The Free Trade Debate

by Eric Balkan

Debate, what debate?  Doesn’t everyone agree that free trade is a good thing?  Isn’t a borderless global economy inevitable?  Well, no.  Free trade — the unrestricted movement of money, goods, and services among countries — has been debated for some 200 years.  But the issues involved are not very well known.  Nor has there been much attempt in the popular media to honestly explain them. I’m going to try and do that.  I have my own biases — I’ll tell you upfront I don’t think much of free trade — but I’ll see if I can present the pros and cons well enough that readers will be able to make up their own minds.  (Or at least do a better job than the many online articles that largely ignore anti-free trade arguments.)

By way of background:  I studied economics in college, years ago, back when I was a libertarian, and have read a lot of economics papers, journal articles, and books, especially over the past year or so, but I’m not a professional economist.  Some may consider that a plus, as a position in favor of free trade seems to be a litmus test for a career in mainstream economics in the US.  Be that as it may, let’s start with some historical background, common definitions, and assumptions that will be helpful in understanding the debate.

Economic policies, as well as a lot of other decisions, can be made using either deductive or inductive methods.  With deductive methods, you start with core beliefs — presumptions — and then logically deduce your conclusions.  Because your beliefs affect how you see the world, you often end up “proving” your conclusions by hunting for data to support them, and literally not seeing any data that don’t support them. Typically, deductivists never change their minds about their positions, because that would mean looking at data that’s not in accordance with their conclusions.

With inductive reasoning, sometimes known as scientific method, you start by making observations, analyzing them, then drawing conclusions from the analysis.  You then continue making observations to see if your conclusions hold up.  Even better, if your conclusions can predict future observations.  If the conclusions don’t hold up, you must either modify them or discard them, and continue with the process.  This can produce a lot of flip-flopping as the data changes.  E.g., corn oil margarine was once considered good for you, until new data showed it actually wasn’t.  This is a difficult process, as few people can admit they’re wrong.

For 200 years, economics has been a battleground between deductive and inductive reasoning.   On the deductive side, leading thinkers include David Ricardo, Carl Menger, Karl Marx, Alfred Marshall, Leon Walras, Ludwig von Mises, Friedrich von Hayek, Paul Samuelson, Milton Friedman, Alan Greenspan.  On the inductive side, you have Adam Smith, Gustav Schmoller, Thorstein Veblen, John Maynard Keynes, JK Galbraith, and less well-known names, of whom my own favorites include Jared Bernstein and Richard Layard.  (I put Samuelson, Friedman and Marx in with the deductivists because, even though they collected observations about the real world, they filtered those observations through a frame of reference set by presumptions and theory.)

The deductive method is the one used by what is now referred to as “mainstream” or libertarian economics, and which consists primarily of the neo-classical and Austrian schools of thought.  (Please note that the converse is not true — all deductivists are clearly not libertarians, it’s just that they all share the same desire to explain the world via rules.)   Libertarian economics basically starts with an interpretation of what Adam Smith — the “father” of capitalism — had written in The Wealth Of Nations, continues with David Ricardo’s theories, including his theory of free trade called the Theory of Comparative Advantage, and then on into the mathematical modeling pioneered by Marshall and Walras, and taught to multiple generations of economics students via successive editions of the Samuelson textbook and its clones.

A lot of the impetus towards the use of math came during the explosion of thinking in physics and hard science in the 19th century.  Many economists felt that economics too, could be a hard science.  That there ought to be a set of principles governing the economic behavior of human beings, as there was for governing the behavior of atoms.  The side effect of using math this way is that you end up with a mechanistic and reductionistic view of the world, being forced to discard whatever you can’t provide math for.

Now to free trade.   Ricaro’s Theory of Comparative Advantage, some 200 years old, but still considered the basis of neoclassical free trade thinking, is simple at its heart.  It starts from the assumption, as all modern neoclassical theory does, that economic efficiency is the primary goal of economic policy and philosophy.  Maximum efficiency would occur with the kind of job specialization that Adam Smith had written about, but taken to a national level.  That is, if a country is ideal for producing cotton, and another country has an advantage in building and operating textile mills, then each should concentrate on what it does best, and not try to compete with the other.

