Monday, July 4, 2016

The Cult of Free Trade in a Nutshell

The argument for unrestricted free trade by Ricardo’s principle of comparative advantage requires a number of stated or hidden fundamental assumptions to work properly, as follows:
(1) domestic capital or factors of production like capital goods and skilled labour are not internationally mobile, and instead will be re-employed in the sector/sectors in which the country’s comparative advantage lies;

(2) workers are fungible, and will be re-trained easily and moved to the new sectors where comparative advantage lies.

(3) it does not matter what you produce (e.g., you could produce pottery), as long as you do it in a way that gives you comparative advantage;

(4) technology is essentially unchanging and uniform; and

(5) there are no returns to scale.
Assumption (1) doesn’t hold today and what happens is movement of capital under the principle of absolute advantage (Lavoie 2014: 508). This results in a type of race to the bottom for industrialised countries that do not protect their industries.

(2) is of course highly questionable. (3), (4) and (5) are utter nonsense. Abstract pro-free trade arguments often seem to make the implicit assumption of full employment, or the effective tendency to full employment, in all nations as well, which is yet another mad and unrealistic assumption (Lavoie 2014: 508).

Movement of capital to a place where it has absolute advantage tends to cause de-industrialization in Western countries, as capital moves to nations with the lowest unit labour and factor costs, and higher wage countries experience falling wages, high unemployment and rising trade deficits.

A country like China actually makes the process worse by actively intervening via mercantilist industrial policies to promote offshoring of manufacturing to their country. But even if this intervention didn’t happen, unrestricted free trade would still have deleterious consequences for the high wage countries. For Post Keynesian alternative policies to free trade, see Norman (1996), Cripps and Godley (1978), and Lavoie (2014: 507–512).

The argument for pure free trade is built on sand and is almost wholly intellectually bankrupt if it is supposed to be describing the world in which we live. A longer analysis is here. This theoretical incompetence in neoclassical and Austrian economics on the issue of free trade is accompanied by a blockheaded ignorance of the real-world success of protectionism (see Bairoch 1993; Chang 2002 and 2008; Hudson 2010; Reinert 2007).

The argument for free trade would be a joke, if it didn’t have such disgusting and terrible consequences for real human beings.

Look at the images of Detroit here and weep. This once prosperous city has been wrecked by the cult of free trade.

Further reading
“The Early British Industrial Revolution and Infant Industry Protectionism: The Case of Cotton Textiles,” June 22, 2010.

“Protectionism and US Economic History,” June 8, 2014.

“Mises on the Ricardian Law of Association: The Flaws of Praxeology,” January 25, 2011.

BIBLIOGRAPHY
Bairoch, Paul. 1993. Economics and World History: Myths and Paradoxes. Harvester Wheatsheaf, New York and London.

Chang, Ha-Joon. 2002. Kicking Away the Ladder: Development Strategy in Historical Perspective. Anthem Press, London.

Chang, Ha-Joon. 2008. Bad Samaritans: Rich Nations, Poor Policies, and the Threat to the Developing World. Random House Business, London.

Cripps, Francis and Wynne Godley. 1978. “Control of Imports as a Means to Full Employment and the Expansion of World Trade: The UK’s Case,” Cambridge Journal of Economics 2.3: 327–334.

Hudson, Michael. 2010. America’s Protectionist Takeoff, 1815–1914: The Neglected American School of Political Economy (new edn.). Islet, Dresden.

Lavoie, Marc. 2014. Post-Keynesian Economics: New Foundations. Edward Elgar, Cheltenham.

Norman, Neville R. 1996. “A General Post Keynesian Theory of Protection,” Journal of Post Keynesian Economics 18.4: 509–531.

Reinert, Erik S. 2007. How Rich Countries Got Rich, and Why Poor Countries Stay Poor. Carroll & Graf, New York.

