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Free Trade Vs. Fair Trade and the Race to the Bottom Theory: All You Need to Know!

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The theories of free trade and fair trade are very complex. It is essential to begin at the basics in order to comprehend these economic foundations. Investorwords.com states that free trade is “international business not restrained by government interference or regulation, such as duties.”1 On the other hand, fair trade is defined by the authors of The Ethical Consumer as “products purchased under equitable trading agreements, involving cooperative rather than competitive trading principles, insuring a fair price and fair working conditions for producers and suppliers.”2

Although the definition of free trade may sound ideal, in reality, free trade agreements have regulations. Often times, free trade still involves duties and quotas, although they are usually reduced. Further explanation and examples of such free trade agreements will be discussed later.

Fair trade can be a very controversial topic and is a relatively new idea. However, it is gaining acceptance in the mainstream as a result of increased awareness of its benefits and ethical consumer behavior.

The History of Trade

In order to fully understand the situation today, it is necessary to briefly look back at where trade came from and how it has developed. The history of trade can be traced back to its prehistoric roots before the creation of a monetary system of currency.

Long-range trade routes, what is called international trade today, first appeared in the 3rd millennium BC, when Mesopotamian Sumerians traded with the Harappan civilization of the Indus Valley. This was the first time that goods were put on board for travel.

One of the first milestones in trading came with the establishment of the Dutch East India Company on March 20, 1662. Also known as the VOC, Vereenigde Oostindische Compagnie, it was created by a group of Dutch merchants and independent trading companies that at the time, were growing impatient with the monopoly the Portuguese had established over the spice trade with East Asia at the end of the fifteenth century. It was also a way for them to keep the British imperial merchants in check by setting up six chambers in the port cities of Amsterdam, Delft, Rotterdam, Enkhuizen, Middelburg and Hoorn. The extensive information network that the VOC built up for its business operations is impressive, to say the least, with much of their documentation still intact and archived by the US government3.

A monumental figure in economic history and trade was Adam Smith, who installed himself as the fountainhead of contemporary economic thought after producing his most significant work, The Wealth of Nations, at the end of the 18th century, which is the culmination of his ideas on the free market. His reputation rests on his explanation of how rational self-interest in a free-market economy leads to economic well-being. He explained the importance to society of self-interest in which someone earning money by his own labor benefits himself and unknowingly, also benefits society, because to earn income on his labor in a competitive market, he must produce something others value. Smith emphasized the importance of a specialized and divided work force which are the fundamentals of trade today.4

Another crucial voice in the history of trade was David Ricardo in the beginning of the 19th century. Ricardo also opposed the protectionist Corn Laws, which restricted imports of wheat. In arguing for free trade, Ricardo formulated the idea of comparative costs, today called comparative advantage. Comparative advantage is the main basis for most economists' belief in free trade today. The idea is that a country trades for products that it can get at lower cost from another country is better off than if it had made the products at home. This fundamental idea shaped the way people were viewed trading and the free market was beginning to emerge.5

Today, there is a growing demand for fairer trade, as the race to the bottom theory (discussed later) is pushing labor costs and inputs way down to a point where it is unsustainable. Free trade cannot be supported this fully while maintaining fair working conditions and addressing all environmental concerns.

Fair Trade

As defined earlier, the goal of fair trade is to create fair and equal international trade.6 Awareness of fair trade is increasing in both the United States and throughout the world.

Jack Davis, a Democrat who ran for Congress in the 26th District of New York in 2006, supports the fair trade movement. On a website for Right Democrats, he makes the argument that after 30 years of free trade agreements the U.S. economy is not better off. The U.S. trade deficit has risen; many cities and localities are running deficits; and family debt is rising very quickly as well. According to him, “A good economy for the majority of Americans is employment, a living wage, a possibility for advancement, affordable housing, affordable medical care, funded retirement, and a stable currency.” From his point of view, free trade is not creating a “a good economy” for the U.S., and that the economic theory of trade should change in order to help build a good economy that helps all classes of Americans.7 From the international perspective, the arguments for fair trade are very similar.

