NAFTA - North American Free Trade Agreement
There have always been concerns and doubts about the effectiveness and significance of free economy and a divide of people for and against it. Economists from the for side suggest that it is prudent not to create differences between the residents of various parts of the world by protectionist policies, thus treating the entire world as a common global hub which in turn is beneficial to every member of this common hub. The economists in few of the developing countries, on the negative side suggest that it is a ploy by the developed countries in order to capture the markets in the developing countries. Their say is that the affluent producers in the developed nation have the capability to produce the goods at a cheaper price from mass production and this will lead to a bankruptcy for small and medium enterprises.
The important theories in this regards are-
Adam Smiths theory of Free Trade.
David Ricardos Theory of Comparative Costs.
Adams Smiths Theory
Adam Smith justified that the interest of consumer be given the priority over the interest of producer and if the interest of producer has to be attended, that interest should be helping to work for the interest of consumer in some way or the other.
He proposed the concept of invisible hand which says that there should be no interference from the government or any other authority in the smooth functioning of the market and the market would correct itself automatically with the help of a pure demand and supply logic. Any artificial curbs or restrictions on the market hamper the smooth functioning thereby a delay in the realization of correct prices of the goods or commodities. He analyzed that different individual although may appear working for their interest, but, at the end of the day are contributing for the welfare of the society.
Smith (The Wealth of Nations, 1776) suggested that if the quantity of any commodity brought to the market is short of the actual demand, and all the potential consumers for the commodity cannot be supplied with the commodity, then there will be a competition emerging in between various consumers and thereby the market price for the commodity will rise. Conversely, if the quantity brought to the market is higher than the actual demand, then there will be a competition amongst the different sellers of the same commodity to get their purchased lot sold in the market thereby leading to a reduction in the prices.
David Ricardos Theory of Comparative Costs
David Ricardo also analyzed that if look in the absolute terms then the free trade is much better for the global economy as compared to the restricted economy. He deducted that the Gross product in terms of the quantity will be much higher in the case of free trade. His theory could be explained with the help of the following hypothetical example. Consider a hypothetical case in which China can produce both wheat and rice more cheaply than France (ie it has an absolute advantage in both commodities). What David Ricardo suggested was that it still would be mutually beneficial for both countries to develop an expertise and trade.
Table 1
CountryWheatRice Cost Per Unit In Man HoursCost Per Unit In Man HoursFrance1530China1015
In Table 1, in France with same number of men deployed, two units of wheat could be produced for every unit of Rice. This means that production of every unit of rice, results in the decline of production in the wheat by two units (i.e. the opportunity cost of a unit of rice is 2 units of wheat). In China, this ratio is 23, much better than 12 in the case of France. That is the opportunity cost of a unit of rice is 1.5 units of wheat in China. Now since the relative cost or the comparative costs differ therefore it is mutually beneficial for the two countries to engage in trading activities even though China has an absolute advantage in both commodities.
Since, China is relatively better at producing rice than wheat therefore China is said to have a COMPARATIVE ADVANTAGE in the production of rice. France is relatively better at producing wheat than rice so France is said to have a comparative advantage in the production of wheat.
Table 2 shows how trade might be advantageous. Costs of production are as set out in Table 1. France is assumed to have 270 man hours available for production. Before trade takes place it produces and consumes 8 units of wheat and 5 units of rice. China has fewer labour resources with 180 man hours of labour available for production. Before trade takes place it produces and consumes 9 units of wheat and 6 units of rice. Total production between the two economies is 17 units of wheat and 11 units of rice.
Table 2
C o u n t r y Production Before Trade After TradeWheat Rice Wheat Rice France 8 518 0 China 9 60 12 T o t a l 17 11 18 12
If both countries now specialize, China producing only rice and France producing only wheat, total production is 18 units of wheat and 12 units of rice. Specialization has thus enabled the world economy to increase production by 1 unit of wheat and 1 unit of rice. If we apply the same logic to the entire economy of the world the production will increase by a gigantic amount.
There are a few assumptions in the simple theory of comparative advantage which are as follows-
No transportation cost is attached..
Costs are constant and there are no economies of scale.
Only two economies are involved in producing two goods.
The theory assumes that traded goods are homogeneous (i.e. exactly identical).
Factors of production are assumed to be perfectly mobile.
There are no tariffs or other trade barriers.
There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.
Mexico has been one of the biggest beneficiaries of North American Free Trade Agreement. A good number of American companies have opened their development centers at Mexico utilizing the cheaper manpower available there and a much lower trade and investment barrier. This intern had reaped good profit for the company because they had lower cost of production. So they could afford to sell their products at a lesser selling price out in United States which benefited even the consumer as he had to now pay a lesser price for the same product which is a win-win situation for consumers as well as producer in United States.