Robinson, J. 1973. “The Need for a Reconsideration of the Theory of International Trade,” in M. B. Connolly and A. K. Swoboda (eds.), International Trade and Money: The Geneva Essays. Allen and Unwin, London. 15–25.

30 comments:

  1. The one that always makes me laugh is that the principle of Comparative Advantage requires all the individuals in a geographic area to be essentially the same sort of generalist, and that conflicts directly with Adam Smith's observation that the division of labour and specialisation is the key to success.

    Always a good one to throw at free trade nuts.

    ReplyDelete
    Replies
    1. You've almost got it. The advantages of free trade in Smith are not those of Ricardo. Free trade enables specialization.

      'The difference of natural talents in different men is, in reality, much less than we are aware

      of' and the very different genius which appears to distinguish men of different professions,

      when grown up to maturity, is not upon many occasions so much the cause, as the effect of

      the diffusion of labour. The difference between the most dissimilar characters, between a

      philosopher and a common street porter, for example, seems to arise not so much from

      nature, as from habit, custom, and education'

      Delete
  2. It also entails that the countries have different hourly pay rates or a currency exchange rate between them to that effect.

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    Replies
    1. Are you implying that they don't?

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    2. I'm noting that it is a mathematical characteristic of it.

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  3. This comment has been removed by the author.

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  4. One question - if every government followed full employment fiscal and monetary policies, would that improve the case for more liberal trade?

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    Replies
    1. Yes, that is basically the Functional Finance / MMT position. The really bad assumption, the one that causes "disgusting and terrible consequences for real human beings" is that of automatic full employment, not (1) - (5).

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    2. No because if the elasticity of demand for imports and exports is relatively low for some countries, while other countries have higher elasticities of exports imports demand.

      In this case the former type of countries will be in an inferior position compare to the latter even if devaluation will occur.

      So devaluation alone will not fix the situation thats why managed trade and heavy capital controls and financial regulations needed anyway no matter what, also i am advocating a proposition of paul davidson (originally of keynes) to establish international monteray clearing union which will not only help all the countries around the globe to achieve full employment and development for third world countries (unlike IMF packages) but also it will help to end the race to the bottom and of course this in turn will help to tame the multinationals as well.

      Delete
    3. Won't be enough. Fiscal and monetary policies have to be coordinated and there has to be balance of payments targets:

      http://www.concertedaction.com/2012/08/08/kaldors-growth-plan/

      Delete
  5. Thanks, LK. Good quick breakdown of the flaws of CA, after I had asked you about it.

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  6. This is all very true, but I think the economic consequences of trade deficits are a bigger issue for "free trade" and anti-protectionist policies.

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    1. Yes, large trade deficits may eventually impose balance of payments constraints.

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    2. "Yes, large trade deficits may eventually impose balance of payments constraints."

      No more so than large oil exports.

      Delete
  7. By following those ideas wealth will move to an ever smaller group of people and jobs will move to the place with the lowest wages and the least regulation.

    Then the economy of scale stops working because group 1 is to small, group 2 and everyone else doesn't have purchase power.

    Technology can work as an illusion here: you could replace workers with any inanimate object (say: replace people with flower pots) and arrive at the same end game where nothing is produced because no one "needs" anything anymore.

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  8. Detroit, where I live, has actually been destroyed by a union mindset and one party rule.

    This is all weak LK, confusing simple formulations with essential assumptions. And trade *promotes* economies of scale; your argument just looks foolish there.
    Landsburg has a recent series of posts and a much sharper commentariat than you face at Murphy's. Try these arguments there, and see what happens. My guess is I won't see that.

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    1. No, Ken B, *you* don't know the arguments or the views of your opponents.

      Your opponents do not want to shut off all trade; they fully agree that the world needs high levels of trade and that this -- as long as certain conditions are fulfilled -- is a good thing.

      (1) "trade *promotes* economies of scale;"

      And where did I say it does not? This is a stupid straw man, indicative of your failure to even understand the arguments above.

