MODULE 2
Commercial Trade Policy
TYBCom Semester VI — Business Economics
Mumbai University
• Free Trade — Arguments For and Against
• Types of Tariffs
• Types / Stages of Economic Integration
FREE TRADE: ARGUMENTS FOR AND AGAINST
Free trade policy promotes the free movement of goods and services between nations with little or no
government tariffs, quotas, subsidies, or prohibitions. The classical economists Adam Smith and David
Ricardo were the champions of free trade.
ARGUMENTS IN FAVOUR OF FREE TRADE (5 Points)
1. Advantages of Specialisation
Free trade ensures all the benefits of international division of labour. Each country specialises in the
production of those goods in which it has a comparative advantage. This leads to efficient utilisation of
resources and reduction in the cost of production.
2. All-Round Prosperity
Because of free trade, global output increases due to specialisation and large-scale production. Countries
can obtain goods at cheaper prices, leading to a rise in the standard of living. Thus, free trade leads to
higher production, higher consumption, and international prosperity.
3. Develops Competitive Spirit
Free trade infuses the spirit of competition in the economy, as domestic producers face intense foreign
competition. This competition enhances efficiency and prevents the creation of domestic monopolies. It
also gives consumers a wider choice of goods at competitive prices.
4. Availability of Goods and Services
Free trade enables each country to get commodities which it cannot produce at all, or can only produce at
a higher cost. Raw materials and commodities unavailable domestically can be procured through free
movement at lower prices. This ensures a wide availability of goods for consumers across the world.
5. Encourages International Cooperation
Free trade safeguards against discrimination among nations and prevents any one country from cornering
raw materials. It promotes international peace and stability through economic and political cooperation.
There is no scope for monopolistic control over essential commodities under free trade.
ARGUMENTS AGAINST FREE TRADE (5 Points)
1. Disadvantageous for Least Developed Countries
Free trade may benefit advanced countries but brings misery to economically backward nations. Historical
evidence shows that free trade led to colonial dependence — India under British rule before 1947 is a
classic example. Poor countries lack the capacity to compete equally with powerful industrialised nations.
2. Destruction of Domestic Industries
Free trade allows imported goods to become available at cheaper prices, creating unfair competition for
domestic industries. Local manufacturers struggle to survive against well-established foreign competitors.
In the process, domestic industries are badly affected and may even shut down.
3. Lack of All-Round Development
Free trade, based on the comparative cost principle, leads a country to specialise in only a few
commodities. Inefficient industries remain neglected and underdeveloped under this policy. As a result,
balanced and all-round industrial development of a country is ruled out.
4. Danger of Overdependence
Free trade brings the danger of excessive dependence on foreign trading partners. If a partner country
faces economic depression, it can drag down the dependent nation as well — as seen during the Great
Depression of 1929-30. Overdependence can also lead to political dominance of powerful countries over
weaker ones.
5. Dumping of Harmful Foreign Goods
Multinational corporations often dump harmful, poor quality, or outdated products in underdeveloped
countries under free trade. This affects local industries and leads to a serious loss of consumer welfare.
Restrictions on trade are therefore necessary to protect citizens from such harmful and substandard
goods.
Exam Tip: Always organise your answer under two clear headings — Arguments For and Arguments
Against. Each point must have 2-3 lines of explanation for full marks.
TYPES OF TARIFFS
A tariff is a duty or tax imposed by the government of a country upon the traded commodity as it crosses
the national boundaries. Tariffs can be levied both upon exports and imports. They are classified into four
main groups:
Classification 1: On the Basis of Criterion for Imposition
1. Specific Tariff
A specific tariff is a fixed amount of duty levied per physical unit, weight, or measurement of the commodity
imported or exported (e.g., wheat, sugar, cement). It is easy to administer as it does not involve complex
evaluation of the value of goods.
2. Ad Valorem Tariff
Ad valorem tariff is levied as a fixed percentage of the value of the traded commodity. For example, if a
70% ad valorem tariff is imposed on watches, a watch worth Rs. 1,000 will attract a duty of Rs. 700.
3. Compound Tariff
A compound tariff is a combination of both specific and ad valorem tariffs applied together on a
commodity. It includes a specific duty per unit plus a percentage of ad valorem duty, providing greater
elasticity to revenues and more effective protection to home industries.
4. Sliding Scale Tariff
Sliding scale tariffs are import duties that vary according to the changes in the prices of commodities.
These may be on a specific or ad valorem basis, but in practice they are generally applied on a specific
basis.