Ricardo lived in 19th century Britain, which at the time was engaged in both a massive colonization of the world in order to obtain raw materials, and a massive industrialization of its own economy.  Ricardo’s theory was a perfect match for what Britain was already doing.  And it was completely logical.    As the Economist magazine has said, talking about another theory:  It doesn’t matter if a theory has no facts to support it, the theory should not be rejected if it’s based on impeccable logic.

It’s possible to write an entire book about what’s wrong with Ricardo’s theory, but I’m not going to do that here.  I’ll just go over the highlights, and then we’ll go on to the other arguments in favor of free trade, including the argument from inevitability, the argument about potential trade wars, and the libertarian concept of maximizing freedom.

The criticisms of The Theory of Comparative Advantage include:

1 – Ricardo assumed that money does not move across borders.  That is, a country with an advantage in building factories because it had the money to do so, would not need to worry that its investors would simply move their money to another country, perhaps where labor is cheaper, start up factories there, and so destroy the original advantage of the home country.  Critics like economist Herman E Daly note that this assumption doesn’t hold up.

2 – Historical data seems to indicate that what looks like a natural advantage is often only related to who got into a market first, as the Swiss did with cuckoo clocks.  There doesn’t seem to be anything in particular about the Swiss national character, or their geography, that would account for their domination of the cuckoo clock market.

3 – Government policies can create an advantage for a particular industry in a country by focusing its efforts in that industry, and by absorbing any startup losses.  E.g., Japanese government policy re steel and automobile industries, starting decades ago when they realized the dominant US companies were vulnerable.

4 – A comparative advantage, and lower costs, can be obtained by unethical means, e.g., forced labor, piracy (of physical goods or intellectual rights), war.

5 – Comparision of the relative costs of a product produced in one country vs another takes into account only what economists call internal costs, and not external costs.   That is, the price paid for a Chinese lamp by a consumer at Walmart versus the US-made lamp formerly available does not take into account the cost of unemployment of the formerly-employed US workers, the global environmental damage caused by the Chinese manufacturer, or the additional risk of using the product given the lower state of product safety and testing in China.

As part of neoclassical theory, the free trade model also has to contend with objections to neoclassical theory in general:

1 –  As economic efficiency is the main goal of neoclassical economics, “softer” goals like the general happiness of society are ignored.  Studies show that unemployment has a much more deleterious effect on a society than lower consumer prices have a benefit.  But things like unemployment, ecological damage, damage to family relationships from employee relocation, are not counted by neoclassical economists because, simply, there is no way to quantify them and so they can’t be plugged into a mathematical model.   French economist Leon Walras is reported to have said:  if you can’t model something mathematically, it’s not worth studying.

2 – The nature of mathematical modeling is such that it works best with a closed system.  E.g., you need to know what all of the inputs are in order to create the model, and then keep anything else in the real world from affecting the system. But in the real world there are billions of potential interactions, many with unpredictable results.  They can’t all be turned into variables, and they certainly can’t all be prevented from affecting the system you’re studying.  In other words, closed systems don’t actually appy to real people.  Which means the models don’t apply to real people.  Psychologists have done studies with real subjects that have produced entirely different results than what was expected from mathematical models, including those using the Nash Equilibrium.

3 – Neoclassical theory is based on a concept of individuals acting in their own rational self-interest, making choices that maximize the value to themselves.  (Competing theories say the world is uncertain, and information is unevenly distributed, so less-than-optimum choices are often made.)  Numerous psychological studies have not supported this concept of rational self-interest.  People often act on behalf of their family or group, rather than individually, and often on a basis of fairness rather than self-interest.  Further, neurological studies have shown that people use both their rational and emotional neural circuits at the same time, in making a decision.

To be fair, I have to say that many neoclassical economists do allow a role for the government in the economy.  But they don’t seem to extend this to trade, which they still view as an all-or-nothing, black-and-white issue when it comes to government intervention.

