Arguments Against Free Trade and Comparative Advantage


In response to Krugman’s awful dismissal of heterodox economics the other day (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.

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 prtection 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.


About pilkingtonphil

Philip Pilkington is a macroeconomist and investment professional. Writing about all things macro and investment. Views my own.You can follow him on Twitter at @philippilk.
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16 Responses to Arguments Against Free Trade and Comparative Advantage

  1. damien1109 says:

    Spot on ! If you go to a cartoon character style fat cat, who cares nothing
    about anything except more money and advise him to sell all his low
    performing shares and put all his eggs in the one basket of high performing
    share, he’ll sack you for being an idiot.
    Too often there is a moral overtone to the economic version of this with the
    ‘real hard money men’ cartoon character talking about ‘free trade’ and
    the softy saying “Ah we need to protect the workers”.
    The gain from free trade, if any, comes from Industrial specialisation and specialisation
    can show short term gains but the cost in terms of risk of a total collapse
    is so high its idiocy.
    If it’s idiocy for an individual to rely on a narrow high performing (at the moment) share portfolio then its idiocy on steroids to have a whole country reply on a narrow high performing (at the moment) Industrial portfolio – this is what free trade gives you – if you ever get that far.
    I’d like the cartoon characters to change to
    “Hard nosed money man” says get rid of free trade and lets have trade
    deals where it suites us and on what terms, and idiots.

  2. Mark Beath says:

    Joan Robinson also proposed that North Korea had the development model right and would succeed while the South would fail.

    • But the South did not rely on free-trade. Everyone knows that they undertook protectionist industrial policy. Do you have even the remotest clue what you’re talking about?

      • LK says:

        Not to mention that whatever Joan Robinson said about North Korea is a red herring in the context of this discussion about comparative advantage and irreverent to the modern case for managed trade or infant industry protectionism.

  3. I’ve always found Ricardo a tough read, in the sense that his ideas seemed so clearly stilted toward the rentier types through the substitution of economic power for political power.

    In fact, as and Robinson and Hamilton so deftly pointed out, the “free-trade” ideal really is its own form of protection for the more industrialized countries and their powerful rentier-class investors (like Ricardo). Comparative advantage really forces cheap industrial labor in the industrialized country by shutting out that country’s more basic industries like agricultural production and small businesses, thereby forcing home labor to find work in the economically dominating industries. On foreign shores, the reverse happens in which the local economy can’t develop those industries that are in the home country. But of course, the foreign country’s elites (read: rentiers) have the sort of money—using the profits of their export businesses—to invest in the home countries industries that transform their exports into manufactured goods that are then sent around the world. Thus, the elites win at both ends while the workers stagnate.

    This sort of arrangement encourage neglect in both countries, since, as Robinson points out, the analysis really only works under static conditions and the elites at both ends will want to use their power to maintain that statsis. And when the day comes that the industries collapse, e.g., becuase of a other countries that out-perform the industries of the two original traders, then the elites simply send their investments there, citing … wait for it … Comparative Advantage, and let the workers rot, claiming they’re just not competitive enough.

    So could Ricardo and “free trade” serve to justify the sort of “hot money” behavior we see today. Since this serves the powerul and cows everyone else (let’s face it, in moder society its’ hard to argue against any idea that starts with “free”), it spread and persists like kudzu.

    • Derryl Hermanutz says:

      In Chapter XXXI (On Machinery) of Ricardo’s 1817 book, “Principles of Political Economy and Taxation”, he explains why he has come around to seeing why the Luddites were right: mechanization really does harm the lot of the laboring class. Ricardo wrote,
      “…I thought that the laboring class would, equally with the other classes, participate in the advantage, from the general cheapness of commodities arising from the use of machinery. These were my opinions, and they continue unaltered, as far as regard the landlord and capitalist; but I am (now) convinced that the substitution of machinery for human labor is often very injurious to the class of laborers. My mistake arose from the supposition that whenever the net income of a society increased, its gross income would also increase; I now, however, see reason to be satisfied that the one fund, from which landlords and capitalists derive their revenue, may increase, while the other, that upon which the laboring class mainly depend, may diminish, and therefore it follows, if I am right, that the same cause which may increase the net revenue of the country may at the same time render the population redundant, and deteriorate the condition of the laborer.”
      Profits and rents (including interest income) can increase at the same time as “the population is rendered redundant”. Ricardo doesn’t opine as to what the redundant working class population ought to do with themselves once they no longer serve the needs of capitalists and landlords: die off, I suppose. My point is that even Ricardo recognized the different consequences to capitalists and laborers that would follow from policies like replacing men with machines. Ricardo’s modern-day acolytes tend to ignore that chapter of Ricardo’s opus.

      • Good point. Perhaps the attitude was that the “surplus” labor population had to migrate to anther country that offered a better deal for their labor. And thus the need for a “globalized” workforce and standardized education and culture, as we are seeing today.

      • Derryl Hermanutz says:

        So what happens when you run out of new countries for your surplus labor to move to? 200 years ago the world looked like a very big place with unlimited space and the illusion of unlimited expansion. I am not aware of any Third World countries that accept economic immigrants from First World countries who want to move there, work for $2/day, and subsist in the splendor of globalized cheap labor.

  4. NeilW says:

    Steve Keen highlights another failure:

    “Arguably labour can be retrained—a vigneron can become a machinist—but how do you convert wine press into a spinning jenny?”

    “But because of the introduction of trade, the price of wine in England would have fallen, so that the sale price of the wine press will also fall. while the price of spinning jennies will have risen, given the new export market to Portugal. Some capital is necessarily destroyed by the opening up of trade and it applies in reverse in Portugal as well.”

    “Since capital is destroyed when trade is liberalised, the watertight argument that trade necessarily improves material welfare springs a leak. If economics were a real science, this real-world complication to Ricardo’s argument would be considered, but it has never been seriously addressed.”

    The idea that capital can be transformed and transported effortlessly and intact across borders is the unwritten assumption, and it is false.

  5. damien1109 says:

    Thanks for that quote Derryl Hermanutz, 1st time I’ve come across it:
    Now that Labour and redundancy of labour – from the 1800’s has entered the
    topic – as it always does because its a massive issue, can
    I show you my “starter for ten” solution to the issue :
    NEFS – Net Export Financial Simulation

  6. Pingback: Is it lefties or righties that love international institutions like the WTO, UN? | Israel Foreign Affairs

  7. The original insight which Ricardo proved in his famous numerical example does not require full employment and is not static at all. For the new interpretation see:

    • Nothing that was dealt with in the above post is contained in the essay linked to. The essay does not deal with the underemployment equilibrium argument. Nor does it show Ricardo’s theory to be non-static. I gather that you are author of the essay therefore I am rather surprised that you do not know what it contains.

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