excerpted from New American
| WRITTEN BY BRIAN FARMER |
| THURSDAY, 08 SEPTEMBER 2011 00:00 |
...So goes the theory, but the example above illustrating the mechanics of comparative advantage makes a number of assumptions that are not altogether realistic in the real world:
• Transport costs are ignored.
• There is full employment in both countries.
• Costs are constant and there are no economies of scale.
• There are only two economies producing two commodities.
• Each commodity is of identical quality in both countries.
• Factors of production are perfectly mobile within each country, in order to allow production to be switched without cost.
• Factors of production are immobile between countries, in order to maintain each country’s comparative advantage.
• There are no tariffs, quotas, or other trade barriers.
• All buyers and sellers know where the cheapest commodities can be found at all times.
• Governments do not impede or distort the marketplace through their domestic tax and regulatory policies — or if they do, the two countries are equally impacted.
Flaws in Free Trade
Those assumptions (and that list is by no means exhaustive) lead to a number of significant flaws in Ricardo’s theory that are all too often overlooked or downplayed by its adherents and, therefore, the predicted benefits do not occur to the extent forecasted, when put into practice.
In fact, transport costs do enter into the final price of a product, and transport costs can vary greatly, depending on the weight or bulk of a product. Also ignored is the cost of economic damage done in the process of manufacturing something. A classic example is environmental pollution, which has an economic cost that is not reflected in the price. Goods from a country with lax pollution standards will be relatively cheap, relative to a country with strict pollution laws. Practicing free trade in such circumstances benefits a country such as China, but harms both itself and other countries, because pollution crosses national borders.
In addition, because of cheap products made in countries with lax environmental standards, countries with burdensome environmental restrictions will be adversely affected in the way of employment. Of course, it could be argued that a country heavily burdened by taxes and regulations should work to get rid of, or at least ease, that burden, rather than work to further block foreign competition. Nonetheless, such a country will suffer the loss of businesses and jobs if it removes its international trade barriers prior to easing its tax/regulatory burden. But as the list above clearly illustrates, not all factors are related to government interventionism.
The theory of comparative advantage asserts that, within any country, free trade will cause factors of production to be reallocated from economic sectors with a comparative disadvantage to economic sectors with a comparative advantage. But this process will break down if factors of production cannot readily reorganize. For example, if labor cannot easily move from an industry in decline to an industry on the upswing, due to mismatching skills, then free trade will lead to increasing unemployment. And that brings us into conflict with the assumption that full employment always exists in every country. The doctrine of comparative advantage not only assumes that workers and their skills are perfectly interchangeable, but also assumes that the up-and-coming industries will always be willing and able to immediately employ any and all displaced workers. Look around and see if that is happening in your area!
The corresponding assumption regarding the factors of production is that they are not internationally mobile. If they were, then productive resources would be located wherever in the world they could be used with the most relative efficiency. This international movement would optimize the world economy, but would not necessarily benefit a particular country, because it would have lost its comparative advantage to the country holding an absolute advantage. An assumption that may have been at least partially plausible during Ricardo’s time is no longer true today. As explained by economist Paul Craig Roberts:
• Transport costs are ignored.
• There is full employment in both countries.
• Costs are constant and there are no economies of scale.
• There are only two economies producing two commodities.
• Each commodity is of identical quality in both countries.
• Factors of production are perfectly mobile within each country, in order to allow production to be switched without cost.
• Factors of production are immobile between countries, in order to maintain each country’s comparative advantage.
• There are no tariffs, quotas, or other trade barriers.
• All buyers and sellers know where the cheapest commodities can be found at all times.
• Governments do not impede or distort the marketplace through their domestic tax and regulatory policies — or if they do, the two countries are equally impacted.
Flaws in Free Trade
Those assumptions (and that list is by no means exhaustive) lead to a number of significant flaws in Ricardo’s theory that are all too often overlooked or downplayed by its adherents and, therefore, the predicted benefits do not occur to the extent forecasted, when put into practice.
In fact, transport costs do enter into the final price of a product, and transport costs can vary greatly, depending on the weight or bulk of a product. Also ignored is the cost of economic damage done in the process of manufacturing something. A classic example is environmental pollution, which has an economic cost that is not reflected in the price. Goods from a country with lax pollution standards will be relatively cheap, relative to a country with strict pollution laws. Practicing free trade in such circumstances benefits a country such as China, but harms both itself and other countries, because pollution crosses national borders.
In addition, because of cheap products made in countries with lax environmental standards, countries with burdensome environmental restrictions will be adversely affected in the way of employment. Of course, it could be argued that a country heavily burdened by taxes and regulations should work to get rid of, or at least ease, that burden, rather than work to further block foreign competition. Nonetheless, such a country will suffer the loss of businesses and jobs if it removes its international trade barriers prior to easing its tax/regulatory burden. But as the list above clearly illustrates, not all factors are related to government interventionism.
