1. Meaning:
A country is said to have free foreign trade when, as a matter of official policy, there is no restriction on, or regulation of, its imports and exports.
Ideally speaking, there are no tariffs, quotas, exchange restrictions, or other forms of non-tariff barriers or subsidies on the production, factor allocation and consumption of exports and/or imports of a country pursuing free trade.
Alternatively, and more realistically, the meaning of the term “free trade” should be extended to include such restrictions as are not imposed with the objective of influencing demand/supply of imports or exports, and market forces are allowed to play their role as freely as possible.
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2. Qualifications:
As a further clarification, we may specifically mention that the policy of “free trade” is subject to several qualifications (or legitimate exceptions).
(a) Tariffs (Customs Duties):
Presence of customs duties and their periodic revision and modification does not imply a restriction on free trade so long as these duties are levied for the purpose of raising only public revenue and have no policy objective of influencing the working of demand and supply forces in the external sector of the country.
It is granted that the customs duties will not be neutral in their impact, but what is relevant is the absence of any policy objective to do so.
These duties are similar to the indirect taxes levied by the government on domestic production, consumption, storage, transport, sale, purchase and so on without the intention of influencing the market activities one way or other.
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Such indirect taxes are considered legitimate levies by the authorities even in a laissez-faire economy, because the State has to collect resources for its own maintenance and for provision of other essential services like defence, law and order and so on.
In the same way, the presence of customs duties does not come into conflict with the policy of free trade so long as they are not levied with the objective of influencing market transactions.
However, while duties have a legitimate place in free trade, subsidies are ruled out. It is because, by their very nature, subsidies are meant to protect and assist certain industries and products.
(b) Legitimate Restrictions:
It is admitted that some “legitimate” restrictions can co-exist with the regime of free trade. These restrictions are justified by the fact that the State is the guardian of the economic, social, political and other interests of the community, and is expected to take appropriate steps to do its duty.
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They cover such fields as (i) protection of health and moral standards of the society, (ii) prevention of environmental degradation and erosion of natural resources, (iii) ensuring adequate defence of the country, (iv) ensuring self sufficiency in politically sensitive products, and so on.
(c) Market Imperfections:
The case for free trade is based on the assumption that free market mechanism has no ill-effects. Factually, however, this is not so, and this necessitates government intervention (including the regulation of external trade).
These days, for example, most markets economies are characterised by a variety of imperfections and rigidities. Monopolistic competition, product differentiation, and selling campaigns are some of the salient features of developed economies.
Instances of tacit agreements between suppliers are also quite frequent. A developed market economy spends a substantial proportion of its productive resources on advertisements and other selling expenses which burden the consumers and distort their preferences.
3. Preconditions:
While recognising the place of above-mentioned qualifications, it is equally important to remember that a laissez-faire policy within the country is a prerequisite for having a genuine free trade policy.
The reason is that when domestic economy is regulated and influenced by some form of planning or intervention, their spill-over effects inevitably cover demand and supply functions of externally traded items as well.
This implies that the government of a ‘free trade country’ should be only a passive observer of the cyclical and other upheavals in the income, price and employment levels of the domestic economy.
However, since most modern governments have welfare-oriented domestic policies, it follows that it is difficult to meet this pre-requisite. This fact, therefore, rules out actual existence of free trade in the world.