Darkstream: free trade part 1

I’ll be doing a Darkstream tonight at 7 PM Eastern on the subject of free trade. This is part 1, and it will focus on David Ricardo and the comparative advantage theory that is the primary economic justification for free trade.

UPDATE: The replay is here. For those who want to prepare for Part 2, read Chapter 11 of Economics in One Lesson by Henry Hazlitt.

For those who want to do a little preparation, here is a partial transcript of an interview I did with Ian Fletcher, the author of Free Trade Doesn’t Work, which played a major role in my reassessment of free trade.

When most people think of opposition to free trade, they think of three things. They think of the 18th century mercantilists that were supposedly routed by Adam Smith and David Ricardo. They think of the UAW opposing cheap Japanese cars in the 1970s. And they think of Pat Buchanan and his pitchfork populism in the 1988 presidential campaign. How are the arguments you put forward in Free Trade Doesn’t Work distinguished from those three things? 

You’ve got to remember that those three examples you gave all consist of people who are, for one reason or another, disreputable in some way and in some currents of opinion but they are also people who did have a point. Mercantilism for example is not just something from the 18th century. It goes back to the very dawn of modern capitalism and the renaissance.

You have to remember that global trade is not something that was invented in 1990. It can go back hundreds of years back to the era when it was conducted with sailing ships. And very shortly after international capitalism began to take shape, various nations and their governments began to learn there were enormous advantages to be derived gaming the system. And surprise, surprise this is still going on it’s what China is doing today it’s what Japan has done for decades.

To some extent, it’s what the United States itself used to do for most of its history.  For most of its history the United States was very exclusively a tariff protected economy. The Founding Fathers were protectionists. The economist among the Founding Fathers is Alexander Hamilton, the guy on the ten dollar bill. And he wrote a report entitled “The report on manufacturers” which he submitted to congress in 1791, in which he layed out a rationale for protectionism that still holds good today. Hamilton was a very smart guy. Among other things you might be surprised to learn that he is the inventor of the R&D tax credit, which he proposed in 1791.

I had no idea. I knew he was big on central banks. I didn’t realize he was up on tax credits as well.

Yeah. The point is that mercantilism is not something that was brought out of the water by Adam Smith who was in many ways, although he was  brilliant guy, he was also the servant of various economic interests in his own time, particularly the economic interests of the Scots who had their own quarrels with the English.  Adam Smith is not a fully reliable guide in the sense that everything he said was true.

And you mentioned David Ricardo. One of the interesting things about Ricardo is if you actually go back and read his original book in which he enunciated for the first time the theory of comparative advantage, you discover that he says things like well, I have this theory, and one of the provisos to this theory is that if you have international mobility of capital, then my theory that free trade is always your best move ceases to be true.

Joseph Schumpeter is extremely harsh on Ricardo’s manner of constructing arguments. He said that Keynes and Ricardo had a lot in common in that way.

There are any number of problems with Ricardo; you have to remember that Ricardo was writing in the early nineteenth century, and his main book came out in 1817. So, to some extent I can forgive him, but the fact that a lot of his reasoning is, by present day standards, exceedingly primitive.  Among his other great discoveries was the so-called Iron Law of wages. According to which, you can never help working class peoples, so you might as well not try. There’s a lot in Ricardo to object to if you actually dig into all the economic theories and the constructs that supposedly given to us to prove that free trade is always our best move, under all circumstances. It just isn’t true.  That’s just not what these ideas actually say if you dig into them.

That leads into my next question. You’ve taken econ 101, and I’ve taken econ 101. Everyone who has is familiar with the theory of comparative advantage. And the example that Ricardo provided using the cloth and wine trade between Portugal and England.  But how has it persisted and remained dominant so long, considering that it contains, as you noted, no less than seven dubious assumptions? 

The theory of comparative advantage, which basically comes down to the idea that nations trade for the same reason people do. And the reason that you buy your coffee in the coffee shop rather than making it for yourself is not that you can’t make it for yourself. It’s not even that you might not even be more efficient at making it yourself than the guy in the coffee shop. It’s just that you have other things to do with your time.

And to fully elaborate, you can understand why it’s advantageous not just to import products, but to import products from nations that are less efficient producers than we are. I mean, we import a huge quantity of goods from China, but China is not a more efficient industrial machine than the United States. In fact, by any of the standard measures they are much less efficient.

Now, the problem with the theory of comparative advantage is that, although it does tell you a lot of good things which are true, and it’s a useful analytical construct for dealing with a lot of economic realities, it was never intended by its own inventor and its own intrinsic logic will not support its being turned into a blank check for 100 percent free trade with 100 percent of the world 100 percent of the time.  That’s just not what the theory actually says.  As opposed to what the US Chamber of Commerce and multinational corporations attempting to corrupt the congress with direct and indirect bribery would like you to believe that it says.

But why is it persistent and been so dominant and for so long, considering that not only does it have those seven dubious assumptions, but that it’s quite clear that it can’t possibly be applied in the manner that it usually is applied?

Because it is advantageous to powerful special interests. That’s the main reason. I mean it gives the answer that these guys want to hear, which is that America should practice free trade towards the rest of the world. Which means that multinational corporate interests can produce in China, lay off their American workforce, bring those goods to the United States, and sell them here at an enormous profit which you get when using slave labor. There’s no secret.

The subsidiary reason why the theory has remained more popular than it deserves to be is it gratifies the desire of academic economists to have one simple formula that explains the whole world. I mean, if you’ve dealt with academics. It’s a beautiful ivory tower construct because once you master the mathematics of this one simple formula you’ve got a magic wand that tells you just about everything about international trade without your even needing to consult any empirical facts or statistics on the matter. Let alone actually visit a factory or a dockyard or a shop to see what’s really going on.