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Definition:

“A policy of unrestricted international exchange of goods is known as the theory of free trade“.

Explanation with Examples:

Adam Smith like the Physiocratics of France, was a staunch advocate of free trade theory. He was of the view that state should not interfere in the internal economic life of the citizens of a country as it hampers economic progress. He was against putting any kind of restrictions on the imports and exports of commodities.

In the words of Adam Smith:

“After all why the protection in needed just to save the gold from going into the other country. I do not give much importance to it. It is a kind of commodity which is less important than other commodities because goods can serve many other purposes besides purchasing money but money can serve many other purposes besides purchasing goods. If protection is levied, it will divert industries from more advantageous trade to less advantageous trade”.

The other English classical economists also believed in the doctrine of laissez-faire.

The policy or theory of free trade has not been carried out completely by any country of the world. Some degree of state regulations has always been there on the international exchange of goods. England was the only country in the world which had maintained free trade for a long period. It was mainly due to the fact that it was more industrially advanced than the other countries and so it suited her interest.

In the late nineteenth century, there was a reaction in favor of protection from U.S.A. and Germany and they set up the industries by erecting, tariff walls. England abandoned her free trade policy during the Great Depression of 1930’s. In recent years, some attempts have been made to establish free trade areas on regional basis.

In 1957, six countries of Europe comprising France, Germany, Italy, Netherlands, Belgium, Luxembourg formed a European Common Market.

A second area of regional free trade is established by Great Britain. Norway, Sweden, Denmark, Portugal, Australia and Switzerland and is known as E.F.T.A.

Advantages of Free Trade:

The main advantages which are claimed for free trade are as follows:

(1) If the policy of free trade is adopted by all the countries of the world, it promotes a mutually profitable international division of labor which leads lo specialization in the production of those commodities in which they have the greatest relative advantage. The diversification of human and material resources of the country into remunerative channels results in increasing the real national product of all the countries. The standard of living of the people all over the world goes up.

(2) Free trade is undoubtedly the best from the point of view of the consumers, because they can get wider range of goods and commodities at lower prices. When protection is levied, the choice is reduced and the prices of commodities go up. The consumers then stand at a disadvantage.

(3) Free trade has the merit that it prevents the establishment of injurious monopolies.

(4) Under free trade, the home producers try to put forth their best because they are faced with foreign competition They quickly adopt the changes which are made in the designs of the commodities or in methods of production.

(5) The factors of production are freely able to move from one place to another or from one occupation to another occupation and thus are able to secure high rewards for their services.

Disadvantages of Free Trade:

The main arguments which are against, free trade are as under:

(1) One of the most captivating argument put forth against free trade is that it leads to over-dependence upon other countries. In time of war or any other emergency, the over-specialized countries may not be able to supply the required goods to the non-specialized ones.

(2) It is pointed out that under system of free trade, the economically backward country remains always at a disadvantage with the economically advanced country. So in order to build up industries, the backward nations must erect tariff walls USA. and Germany in the late 19th century abandoned free trade, because they were late in entering the industrial field. They developed the industries behind tariff barriers. So is also the case with India.

(3) When trade is unrestricted, the import of injurious and harmful goods cannot be hindered.

(4) Under free trade, if a country resorts to dumping with a view to capturing foreign markets, the home industries cannot be protected.

(5) Another argument advanced against free trade is that international specialization leads to an unbalanced economy of the country.

In the past, all the countries of the world have abandoned free trade and have turned protectionist In the last few years, there is again, a reaction in favor of free trade on regional basis. It has been experienced by the member of the ECM that the reduction of tariffs has greatly increased their trade with one another and the consumers have been able to get goods at cheaper prices.