Free Trade and Protection — Flashcards & Quiz

Q1: What are the main arguments for free trade?

Free trade increases economic efficiency by allowing countries to specialise according to comparative advantage. It provides consumers with greater choice and lower prices through increased competition. Free trade encourages innovation and productivity growth as domestic firms face global competition. It allows economies of scale as firms access larger export markets. Overall, free trade maximises global economic welfare, though it may create short-term adjustment costs for some domestic industries.

Q2: What is a free trade agreement and what are Australia's major FTAs?

A free trade agreement (FTA) is a treaty between countries that reduces or eliminates trade barriers like tariffs, quotas, and regulatory restrictions. FTAs aim to increase trade and investment flows by improving market access. Australia has FTAs with major trading partners including China (ChAFTA, 2015), Japan (JAEPA, 2015), South Korea (KAFTA, 2014), and is part of regional agreements like RCEP (Regional Comprehensive Economic Partnership, 2022) covering 15 Asia-Pacific nations. FTAs can be bilateral (two countries) or multilateral (multiple countries).

Q1: Free trade always benefits all workers in all industries without any adjustment costs.

Answer: FALSE

While free trade increases overall economic efficiency and welfare, it creates winners and losers. Workers in import-competing industries may face job losses and require retraining. Regions dependent on protected industries may experience structural unemployment. However, consumers benefit from lower prices and greater choice, and workers in export industries gain. The overall net benefit is positive, but adjustment costs are real and may require government assistance.

Q2: Free trade agreements can lead to trade diversion where less efficient producers inside the agreement replace more efficient producers outside it.

Answer: TRUE

Trade diversion occurs when FTAs cause trade to shift from more efficient non-member producers to less efficient member producers due to preferential tariff treatment. For example, Australian beef might replace more efficient Brazilian beef in Japanese markets due to the Japan-Australia FTA. This reduces global efficiency. Trade diversion contrasts with trade creation (shifting from domestic to more efficient foreign production), which improves efficiency. The net welfare effect depends on which effect dominates.