Free-trade, or trade with a minimum or complete lack of tariffs, has, throughout the history of economics, been assumed by some to be the key to economic growth and by others to be a detrimental force, particularly for developing economies. Classical and neoclassical economists, who established broad and foundational economic theories, posited that through free-trade and a reliance on market forces, individual countries as well as the global economy as a whole would benefit. Later groups of economists, such as the developmentalists, structuralists, and institutionalists, doubted the applicability of this theory in the case of developing economies. Some completely opposed free-trade as a beneficial force for developing economies, while others in these groups found that economies could develop within, and benefit from, the system of free-trade.
Adam Smith, who is commonly referred to as the “father of modern economics”, found benefit in the free-trade system for several reasons. Smith believed that the key to economic growth is the increase in the productive powers of labor, which can be most improved upon through the division of labor. Free-trade and the resulting expanded market would allow for a finer division of labor through specialization. With specialization, the benefits of economies of scale could be realized. Competition would increase when trade is opened to the world, which would bring about fair pricing and a constant drive to improve efficiency. Smith concluded that, because of these factors, the global economy as a whole would benefit from free-trade. The broadness of Smith’s theory, albeit allowing it to become a foundational work, meant that it ignored the particularities of individual countries. Thus, some argue, its applicability to economic development is limited.
David Ricardo, like Smith and the other classical and neoclassical economists, was also a staunch supporter of free-trade. Free-trade is applicable in both of Ricardo’s major contributions to economics: the theory of diminishing marginal returns and that of comparative advantage. In terms of diminishing marginal returns, Ricardo believed that free-trade could help offset the diminishing returns experienced in agriculture. When, domestically, agricultural workers were forced to start using inferior land, diminishing marginal returns would be experienced and food prices would rise. If, with free-trade, these countries could import cheaper food, wages for industrial workers would not have to rise to balance growing food prices and thus profits could be retained for capitalists to further capital accumulation.
Ricardo’s support of free-trade is strengthened within his theory of comparative advantage. Ricardo believed that if each country specialized in the production of the good it can produce at a lower relative cost compared to other countries, global output as a whole would rise. Individual countries would experience expanded consumption possibilities, and so long as the trade price of the good is greater than the cost of production in the exporting country and lower than the cost of production in the importing country, both countries would benefit economically. This, however, is not often the case. The benefits of trade are often shifted exclusively to the more powerful country. In his theory, Ricardo assumed that resources are fully employed in each country. In developing countries with dated or ineffectual institutions, this is often false. When resources are not fully employed, protectionary measures to block imports could be more effective in helping an economy develop. Ricardo believed that free-trade would ultimately be a great equalizing force, raising the income levels of developing economies toward equality. He, however, did not consider that the existing imbalance of power would work to prevent that from occurring.
The developmentalist school of thought developed after WWII and the success of the Marshall Plan in the recovery of European economies. Economists such as Ragnar Nurkse and Sir Arthur W. Lewis, encouraged by this success, focused on the development of other nations. The developmental economists respected the value of market forces, but also saw potential for government intervention, like Keynes, whom they much admired. The push to develop industrialization is a common thread among developmentalists. On the topic of free-trade, however, the developmentalists did not hold a consistent opinion.
Ragnar Nurkse, a developmentalist, argued that developing economies sticking with what they were traditionally thought to have a comparative advantage in, the production of tropical products and raw materials, was, in fact, detrimental to them. He believed that the demand for tropical products and raw materials would be slow to expand and the increase in supply would lead to lower prices, thus negating growth. He also believed that in developing countries, the propensity to import would be strong as high-income earners would want the same luxuries afforded to those in other countries. Acquisition of imported capital goods would thus be made more difficult as savings within the country would be reduced and the importation of luxury consumer goods would cut into the foreign exchange afforded from exports. Nurkse concluded that these nations must industrialize, and in order to foster a conducive environment for young firms, “nascent industry” promotion should be instated by the government, meaning the government would impose tariffs on the importation of goods that could be created domestically. This would create demand for the domestically produced products. This strategy, which would continue to garner respect from developmental economists, came to be known as “import substitution industrialization”.