Fair trade organizations are designed to help impoverished workers and producers attain economic stability and self-sufficiency through building transparent relationships. The market size of fair trade has been growing. Currently there are more than 800,000 small-scale producers who are working in almost 3,000 grassroots organizations around the world. In 2002, members of the European Fair Trade Association had a turnover of around 150 million Euros.6

The benefits of fair trade are numerous. It encourages equality in international trade through encouraging relationships and partnerships within the supply chain, the development standards, and helping companies comply with international agreements such as the UN Universal Declaration of Human Rights. These organizations “take a pro-active approach to socially responsible business practices, focusing on the positive benefits of sustainable business practices for all.”6

It is important for fair trade organizations to stay focused on the goals and purpose of fair trade. If it is mismanaged, fair trade will not help those in poverty and it can discredit the movement. Because it is a newer movement, there is not one international organization to define and approve fair trade labels or products. Some organizations have taken advantage of this fact to sell and market products as fair trade products even though they are not. According to economists in favor of free trade, fair trade causes prices to rise without benefiting the poor in the long term because it disrupts the free-market economy.8

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International Labor Standards

One of the main arguments that advocates of fair trade use against free trade is that it ignores labor issues, and thus ends up hurting the workers.The International Labor Organizations, founded in 1919, is a UN specialized agency that is responsible for labor issues and standards. It currently has 179 member states.

The goals of the organization are to protect and strengthen workers’ rights, create employment, protect and create safe working and living conditions, and provide education and technical training for workers around the world.It provides technical assistance in the following fields: vocational training and rehabilitation, employment policy, labor administration, labor law and industrial relations, working conditions, management development, cooperatives, social security, and occupational safety and health.9

In 1998 the ILO adopted the Declaration on Fundamental Principles and Rights at work which covers four areas, freedom of association and the right to collective bargaining, elimination of forced and compulsory labor, abolition of child labor, and elimination of discrimination in the work place. It requires that member states promote and protect the rights listed in the Declaration.The ILO and the Declaration on Fundamental Principles and Rights cover labor standards that address wages, freedom of association and collective bargaining, forced labor, child labor, occupational safety and health, and maternity protection.9

Wages are not guaranteed in many countries and are sometimes given in the form of bonds, manufactured goods or alcohol.The ILO standards require the regular payment of wages, fix the minimum wage levels, and set a process for the settlement of unpaid wages if an employer should go bankrupt.9

The ILO places an emphasis on the importance of the freedom of association and collective bargaining.They believe that these rights are essential to efficiently negotiate work relations and that both the employer and employees have an equal voice in the negotiations.They have found research that shows that countries that allow effective “collective bargaining tend to have less inequality in wages, lower and less persistent unemployment, and fewer and shorter strikes” than countries that do not allow collective bargaining.9

Forced labor, as well as traditional slavery, is found all over the world and approximately 12.3 million people around the world are victims of this.Workers are exploited by private agents as well as the State and military groups.The reasons that cause forced labor are varied and complex, but the goal of the ILO conventions are to prevent it and help alleviate the associated poverty.Some example conventions are Forced Labor Convention, 1930 and Abolition of Forced Labor Convention, 1957.Both condemn forced labor under any condition and are explicitly against forced child labor.9

Under ILO standards and conventions, child labor is a direct violation of human rights.Research has shown that there is a direct link between the continuation of poverty and child labor.Child labor causes physical and psychological damage to children and prevents them from furthering their education.Education is a critical part of eliminating poverty and encouraging upward class growth.ILO conventions establish age limits and define what unacceptable labor is for children.9

The ILO Constitution and numerous conventions address the issue of occupational safety and health and state that workers should be protected from diseases and injuries related to their employment.However, this is not the case in many places around the world.Millions of people are injured or killed each year while performing their job duties.Many of these deaths and injuries could be prevented by implementing stricter safety standards.In 2003 a “global strategy to improve occupational safety and health” was adopted by the ILO and it contains three key points which are: preventive safety and health culture, the promotion and development of relevant instruments, and technical assistance.9

ILO also has standards to ensure that expectant and nursing mothers have their rights protected.It is important that they have protection to prevent harm to themselves or their infants as well as protection to make sure that they will have a job to return to after their pregnancy or maternity leave.These standards protect a woman’s equal access to employment and vital income to her family.9

Environmental standards can also affect how a company does business and its labor standards.An example of a recent agreement addressing the issue of the environment is the Kyoto Protocol which is an amendment to the UN Framework Convention on Climate Change.It was entered into force February 16, 2005 after Russia ratified it in October 2004 and assigns mandatory targets for reductions of greenhouse emissions by countries that have signed and ratified it.

The protocol now covers over 160 countries which are responsible for 55% of all the world’s greenhouse emissions.The Kyoto Protocol has not been ratified by the United States and Australia who disagree with the lax treatment of China and India and say that it will be harmful to their economies.10These labor and environmental standards are one way to protect the rights of workers and to encourage fairer trade.