The arguments in favor of free trade don’t stop with Ricardo, of course.  Let’s start with the libertarian argument that government is the problem, and not the solution.  Libertarians believe in maximizing individual freedom.  To do this, they espouse laissez-faire capitalism, in which the government only serves to provide a police/legal function, and possibly national defense.  Under this theory, any government regulation of trade is wrong on its face, because it introduces government into the private sector.  In its extreme form, espoused by Friedrich von Hayek in “The Road to Serfdom”, any government intervention into the economy is collectivism, and any little bit of collectivism leads to totalitarianism.   I don’t recall, when I read this years ago, if Hayek made an exception for public libraries or city fire departments, but you get the drift.  (Actually, New York City fire departments were once private, but after too many houses burned down while competing fire companies argued about who would be paid, the City took over that function.)

LIbertarianism doesn’t do well when measured against history.  The US followed a very libertarian path in the 19th century.  But for various reasons, such as labor unrest, financial panics,  unhealthy/unsafe living conditions, Americans largely came to believe that there was a proper place for government in the economic sphere.  I say “largely” because there is still a strong undercurrent of libertarianism in the US, especially among economists.

In terms of free trade, the libertarian approach, for instance, is not for the government to be proactive in preventing unsafe products like lead-based painted toys to enter the US, but for consumers to sue the vendor of those products after the damage, if any, has been done.  This eliminates, according to libertarians, expensive recalls of entire product lines when perhaps only a few items are affected.   The idea here is that if vendors are successfully sued by the victims, or by the relatives of the victims if deceased, they will make their products safer.

The criticisms of libertarian economic policy, again, could fill a book.  But here are some highlights:

1 – It requires giving human life a value (for court judgments).   In the infamous Ford Pinto exploding gas tank case, Ford did a cost-benefit analysis showing that spending $11 per car would cost more than the legal settlement at $224,000 a pop for each of an expected 50 people dying in fires caused by rear-end collisions.  So Ford didn’t spend the $11. (This kind of CBA often accompanies libertarian economic thinking.)   Ford felt justified in making this decision.  However, this kind of thing — where people die needlessly through no fault of their own — doesn’t sit well with the public’s sense of fairness.  The libertarian response to this might be that Ford should have figured in the additional cost of their internal documents being leaked and their getting unwanted negative publicity.  So their CBA should have taken this into account, and used different numbers, which might have produced a different decision.  Yet, I think most people would feel that’s not the right answer.  (As an aside, it can be very difficult to even make a court case when a product has a very slow effect on health, such as tobacco does.)

2 – Libertarianism leads to a concentration of economic and political power into fewer and fewer hands, producing a kind of oligarchic system that some have called “corporate mercantilism”, as opposed to the free market capitalism libertarians originally intended.  In The Wealth of Nations, Adam Smith had disparaged multi-national corporations, like the British East India Company, for doing just what multi-national corporations do today — restraining trade.  Modern defenders of libertarian economics don’t seem to have noticed that corporations try to reduce competition, not increase it.  And, as Smith noted about the British East India Company, they pursue profit in the nearly complete absence of any ethics.   Interestingly, common sense sayings like “He who has the gold, makes the rules” seem to have escaped libertarian economists.

3 – The free market has no provision for resolving problems that society has to face as a whole.  That’s why libertarian economists make an exception for national defense — it wouldn’t make sense for everyone to arrange his own defense.  Libertarian economists also need to make a similar exception for ecological damage.  But, instead, the thinking seems to go something like this:  given that the free market can solve any problem, and there is no free market solution for global warming, ergo, global warming must not be a problem.

Sidebar:  neoclassical economics is very much related to neoliberal politics.  That phrase is used more outside the US than in, but it’s a useful phrase.  It’s related to “classical liberalism” and to libertarianism, but whereas libertarian economics inadvertently degrades into corporate mercantilism, neoliberals welcome corporate mercantilism as a good thing.  They approve of multi-national corporations, and even the neoconservative policy of the government aiding MNCs.  Inequality is good.  Greed is good.  Many neoliberals derive much of their income from investments, as opposed to wages, so it’s not hard to see where they’re coming from.