Sir Arthur W. Lewis, unlike Nurkse, was not an “export pessimist”. He disagreed that developing economies should shift away from the exportation of tropical products and raw materials, claiming that the global economy would be able to absorb these products and that rising incomes and levels of production in advanced nations would result in increased demand. Lewis’ strategy for development functioned within the free-trade system. He believed that developing countries had a comparative advantage in labor-intensive manufacturing because the wages for industrial workers were lower. He believed that by moving the surplus labor in agriculture into industry, low wages could be maintained and the comparative advantage retained. When the surplus of labor in agriculture was eventually exhausted, the developing country would be in a much better position, and wages for workers would begin to rise and equalize with the rest of the world.
The structuralists believed that less-developed nations were structurally and institutionally different from their more-advanced counterparts, making some classical and developmentalist theories less applicable. The structuralists generally opposed free-trade in the case of developing economies, emphasizing the often-unequal benefits received by each country. The structuralists are concerned with the entire social system and the relationships between elements of the system, which can have significant impact on economic development.
Raúl Prebisch, a structuralist, believed that with the existing international division of labor, the benefits of trade go completely to the more-advanced center nations who produced manufactured goods, while the less-developed periphery nations who focused on primary products experienced no benefits. This results from the tendency Prebisch found for the terms of trade for primary exports to decline over time, meaning that they become less valuable with respect to imported manufactured goods. Prebisch pushed for the peripheral economies to become more like the center economies and focus on industrialization. He advocated for “development from within”, which included import substitution industrialization and the imposition of tariffs on imported goods that could be produced domestically. Limits on trade could also focus foreign exchange earnings toward the acquisition of capital goods. Prebisch’s theory was criticized because focusing production on the demand created for domestic consumption would result in a decline of foreign exchange earnings.
Hans Singer, another structuralist, had a similar theory to Prebisch. Their theories are often combined and referred to as the Prebisch-Singer, or P-S hypothesis. Singer also pushed that free-trade would be detrimental to less-developed nations. The center nations, Prebisch argued, were often controlled by oligopolistic industries and thus were given the ability to determine the prices of their goods. Peripheral countries exporting primary products, however, face intense competition, and are forced into the role of price-takers. Technological innovations that increased the productivity of agriculture would increase global supply and result in lower prices for outputs and thus declining wages for agricultural workers. The prices of manufactured products would remain the same, causing, with no interference from the government, all of the benefits to accrue to the country producing manufactured goods, with lower input prices and higher output prices, and disadvantages to the country producing primary goods in the opposite manner. Although the initial specialization and adherence to natural comparative advantage would increase global efficiency, it would ultimately be disadvantageous to the peripheral country. Singer claimed that international agreements must be put in place to stabilize the prices of primary products.
The institutionalists believe that, in addition to the commonly considered elements of an economy, the conditions of society must also be taken into account. Tradition can be impactful in the institutions of an economy and create great differences among nations. Thus different solutions exist for different economies. Institutionalists also focus on evolution in their theories to take into account the constantly evolving institutions of a society.
Gunnar Myrdal, an institutionalist, speaks out against free-trade, claiming that free-trade would, instead of equalizing incomes throughout the world, increase inequality between countries. Myrdal advocated for a regulation of foreign trade in developing countries to protect nascent industries (Reubens 1957). Myrdal believed that the weak states that often characterized less-developed countries were run by political elites who deterred effectual development policies that could lessen their personal gains. Myrdal believed that once an economy had developed and had strong and effectual institutions, it should join other advanced nations in free-trade (Reubens 1957). Myrdal thus is not strictly for or against free-trade but argues that trade conditions must evolve with the evolution of the country’s economy and institutions.
Over time, with the establishment of developmentalist, structuralist, and institutionalist theories, the strength of free-trade theory as presented by classical and neoclassical economists is questioned. Free-trade is generally held by later economists in the field of economic development as an end goal, but many conclude that it may not be appropriate for a less-developed economy. Instead, many promote protectionist policies that will aid nascent industries in their growth. Despite the attacks it has endured, free-trade will likely remain a significant consideration in future economic development theories because of the promise for global economic growth and welfare it provides.