Now looking from Mexicos perspective, investments by U.S. firms in their country meant a higher Foreign Direct Investment and higher government earning by the means of taxes on these companies. The higher government earning is directly related to the amenities that could be offered to the citizens of Mexico. To add to this increased FDI meant a fresh lot of jobs created for the youth as well as the veterans of Mexico and an increased standard of living. We will just take an example of Delphi Corporations which has set up its auto-parts plant at Ciudad Juarez.
The assembly line employees people in Mexico from the age twenty to those in their sixties. After the reduced barriers and tariffs, through NAFTA, Delphi had increased its employee strength in Mexico to a whopping 70,000 receiving up to 70 million U.S. made components every day, to assemble into parts. The average salary offered to a laborer by the company is 1.9 dollars an hour which is much lower as per U.S. standard but that is three times the minimum salary wages in Mexico, as per the statistics taken in 2003. Moreover, the work culture at Delphi is one of the best in the country.
Both Mexico and United States have seen immense benefits as a result of NAFTA. U.S. producers were having a hard time with stiff competition from the Asian counterparts especially the lower cost Chinese goods produced as a result of a cheaper manpower and devalued currency. With NAFTA in effect, they rushed to Mexico and the Mexican annual average Foreign Direct Investment increased to more than 12 billion dollars a year which is much higher than that of India. For Mexico it yielded a growth of annual average income by more than 24 which is multiple folds more than per capita income of China. The success of NAFTA has given motivation to the Latin counterparts of Mexico to open up their economy and join the brigade of globalization.
However there are a certain factors because of which countries try to introduce the trade barriers generally in the form of import duties some of which are as follows-
Favorable balance of trade and reducing the fiscal deficit.
In order to protect a specific industriesclass of people.
Anti dumping duties
Public Psychology
Policies created to woo vote banks generally in democratic form of governments.
Favorable balance of trade and reducing the fiscal deficit-
Fiscal deficit is a major reason for which most of the government introduces the protectionist policies. Fiscal deficit is given by the formula-
Fiscal Deficit Imports - Exports
Countries try to reduce their fiscal deficit as far as possible. In their attempt to reduce import they try to minimize the imports into their country by introducing entry barriers on goods and commodities which are getting imported from other countries in the form of import duties.
The balance of trade (which is also the difference between exports and imports) is said to be favorable when the fiscal deficit is negative that is when exports are higher than the imports.
Every country wants the balance of trade to be in its favor by exporting more and importing less. The countries try to introduce an entry barrier thinking that the other nations will still keep on importing the goods supplied, which is highly improbable. If a country resorts to curb in imports by adding import duties, its counterpart will also resort to the same measure and if every country does so the fundamental of globalization will vanish and hence the gross production of the world will come down significantly causing the economies to suffer.
In order to protect a specific industriesclass of people
Generally the developing countries have a certain segments of society who are poor and their interest needs to be protected against the market competition. Therefore the government protects their interest either by giving them subsidy or by protecting their interest by introducing import barriers. For an instance, some of the developed countries give agriculture subsidies to their farmers, who are financially weak, so that they could earn their livelihood by engaging themselves in their family business of farming. But, it should be understood that subsidy should be introduced only for the financially weaker class and not the already profit generating segment and the subsidy policies should be reviewed time to time
Antidumping duties
Some nations argue that owing to free trade, other nations may dump some of the products in their market, thus creating a collapse in their economy. In order to prevent this, they have an option of introducing anti dumping duties which are another entry barrier used to prevent free trade.
Public Psychology
There have been recent incidents of protectionist policies by US trying to reduce outsourcing by passing a law which is favorable to the companies that do not outsource owing to the psychology of the people that outsourcing creates a dent in their job. Intelligent brains however argue that outsourcing results an increase in profit for the organization which in tern is also passed to the consumers not only in the form of reduced price but also generation of more jobs in their own country itself. Owing to a similar kind of public psychology, albeit in terms of import of foreign goods, Indian government adopted protectionist policies until as late as 1992 and was considered as underdeveloped economy of the world. The condition of the country had deteriorated so much that the government of the country was forced to open their market and finally after around 16 years it is amongst the fastest growing countries of the world.
Policies created to woo vote banks generally in democratic form of governments-
Although there are limited number of cases, but it has been seen in some instances that in order to woo vote banks from a particular section of society, the government introduces entry barriers and thus find increased number of people backing their policies.
What so ever may be the case, the economists across the globe agree that in normal circumstances the free trade is the only manner in which we could develop a world which has every part of it growing. So lets try and make this world barrier free
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