But maybe free trade, despite its theoretical flaws, actually works?  Well, no. For some 30 years, the World Bank and the IMF have provided assistance to countries in need on the proviso that they adopt free trade policies. But the World Bank has admitted this hasn’t worked well.  Others say that this is putting it mildly, that it’s been a disaster, e.g., the documentary “Life and Debt”.

I said earlier I would cover the bugaboo of trade wars.  Since the start of the US, the federal government has protected “infant industries”, a term coined by the first Secretary of the Treasury, Alexander Hamilton. It’s also protected a lot of other industries.  Through much of the 19th century, when Britain had zero tariffs — no tax on imported products — the US had tariffs of 30-50%, much higher than today.  In 1930, the US Congress, worried about a coming depression, passed the Smoot-Hawley Bill which raised tariffs.  According to libertarian analysts, other countries followed suit and this deepened the coming depression.  That seems like a fairly speculative statement.  If we stick to the facts, we note:

– By 1929, the year of the stock market crash, the US had gotten caught up in a feeling of irrational exuberance, to borrow a phrase.  For instance, despite the fact that pretty much every family in the US that could afford to operate a car already owned one, Ford was still rolling cars off their assembly lines at full speed.  It’s not like there was a big export market either, as Europe had its own car companies and the undeveloped world couldn’t afford them.  Ditto for radios, locomotives….   The market for these products was no longer there, and so layoffs were inevitable — thus further reducing the market, as unemployed people with no unemployment compensation don’t spend much.  On top of this, many people were speculating in the stock market on 5% margin, meaning that their money could be entirely wiped out by even a small drop in stock prices, which was inevitable once sales stopped growing.  Then, after the Depression got underway, libertarian economists insisted that the government not take any action — that this was a problem of people not saving enough money, as opposed to the obvious problem being that they weren’t spending and investing enough.  Eventually, WWII broke out, the government was forced to spend and to provide people with jobs, and the Depression ended.  That’s an oversimplification, but I think you can see deductivist thinking at work where only facts in accordance with a particular theory are considered, and any other facts are ignored.

– Japan has always had very high tariffs, but no one has engaged them in a trade war.  Also, none of the Asian economies, except South Korea, has a free trade policy.  For instance, the Chinese government owns 50% of most of China’s largest companies, the SOES.  That hardly describes the free trade model, where government keeps out of the economy.

– The US has put a 49 cent a gallon tariff on Brazilian ethanol, to protect our own ethanol producers.  This hasn’t sparked a trade war either.   If I may make an observation, it appears that we have tariffs on products that help the largest corporations, especially agri-business, and low or no tariffs where it would hurt those corporations.  That’s not really free trade.  The trade war argument seems to serve a boogeyman function.

Now we’re down to the final argument in favor of free trade:  the case for the borderless economy.  (Well, if you think of other arguments, email me.)   There is an ongoing debate between proponents of a global economy and those favoring the localized economy.  I won’t get into that here.  Let’s just assume for the moment, just for purposes of discussion, that globalization is the toothpaste that can’t be put back into the tube.  The question then becomes: should globalization be monitored and regulated, or should it be borderless, with unrestricted movement controlled not by governments but by commercial entities, i.e., MNCs.   Illegal drugs are essentially borderless already. Despite a huge expenditure over the years, the US hasn’t been able to do much to stop it.  Ditto for illegal immigration.  Even though it’s harder to hide people than drugs, the government doesn’t seem to have stopped this flow any better than the one for illegal drugs.

Well, if borderless flows can’t be completely regulated, is it worth it to just try and regulate them as much as possible?  It does, in a social contract (i.e. cooperative agreement) type of society where the public chooses what kind of society it wants to have, and uses the government to establish rules that at least try to create that society.

If you opt for for a social contract in which people understand they must compromise with each other in order to live together, and decisions should be made on what’s fairest for everyone, then a trade model that puts people out of work, allows dangerous products into the country, allows foreign manufacturers to make more money the more unethical they are…  Well, that can’t possibly be a good idea.  And if it’s not a good idea, it should be opposed, even if the battle is uphill all the way.

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