Trade Liberalisation

Trade liberalisation involves a country lowering import tariffs and relaxing import quotas and other forms of protectionism.

One of the aims of liberalisation is to make an economy more open to trade and investment so that it can engage more directly in the regional and global economy. Supporters of free trade argue that developing countries can specialise in the goods and services in which they have a comparative advantage.

Consider the diagram below which shows the effects of removing an import tariff on cars perhaps as part of a new trade agreement between one or more countries:

Removing a tariff (ceteris paribus) leads to:

• A fall in market prices from P1 to P2
• An expansion of market demand from Q2 to Q4
• A rise in the volume of imported cars (no longer subject to a tariff) to a new level of Q1-Q3
• A contraction in domestic production as demand shifts to relatively cheaper imported products
• A gain in overall economic welfare including a rise in consumer surplus
• There is a fall in the producer surplus going to domestic manufacturers of these cars

Exploring the possible impact of trade liberalisation

Trade liberalisation can have micro and macroeconomic effects:

Micro effects of trade liberalisation:

• Lower prices for consumers / households which then increases their real incomes.
• Increased competition / lower barriers to entry attracts new firms.
• Improved efficiency – both allocative & productive.
• Might affect the real wages of workers in affected industries

Macro effects of trade liberalisation:

• Multiplier effects from higher export sales.
• Lower inflation from cheaper imports – causing an outward shift of short run aggregate supply.
• Risk of some structural unemployment / occupational immobility.
• May lead initially to an increase in the size of a nation’s trade deficit.

Revision video on trade creation

Revision video on free trade agreements