation, there are no longer shared gains — some countries win and others lose”.
For Stephen D. King, “Ricardian assumptions worked better in the 1950s and 1960s, a world in which capital flow across borders was relatively limited and where trade flows took place between a group of economically ‘like-minded’ OECD countries”. Today, the problem isn´t if free trade is good or bad. The problem is that free trade doesn’t exist in Ricardian terms simply because labor and capital are not immobile like Ricardo has thought. According to Schumer and Roberts, “when Ricardo proposed his theory in the early 1800s, major factors of production — soil, climate, geography and even most workers — could not be moved to other countries. But today's vital factors of production — capital, technology and ideas — can be moved around the world at the push of a button”. In Ricardo’s book, comparative advantage will occur only in a world without this free flow of factors of production. In this case, is possible to say that there is not free trade anymore and then is impossible to say if free trade is good or bad because there isn’t free trade around the world.
