How Can Free Trade Allow Firms or Industries to Take Advantage of Economies of Scale?
Free trade means that countries can import and export goods without any tariff barriers or other non-tariff barriers to trade. Essentially, free trade enables lower prices for consumers, increased exports, benefits from economies of scale and a greater choice of goods. This explains that by specialising in goods where countries have a lower opportunity cost, there can be an increase in economic welfare for all countries. Free trade enables countries to specialise in those goods where they have a comparative advantage.
One important motivation for international trade is the efficiency improvements that can arise because of the presence of economies of scale in production. Although economists wrote about these effects long ago, models of trade developed after the 1980s introduced economies of scale in creative new ways and became known as the “New Trade Theory.” Another major reason that international trade may take place is the existence of economies of scale (also called increasing returns to scale) in production. Economies of scale means that production at a larger scale (more output) can be achieved at a lower cost (i.e., with economies or savings). When production within an industry has this characteristic, specialization and trade can result in improvements in world productive efficiency and welfare benefits that accrue to all trading countries. Trade between countries need not depend on country differences under the assumption of economies of scale. Indeed, it is conceivable that countries could be identical in all respects and yet find it advantageous to trade. For this reason, economies-of-scale models are often used to explain trade among countries like the United States, Japan, and the European Union. For the most part, these countries, and other developed countries, have similar technologies, similar endowments, and to some extent similar preferences. Using classical models of trade (e.g., Ricardian, Heckscher-Ohlin), these countries would have little reason to engage in trade. Yet trade between the developed countries makes up a significant share of world trade. Economies of scale can provide an answer for this type of trade.
FT presupposes elimination of “quantitative restrictions” on mutual trade between the partners that sign an FT agreement (Bento 3). Therefore, FT, which is the result of FT agreement, presupposes creating an area where the trade between the partners cannot be hindered by any barriers (those may include taxes, quotas or tariffs) or border restrictions. On the other hand, parties that are not included in the agreement can still be subjected to different kinds of restrictions. It is not difficult to deduce that third parties could attempt to exploit the differences in tariffs. However, this possibility is eliminated through the introduction of rules of origin3. According to them, only the goods that are produced within the borders of a lower-tariff country can be subjects of the benefits of FT area (Mohamed Ramadan Hassanien, 2010). For the goods that are partially produced by a country, the rules may vary. There exist different types of FT agreements. Multi- and bilateral as well as regional FT agreements can be created depending on the political preferences of the member countries. An example of bilateral FTA is the US-Chile FTA while the North American Free Trade Agreement (NAFTA) is a regional one4. At the same time, it should be pointed out, that when the members find it more appropriate, an FT agreement may cover only a certain type of merchandise. In such a case, the suppliers of other goods cannot enjoy the mentioned benefits. For example, before the North American Free Trade Agreement (NAFTA), the US and Canada had an FT agreement that covered only cars
By and large, since the opportunities are there and favorable for the growing business to enter a foreign market, I recommend that a growing business such as manufacturing business should explore these opportunities and learn from larger manufacturers especially technologically. This will help to increase efficiency, profitability and manufacturing better goods to its customers and succeed in the industry competition as well as gaining a competitive advantage which will help the growing business becoming a larger business world wide.
W. Seay, “The Origins of political Economy” (ECON 101:Virginia Commonwealth University), 1. Web.
Mohamed Ramadan Hassanien, United States Bilateral Free Trade Agreements (Alphen aan den Rijn, The Netherlands: Kluwer Law International, 2010), 4. Web.
Joao Paulo Cerdeira Bento, Economic Integration, International Trade and the Role of Foreign Direct Investment (Berlin, Germany: Lit, 2009), 3. Web.