The Free-Traders' Blind Spot

[unlawflcombatnt]

THE FREE TRADERS' BLIND SPOT

Many economists appear to have a blind spot when it comes to free trade. Free trade advocates are like a religious cult. Their advocacy is based on pre-conceived theory with little regard for actual reality. They just keep chanting "free trade is good. Free trade is good. Free trade is good." Some economic theories are based on a carefully selected set of facts and concepts, while completely ignoring others. In addition, the application of some of these theories does not work in reality. This also seems to be ignored. The benefits of unrestricted free trade, along with unrestricted free flow of capital, is one such phantom belief.

The argument frequently used is that of "comparative advantage." Modern economists often ignore one important aspect of this theory. It requires that CAPITAL AND LABOR CANNOT BE INTERNATIONALLY MOBILE.

Let me repeat this. In order for the "Comparative Advantage" theory to work, CAPITAL AND LABOR CANNOT BE INTERNATIONALLY MOBILE.

Here is the quote from Paul Craig Roberts article regarding David Ricardo's original Comparative Advantage theory:

"For comparative advantage to reign, two conditions are necessary:

One is that capital and labor must be mobile within each country so that the capital and labor employed in England in the production of wine can flow into the production of cloth, where England’s trade advantage lies. In Portugal capital and labor must be able to flow from cloth to wine where Portugal’s advantage is greatest.

The other necessary condition is that capital and labor (factors of production) cannot be internationally mobile. If the factors of production are internationally mobile, capital and labor would move from England to Portugal, where both commodities can be produced the cheapest. Both wine and cloth would be produced in Portugal. Portugal would gain and England would lose.

Ricardo makes it clear that for trade to make both countries better off, trade must be based on comparative advantage. Ricardo gives reasons why, in his time, factors of production are internationally immobile.

Since the time of Ricardo, the key assumption of trade theory remains, in the recent words of trade theorist Roy J. Ruffin, "the inability of factors to move from a country where productivity is low to another where productivity is higher." In a recent article in History of Political Economy (34:4, 2002, pp. 727-748), Ruffin shows that Ricardo’s claim over Robert Torrens as the discoverer of the principle of comparative advantage lies in Ricardo’s realization that comparative advantage, the basis of the case for free trade, lies in "factor immobility between countries." Ruffin notes that "of the 973 words Ricardo devoted to explaining the law of comparative advantage, 485 emphasized the importance of factor immobility."

If factors of production are as mobile as traded goods, the case for free trade--that it benefits all countries--collapses. There is no known case for free trade if factors of production are as mobile as traded goods.

For some time I have been pointing out that the collapse of world socialism and the advent of the Internet have made factors of production as mobile as traded goods. Indeed, factors of production are more mobile. Capital, technology, and ideas can move today with the speed of light, whereas goods have to be shipped.

The collapse of world socialism has made Asian countries, such as China and India, receptive to foreign capital, and it has made first world capital willing to migrate beyond first world countries. The Internet makes it possible for a country to hire knowledge workers anywhere on the globe.

The Internet and the international mobility of capital and technology have, in effect, made labor internationally mobile, especially labor that is paid less than the value of its marginal product or its contribution to output. The huge excess supplies of labor in countries such as China and India ensure that it will be many years before labor in those countries, both skilled and unskilled, will be paid the value of its marginal product.

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.

Many people confuse the workings of capitalism that lead to lower costs and greater profits with free trade. They overlook the necessary conditions for free trade to be mutually beneficial. The same people tend to confuse the free flow of factors of production with free trade. I have been amazed at the number of fierce adherents of free trade, even among economists, who have no idea of the necessary conditions on which the case for free trade rests..."

The following is the link to the article:
http://www.mises.org/fullstory.aspx?control=1420&id=64

It truly is amazing that economists constantly regurgitate the free trade mantra, and attempt to support it by misapplying the "comparative advantage" theory.

A big problem with some economists is that they "miss the forest for the trees." They often develop complicated mathematical equations to explain theories that don't make any sense. It's almost as if they try to prove mathematically that the sky is red, instead of blue. Then they ignore the fact that most non-economists agree that the sky is actually blue.

I'm going to take a stab at disproving the benefits of unrestricted "free" trade, using a simple equation -- the GDP equation. I think economists will agree that it goes as folloows:
GDP=Consumption+Invstmt+GovSpending+TradeBalance

If applied globally, "trade balance" should be zero (unless Martians are buying some of our goods.) Therefore, this should be the "global" GDP equation:

GlobalGDP=GlobalConsumption.+GlobaInvestmnt+GlobalGovtSpending

Economists state that consumer spending, or consumption, is 2/3 of all economic activity. Thus, global consumption is 2/3 of all global economic activity. It's the generally accepted consensus that consumer income is the biggest determinant of consumer spending. Logically, it is essentially the only long-term determinant of consumption. (Consumption financed by borrowing cannot last indefinitely) Thus, global income is the biggest determinant of global GDP. If the aggregate loss of American wages is not compensated for by aggregate foreign wage increase, global income goes down. So does global GDP.