The Race to the Bottom Theory

Another argument that advocates of fair trade will use against free trade is the race to the bottom theory. As more and more free trade agreements open up the world’s market to the freer movement of not only goods but labor and currency, economic analysts are forced to look more and more towards the coming world economy. This world economy with free movement of resources, especially labor, presents a potential problem that could occur and potentially devastate not only the economy but the environment as well. The race to the bottom theory presents the worries that some economists are seeing as a very real danger.

The American Friends Service Committee’s Glossary of International Trade Terms states the definition of the race to the bottom theory as

“the constant search for cheaper wages, lower taxes and weaker environmental and other regulations, produces a downward spiral in socio-economic conditions in the United States and in countries around the world. For example, jobs moved from Detroit to Mexico in pursuit of lower wages, and now jobs are being moved from Mexico to China.”11

A basic view of this theory is that when there are no regulations on trade and no regulatory standards, companies will move from country to country searching for cheaper resources with less environmental regulations until they devastate the economies of the entire world in their quest for cut costs.

This type of phenomenon could only occur in the absence of strong regulations regarding trade and the actions that companies can legally take to lower their operating costs. Races to the bottom could also occur between the administrative regions within nations, but this is limited by the power of central national governments to act against them. These races to the bottom seem to be occurring less frequently than some critics had previously speculated. This is possibly due to the fact that some federal governments have recourse to enact legislation that works to slow or halt these races before their effects can become too detrimental.12

In its early stages a race to the bottom can appear to be beneficial to the parties involved as one country sees the benefit of lowered costs and another sees the benefit of increased foreign investment. However, the process of competition involved in a race to the bottom serves to undermine the ability of governments to improve living and working conditions through the enforcement of labor standards or the raising of taxation for funding social services. This is because these multi-national corporations have the freedom to move their operations from country to country, seeking less regulation and lower wages. This has an effect on countries’ abilities to pass labor laws, particularly developing countries. The effect is usually lower minimum wages, below standard overtime pay, if it exists at all. All this is because higher wage rates, etc, would create a barrier to low-cost labor and drive these companies to other labor sources, taking the potential investment elsewhere. A writer for the Conjecture Corporation, Brendan McGuigan states that “the race to the bottom… dictates that more and more nations (again, particularly in the developing world) will eliminate their labor laws.”12

The idea that corporations and governments lower their costs by reducing environmental protection, wages, salaries, health care, and education is referred to as a “downward leveling” of labor, social and environmental conditions. This “downward leveling” is something that greatly concerns economists, especially when the potential damage to the environment is considered.

Downward leveling is such a concern to workers, consumers, farmers, and citizens that they are organizing themselves into groups in order to encourage governments to pass environmental, social, and labor policies that will block this negative sloping of economical trends. However, the corporations responsible can avoid these regulations and government controls by simply relocating their facilities around the world.13

Some believed that companies relocating their facilities into other nations with less expensive labor and more relaxed regulations would be beneficial for these countries. There have been studies done in third world nations that are proving the opposite. The Boston Globe found that “rather than raising the standards of living, American firms are more likely to be paying no better than local minimum wages.” This was in a study of U.S. corporate behavior abroad.13

Race to the bottom may also be contributing to environmental destruction worldwide. The leading sources of greenhouse gases, ozone-depleting chemicals, and toxic pollutants are now located all over the world and with decreased environmental regulations their effects are becoming more and more potent.13

Combatting the Race to the Bottom

There are several responses to the negative effects of the races to the bottom. One of which is utilizing international organizations powerful enough to make environmental and labor rules on a global level, such as the World Trade Organization (WTO).

Another method for avoiding races to the bottom is moral purchasing. This process can involve forbidding or applying heavy tax, tariff and trade sanctions to nations that permit the export of offensive goods. This process can redirect the revenues raised from taxes and tariffs to combat abuses.

Another strong combatant of these races to the bottom are standard-based tariffs. Standard-based tariffs are designed to protect country-wide standards. With these tariffs, a product imported from a country with low labor and environmental standards will face a higher tariff upon entry and a product imported from a country with equal or higher domestic environmental and labor standards will face no tariff. This removes the incentive for a producer to move their factory to another country with a lower minimum wage and maintains environmental and labor standards that are better for the overall economy. However, there is another important factor to note when considering these tariffs. Standard-based tariffs encourage free trade between the world’s wealthiest nations while restraining exports from poorer countries to wealthier countries.13