Free Trade Fallacies

Ross Gittins has decided to publish a piece praising economic orthodoxy, an unfortunate change from his recent healthy scepticism.  Perhaps his tongue was firmly in his cheek: I hope so.

This led him to restate the theory of comparative advantage as a justification for free trade.  To assert the relevance of this theory requires ignoring history and a great deal of relevant research.  One example of this research is Michael Porter’s The Competitive Advantage of Nations, published in 1990.

One would think that 25 years is long enough for facts to influence economic discourse, but apparently not.

Porter makes it clear that comparative advantage refers to “factor economies”.  Comparative advantage reflects natural endowment, like Australia’s deposits of iron ore.  It would make very little sense for Australia to import iron ore, and it doesn’t.  As  Porter makes it clear, trade flows based on comparative advantage are a small fraction of total trade, and an even smaller fraction of global output.

The economies of the modern developed world are dominated by competitive advantage, advantages created by deliberate policy choices and government action.  Such actions may include the use of protective tariffs, import quotas and purchasing preferences.

Ricardo’s explanation of his theory of comparative advantage used the example of Portugal, with a climate suitable for winemaking, and England.

Ricardo “proved” that the Portuguese were better off sticking to wine making and importing all their manufactures from Britain.  He argued, and most economists today argue, that this held even if Portugal could have developed an efficient manufacturing industry.  Its advantage over England in winemaking was greater than any possible advantage over England in manufacturing, and so using its comparative advantage meant sticking to wine.

Two hundred years after Ricardo offered his theory Britain is an affluent country while Portugal remains a poor one.  Portugal still makes wine.

The German economist Frederich List profoundly influenced German and American trade and industry policy in the nineteenth century.  The world’s most powerful economy is the USA; the world’s most technically advanced, Germany.  Both spent the nineteenth century building their domestic industry behind protective tariffs and other measures of industry policy.

List ridiculed Ricardo’s argument as no more than an English attempt to keep other countries in a state of relative poverty:

It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, in order to deprive others of the means of climbing up after him. In this lies the secret of the cosmopolitical doctrine of Adam Smith, and of the cosmopolitical tendencies of his great contemporary William Pitt, and of all his successors in the British Govern­ment administrations.

Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth.

The present Australian government managed, in a few weeks, to initiate the destruction of the motor car manufacturing industry in this country.  This reversed policies pursued by Australian governments of all persuasions for the last ninety years.  Economists applauded: Australia can now exploits its comparative advantage in coal and iron ore.  Or can it?

Australia’s facts reveal the critical flaw in Ricardo’s theory.  He assumed that the world would want so much Portuguese wine that the Portuguese could sell every drop that they could produce.  Unfortunately for Australia, the world is already buying all the iron ore and coal that it needs.  The resources “freed” by destroying the car industry won’t get taken on by the miners.

The equipment in the car factories will be scrapped or shipped off shore.  Some of the workers will find low paid casual jobs but a lot of them will wind up on the Disability Support Pension with depressive illness.  The Australian trade deficit will increase until the currency collapses, raising the price of imported cars way above the present level.

And this is a good thing?

Leave a Reply