      Yes, increased exports allow a greater volume of production and so can increase industrial economies of scale.

      But so can tariffs to promote import substitution in the early stages of industrial development. Your statement above does not in any way refute the argument for infant industry protectionism.

      (2) As for Landsberg, I'll take up your challenge. Which posts are you talking about?

      Delete
    2. Wow, you sure showed us what a sharp cookie your "hero" is:

      https://www.amazon.com/review/R270AMAGMS9MSN/ref=cm_cr_dp_cmt?ie=UTF8&ASIN=B0012FB9T8&channel=detail-glance&nodeID=283155&store=books#wasThisHelpful

      Just a cursory review of what he claims is all I need to know about this buffoon.

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    3. Landsburg's libertarian morality:

      "Landsburg [sc. is] a self-described "hardcore libertarian", Landsburg emphasizes the importance of individual choice. This position extends to health care, and his view that those who choose no insurance should not receive potentially life-saving treatment"
      https://en.wikipedia.org/wiki/Steven_Landsburg#Writings_and_work

      He sounds like a hysterical regressive leftist:

      Landsburg's comparison of protectionism to racism in Forbes magazine prompted a response from Pat Buchanan
      https://en.wikipedia.org/wiki/Steven_Landsburg#Writings_and_work

      Delete
    4. I found one post on CA on Landsburg's blog you can reply to if you're interested:

      http://www.thebigquestions.com/2016/06/28/trumponomics

      Delete
  9. Thanks for saying this, Lord Keynes.

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  10. It seems to me most here, LK to the fore, simply do not understand the Ricardo argument. So let me illustrate simply, with LK and myself as the trading partners. Bats and balls are equally profitable per item. LK produces 3 bats per hour and 2 balls per hour. I produce 2 bats and 1 ball per hour. Who has the comparative advantage in producing bats?
    We each work 8 hours. who should produce what? If we both need to consume 2 bats and 2 balls per day, does that answer change? Are we then not both better of trading? Won't a barrier hurt us both?

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    1. Poppycock. We understand the abstract argument for comparative advantage as expressed by Ricardo.

      The point is that it would only hold under highly unrealistic conditions, under the stated and hidden assumptions I have listed above.

      Unless you want to address this, you've answered nothing.

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    2. Don't forget Anonymous that can produce 6 bats and 6 balls per day. With no income you will buy my bats and balls on credit. How does it work now?

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    3. That example doesn't have the necessary conditions for trade to commence under comparative advantage as both parties produce more bats per hour than they do balls.

      Delete
  11. The Real News Network just posted a good one on TTIP today:

    https://youtu.be/QPoyj5QkMtU

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  12. https://fixingtheeconomists.wordpress.com/2014/05/01/arguments-against-free-trade-and-comparative-advantage/

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  13. I'd like to hear your arguments about how it was free trade that destroyed Detroit. I've never been there so maybe all ive heard has been bs to this point, but hearing this is a first for me.

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  14. A good re-statement of your previous arguments, although the comment about the harmful effects of free trade on Detroit may neglect other vital factors which gradually came to fruition in the last half century and before. Much could be added in support of protectionism, such as the crucial fact that a nation which practices free trade loses its sovereignty and ability to act independently in its national interest, as well as being more vulnerable to economic shocks originating in foreign nations. Tariffs also raise tax revenue, prevent excessive social dislocation being created and prevent foreign nations from developing economically (and therefore benefiting geo-politically) at your nation's expense.

    The destructive economic effects of free trade for developed nations are just one aspect of its destructiveness. Its effect on sovereignty, stability, culture and the environment are less often mentioned but very important. As an aside which you may well be aware, Marx was a strong supporter of free trade as he believed it increased the tension between labour and capital and hastened the socialist revolution. In light of this fact, it doesn't make much sense that modern "conservatives" support free trade (a classical liberal idea) they certainly never used to.

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