The theory of comparative advantage asserts that, within any country, free trade will cause factors of production to be reallocated from economic sectors with a comparative disadvantage to economic sectors with a comparative advantage. But this process will break down if factors of production cannot readily reorganize. For example, if labor cannot easily move from an industry in decline to an industry on the upswing, due to mismatching skills, then free trade will lead to increasing unemployment. And that brings us into conflict with the assumption that full employment always exists in every country. The doctrine of comparative advantage not only assumes that workers and their skills are perfectly interchangeable, but also assumes that the up-and-coming industries will always be willing and able to immediately employ any and all displaced workers. Look around and see if that is happening in your area!
The corresponding assumption regarding the factors of production is that they are not internationally mobile. If they were, then productive resources would be located wherever in the world they could be used with the most relative efficiency. This international movement would optimize the world economy, but would not necessarily benefit a particular country, because it would have lost its comparative advantage to the country holding an absolute advantage. An assumption that may have been at least partially plausible during Ricardo’s time is no longer true today. As explained by economist Paul Craig Roberts:
The international mobility of factors of production is a new phenomenon. It permits first world businesses, seeking lower costs, greater profits, and a stronger competitive position, to substitute cheap foreign labor for the entire range of domestic labor involved in the creation of tradable goods and services. Only labor involved in non-traded goods and services is safe from foreign substitution. It is not yet possible to package hair cuts, surgical operations, dentistry or home repairs as internationally tradable services.
The known necessary conditions for free trade to be mutually beneficial do not hold in today’s environment where factors of production are as mobile, if not more so, than traded goods. What we are witnessing is not trade based on comparative advantage but the flow of first world factors of production to cheap Asian labor where the productivity of capital and technology is highest.
[I] do not dispute that global gains might exceed first world losses. Nevertheless, the flow of factors of production to absolute advantage in place of comparative advantage vitiates the case for free trade — that it produces mutual gains to the countries involved. What we may be witnessing is global capitalism destroying national sovereignties, leading to a global government.
The known necessary conditions for free trade to be mutually beneficial do not hold in today’s environment where factors of production are as mobile, if not more so, than traded goods. What we are witnessing is not trade based on comparative advantage but the flow of first world factors of production to cheap Asian labor where the productivity of capital and technology is highest.
[I] do not dispute that global gains might exceed first world losses. Nevertheless, the flow of factors of production to absolute advantage in place of comparative advantage vitiates the case for free trade — that it produces mutual gains to the countries involved. What we may be witnessing is global capitalism destroying national sovereignties, leading to a global government.
Thus we have the awkward situation that Americans experience today, when cheaper foreign-manufactured goods replace goods that used to be produced here: Corporations and investors like the higher profits, consumers like the lower prices, but workers don’t like the resulting job losses. Because most consumers are also workers, there is no guarantee that, under free trade, they will gain more as consumers than they lose as workers.
IOUs, such as corporate and government bonds. As the United States has moved from a manufacturing economy to a service economy, it has put itself into a precarious situation. Because we have not been willing to protect various manufacturing industries, America can no longer produce goods in sufficient quantities to offset the amount of goods that it imports. And much of what we do “produce” is not exportable: How does one export the output of a retail sales clerk, a fast-food restaurant server, or a bartender? With every month that goes by, we are told that America has racked up yet another monstrous trade deficit. Common sense should tell us that this situation is unsustainable because we have only a limited number of assets that we can sell off, and we cannot afford to service an unlimited amount debt. But based on the dogma of comparative advantage, that is what blind faith in unrestricted free trade has brought us.
While the theory of comparative advantage can be a useful tool for economic analysis, it is simply not logical to use it as proof that unlimited free trade all of the time with every country in the world is good for America. That could only be true if all of the associated assumptions about comparative advantage were actually valid in the real world, but they are not. In fact, the way the world works nowadays means that those assumptions move further away from reality with every passing day.
IOUs, such as corporate and government bonds. As the United States has moved from a manufacturing economy to a service economy, it has put itself into a precarious situation. Because we have not been willing to protect various manufacturing industries, America can no longer produce goods in sufficient quantities to offset the amount of goods that it imports. And much of what we do “produce” is not exportable: How does one export the output of a retail sales clerk, a fast-food restaurant server, or a bartender? With every month that goes by, we are told that America has racked up yet another monstrous trade deficit. Common sense should tell us that this situation is unsustainable because we have only a limited number of assets that we can sell off, and we cannot afford to service an unlimited amount debt. But based on the dogma of comparative advantage, that is what blind faith in unrestricted free trade has brought us.
While the theory of comparative advantage can be a useful tool for economic analysis, it is simply not logical to use it as proof that unlimited free trade all of the time with every country in the world is good for America. That could only be true if all of the associated assumptions about comparative advantage were actually valid in the real world, but they are not. In fact, the way the world works nowadays means that those assumptions move further away from reality with every passing day.
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