Arguments Against Free Trade and Comparative Advantage

July 15th, 2017
in history, macroeconomics

by Philip Pilkington

Fixing the Economists Article of the Week

In response to Krugman’s awful dismissal of heterodox economics about three years ago (see here) Ramanan has dug up an old quote reminding us that Krugman actually got his Swedish bank prize for being a defender of the status quo. In a 1996 lecture paper Krugman lays out a propaganda plan so that economists can argue in favour of free trade.

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Krugman is, rather interestingly, very self-conscious in thinking that he is pushing an orthodox line while playing at being a rebel — something interesting to note given that he is taking what seems to be a very similar line today when it comes to the ISLM and what he thinks to be a liquidity trap. He writes,

(ii) Adopt the stance of rebel: There is nothing that plays worse in our culture than seeming to be the stodgy defender of old ideas, no matter how true those ideas may be. Luckily, at this point the orthodoxy of the academic economists is very much a minority position among intellectuals in general; one can seem to be a courageous maverick, boldly challenging the powers that be, by reciting the contents of a standard textbook. It has worked for me!

Anyway, leaving aside the parallels between what Krugman does today with regard to the ISLM and what he used to do back in the 1990s regarding free trade let us turn to the actual ideas. Krugman is referring in the paper, of course, to Ricardo’s theory of comparative advantage. He calls this ‘Ricardo’s difficult idea’ but, as any student of economics knows, it is one of the simplest ideas in economics. Krugman is calling it a ‘difficult idea’ to flatter his audience (of economists) into thinking that they uphold an esoteric truth that others simply cannot grasp.

He seems to think that no lay person grasps free trade and that only economists have sufficient wisdom to recognise its Truth. Well, yes some groups of people do recognise the ‘wisdom’ of free trade agreements — namely, corporations looking for cheap labour — and they will push so-called free trade rather hard in the policy arena; just look at the recent debacle around the TPP. Likewise Krugman must know this as he is writing two years after the NAFTA agreement had been set in place. But, of course, his real audience is left-leaning intellectual types. Being a good Clinton democrat Krugman wants to convince all those people who were skeptical of the likes of NAFTA that it was a good idea.

So, what are the problems with the old Ricardian theory? Well, Joan Robinson dealt with it rather well in her book Aspects of Development and Underdevelopment. First of all she lays out the supposedly difficult idea as such,

Modern teaching is still based upon the case that Ricardo made against protective tariffs in England in the early nineteenth century. The classical argument against protection was that it produces a misallocation of resources inside the country that imposes it. Ricardo’s analysis of comparative advantage is often misunderstood. The comparison is not between the costs of production, in money terms, of particular commodities at home and abroad; it is a comparison between the real costs (in terms of labour and other resources) of different commodities at home. The argument was that, when protection is taken off, resources will move from the production of commodities with high real costs (which can then be imported) to those with lower real costs so that their productivity is increased. (pp102-103)

She then goes on to point to various logical and empirical problems with it.

This argument applies when all resources are always employed. It has no force for a country with massive unemployment where the potential surplus is far from being realised. Moreover, the argument requires that exports pay for imports so that an increase in the value of imports (following the removal of protection) will automatically be accompanied by a corresponding increase in exports of the commodities in which the country has a comparative advantage. In fact, the value of exports for any one Third World country largely depends on the state of demand in the world market for whatever primary commodity it can sell (and on the prices offered by rival suppliers). (p103)

Already the problems with the argument are beginning. In a situation of high unemployment the opportunity cost of employing labour in a sector that is, by international standards, inefficient is zero. Given that most countries are not, contrary to the mainstream theory, in a situation of full employment most of the time this does real damage to the theory.

Also, as Robinson points out, the theory depends upon a stable demand for exports (this is tied up with the full employment assumption but also tied to the idea that prices for commodities and the like are stable). This is deeply problematic. Swings in demand for commodities can have crushing consequences for developing countries that have geared their economy to narrow markets.

The classic case is that of Ghana which became heavily dependent on the cocoa market after WWII and whose economy collapsed when cocoa prices fell in the 1960s. Another more contemporary case is that of Scotland which relies far too heavily on oil exports which, at some point in the future, will dry up.

But there are other deeper and, arguably, more important problems with the Ricardian doctrine too.

The most misleading feature of the classical case for free trade (and the arguments based upon it in modern textbooks) is that it is purely static. It is set out in terms of a comparison of productivity of given resources (fully employed) with or without trade. Ricardo took the example of trade between England and Portugal. He argued that England, by allowing imports of wine from Portugal, would expand the production and export of cloth to pay for it. Ricardo, of course, was thinking of the English side of the exchange but the analysis is perfectly symmetrical; it implies that Portugal will gain from specialising on wine and importing cloth. In reality, the imposition of free trade on Portugal killed off a promising textile industry and left her with a slow-growing export market for wine, while for England, exports of cotton cloth led to accumulation, mechanisation and the whole spiraling growth of the industrial revolution. (p103)

From a developmental perspective this, I think, is an extremely forceful argument. Innovations in certain sectors — notably manufacturing — have knock-on effects into other sectors. If a country simply continues exporting, for example, a primary product, the rest of its economy is highly likely to remain in the Dark Ages. Many of the Middle Eastern oil producers like Saudi Arabia that have ignored the rest of their economy maintain this structure; with literal Kings sucking up the oil revenue and allowing it to trickle down to a few of their subjects while the rest live in huts. Meanwhile, oil producers with active industrial policies, like Iran, much more so resemble truly modern or at least modernising economies.

Another problem is that larger countries often have protected industries. The US, for example, has a heavily subsidised agribusiness sector. When NAFTA was passed cheap subsidised food imports flooded Mexico and ruined its agricultural sector. This led to an influx of impoverished farmers into the urban centers which in turn led to a rise in crime and, ultimately, this precipitated the rise of the drug cartels that are currently plaguing the country — not to mention the border of the US.

The fact is that many successful countries have built their industries using protectionist measures. The most obvious example is the US. Founding father Alexander Hamilton was one of the first theorists of protectionism. He pointed out that, in line with Robinson’s last criticism, that if one nation had an already-established manufacturing base it was absurd to assume that another nation might have a fair chance getting their industry off the ground. In his seminal Report on Manufactures,

The superiority antecedently enjoyed by nations who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle than either of those which have been mentioned, to the introduction of the same branch into a country in which it did not before exist. To maintain, between the recent establishments of one country, and the long-matured establishments of another country, a competition upon equal terms, both as to quality and price, is, in most cases, impracticable. The disparity, in the one, or in the other, or in both, must necessarily be so considerable, as to forbid a successful rivalship, without the extraordinary aid and protection of government.

Even though a myth exists today of the US as a bastion of free trade, historically this is completely contrary to the facts. Ironically, this myth is often pushed by people who claim to be constitutionalists. But the US Constitution has a very clear passage mandating the government to control the volume of trade. In Article I, Section 8, Clause 3 the US Constitution gives Congress the power

To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.

This is not to say that free trade is always a bad thing. Dean Baker often makes a very good case to open up certain professions to free trade. But economists need to look at these things on a case by case basis. The Ricardian dogma is attractive to, well, dogmatists — people that are more interested in pushing their supposedly profound and esoteric ideas onto others than they are in engaging with the real world. But serious policy economists should view free trade arguments with a heavy amount of skepticism.

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