Classification 2: On the Basis of Purpose
5. Revenue Tariff
A revenue tariff is imposed primarily to generate income for the government rather than to protect
domestic industries. Less developed countries often rely heavily on this source of government revenue.
6. Protective Tariff
A protective tariff is imposed by the government to protect home industries from cut-throat competition
from foreign goods. The higher the tariff imposed, the greater is its protective effect on domestic industries.
Classification 3: On the Basis of Discrimination
7. Non-Discriminatory Tariff (Single Column Tariff)
When uniform tariff rates are applicable to all commodities irrespective of the country of origin, it is called a
non-discriminatory tariff. This system is simple and easy to administer but lacks flexibility to adjust to
changing industrial needs.
8. Discriminatory Tariff
In discriminatory tariffs, varying tariff rates exist for different commodities and countries. Products from
favoured countries are subject to lower tariff rates. These are further divided into: (a) General and
Conventional Tariff — General tariff is flexible and set by the legislature; conventional tariff is evolved
through commercial agreements and is more rigid. (b) Maximum and Minimum Tariff — Minimum rates
apply to Most Favoured Nations; maximum rates improve bargaining position. (c) Multiple Column Tariff —
Consists of three rates: general, international, and preferential.
Classification 4: On the Basis of Products
9. Import Duties
When the home country imposes a tariff on foreign products as they enter its territory, it is known as an
import duty or import tariff. Import tariffs are widespread and almost every country makes use of them.
10. Export Duties
When products of the home country are taxed as they leave its territory to be sold in foreign markets, the
tax is called an export duty. Export duties are applied to a very limited extent; some countries like the USA
have even prohibited them by law.
Exam Tip: Always organise tariffs under all 4 classifications. This structured approach fetches maximum
marks.
TYPES / STAGES OF ECONOMIC INTEGRATION
Economic integration refers to an arrangement whereby two or more countries come together by reducing
trade barriers and coordinating their economic policies. It exists on a spectrum — from the loosest to the
most advanced form.
Stage 1: Preferential Trade Area (PTA)
The preferential trade area is the most loose and basic form of economic integration. In this arrangement,
member countries lower tariffs on imports from each other while continuing to maintain their own individual
tariffs against non-member countries. They simply give preferential (favourable) treatment to one another
without completely removing all barriers.
Example: The Commonwealth System of Preferences, established in 1932, headed by Britain.
Stage 2: Free Trade Area (FTA)
In a free trade area, member countries completely eliminate both tariffs and other trade restrictions among
themselves. However, each member country remains free to maintain its own trade barriers against
non-member countries — there is no common external tariff policy.
Examples: European Free Trade Association (EFTA) — formed in 1959; Latin American Free Trade
Association (LAFTA) — formed in 1961.
Stage 3: Customs Union
A customs union is a more formal and closely-knit type of integration. Member countries abolish all tariffs
and trade barriers among themselves AND also adopt a common external tariff and commercial policy
against non-member countries. All members act as a single economic unit against outsiders.
Example: The European Economic Community (EEC), formed in 1957 by West Germany, France, Italy,
Belgium, the Netherlands, and Luxembourg.
Stage 4: Common Market
A common market goes a step further than a customs union. It involves abolition of all tariff and trade
restrictions among members, adoption of a common external tariff, and additionally allows free movement
of labour and capital among member nations. There is thus a free and integrated movement of both goods
and factors of production.
Example: The European Common Market (ECM), also known as the European Economic Community
(EEC).
Stage 5: Economic Union
The economic union is the most advanced and highest form of economic integration, involving the greatest
degree of cooperation. Member countries form a common market and additionally adopt common fiscal,
monetary, exchange rate, industrial and other socio-economic policies. They also attempt to create a
common currency and banking system.
Examples: BENELUX (Belgium, Netherlands, Luxembourg) — formed in 1948, converted to economic
union in 1960. European Union (EU) — EEC transformed into EU in 1991.
Quick Comparison Table
Reduced No Trade Common Free Common
Stage
Tariffs Barriers Ext. Tariff Movement Policies
Preferential Trade Area YES NO NO NO NO
Free Trade Area YES YES NO NO NO
Customs Union YES YES YES NO NO
Common Market YES YES YES YES NO
Economic Union YES YES YES YES YES
Exam Tip: Remember the stages in order — PTA → FTA → Customs Union → Common Market →
Economic Union. Each stage adds one more feature over the previous one. The comparison table is very
useful for diagram/comparison questions.