How does global income decrease affect the remaining factors? Let's start with global investment. Global investment will not make any real contribution to GDP if global consumer spending declines. Increased investment is supposed to increase production. If global income falls, so does global demand for production. If global demand falls, there is NO benefit to increased investment. There is no need to build more production facilities or provide more services, if there is no demand for them. Excess "investment" would simply go into corporate coffers, in the form of CEO salaries, stock holder dividends, "cash-on-hand" and bank accounts. In actual reality, as opposed to economists' "pseudo-reality," this investment would add absolutely 0 to global GDP in the long-term. (It's mis-allocated money that would have contributed to global GDP, if it had it gone toward global consumer spending.)

How about government spending? Government spending is financed exclusively from taxes. Taxes subtract directly from private wealth. Thus, government spending reduces private wealth, dollar-per-dollar. However, the "marginal propensity to consume" concept needs to be considered here. ( Which basically states that the more affluent devote a smaller percentage of their wealth towards consumption. The more affluent they are, the smaller the percentage.) Taxes on lower income individuals reduce consumption more than those on higher income individuals. Taxes directed mainly at consumers, such as sales tax, reduce consumption spending dollar-for-dollar. In contrast, taxes on corporations primarily reduce investment spending. Thus, the type of taxation affects how much it subtracts from consumer spending. But it is clear that government spending subtracts significantly from consumer spending. In addition, reduced consumer income reduces the money availabe for taxation. Government spending cannot make up for consumer spending reduction. Not only does it depend on consumer income, it subtracts from consumer spending.

In summary, the global GDP equation is almost overwhelmingly dependent on global consumer income. Labor cost reductions reduce global income, and global GDP. When $90/day workers are replaced with $2/day workers, global consumer income drops. Global consumer spending then drops as well, further reducing global demand for goods and services. The increased profits made from the labor cost reduction do NOT help the world economy. The increased investment capital that results has NO benefit when global consumption drops. It merely provides a short-term gain in profits, at the expense of a long-term loss in global GDP. Unfortunately, many economists DO have a blindspot to this simple mathematical reality.

unlawflcombatnt

EconomicPopulistCommentary

http://www.unlawflcombatnt.blogspot.com/

_____________________________
Investment does NOT create jobs. It only "allows" for their creation. Increased Demand for goods creates jobs, because it necessitates hiring of workers to produce more goods. Investment "permits" job growth. Demand necessitates it.

Building a factory does NOT create jobs. Demand for production DOES create jobs. Goods are not produced if there is no demand for them. Without demand for goods, there is no demand for workers to produce them. Without demand, no amount of investment creates jobs.

[ebayfool]

1. kick & recommended!

Okay, now I can read this (laid out elegantly & simply, thank you!) & get it it. So why does the government-bighead-guys & corporations have such a hard time 'getting it'? Less workers = less demand = less taxes, profits, manna for the fat cats? How do they get that outsourcing (to cut their costs) result in a growing demand for the products? Doesn't help to cut costs if no one can afford to buy when their jobs are gone to another country or downsized (less pay).

Do you institute tariffs to protect local industry, cut out the tax breaks for those that take them to another locale?

'Free trade' as described will leave fewer consumers, & I don't think these guys are gonna keep their profit margins growing just selling to each other LOL!

Welcome to DU, unlawflcombatnt. I'm off to see your blogsite!

on edit: First thing on the site - BOOM! Catches the eye! You are a fine addition to DU, please post often. Demand-Side Economics ... I love it!


snip/

Unlawfulcombatant: Economic Populist Commentary

Economic commentary by a pro-capitalist, economic populist. Demand-Side Economic theory. Consists of author's economic views. Questions & comments appreciated. Dissenting posts are VERY welcome. Only "agenda" is prevention of an economic Armageddon. Encouraging open discussion of US economy.

[tech3149]

2. Glad to see this back again

It's a good story to recirculate.

[allemand]

3. Both mises.org and Paul Craig Roberts are very right-wing.

I'd prefer the more differentiated view of globalization and free trade that you can find in the recent writings of Joseph Stiglitz (or, a bit more radical, Ha-Joon Chang). Even Paul Krugman's idea of globalization seems to be developing.

There is a huge difference between free trade and free capital mobility which was the main cause of the Asian financial crisis.

[unlawflcombatnt]

9. Free Trade vs. Free Capital Flow

You're so right about that difference. I tried to make that point in my post. Though I like Paul Krugman, I have not liked his free trade positions. He has been fairly pro-free trade in the past. If his position is changing, I'd like to hear about it. It seems like the shear logic of the pitfalls of unrestricted free flow of capital would be overwhelming. It just allows for exploitation of the most exploitable workers on the planet. It takes advantage of workers who are too impoverished to be aware of their exploitation. And in order for American workers to remain "competitive," they need to be able to tolerate the same exploitation. Should we re-train Americans to live like slaves, so they can compete with foreign labor? In my opinion, a better idea is to re-train CEOs to live on less that $50 million a year. Maybe we can re-train the most affluent that everyone can't be a millionaire. (The less affluent already know this.)

unlawflcombatnt

EconomicPopulistCommentary

http://www.unlawflcombatnt.blogspot.com/
_____________________
Investment does NOT create jobs. It only "allows" for their creation. Increased Demand for goods creates jobs, because it necessitates hiring of workers to produce more goods. Investment "permits" job growth. Demand necessitates it.

Building a factory does NOT create jobs. Demand for production DOES create jobs. Goods are not produced if there is no demand for them. Without demand for goods, there is no demand for workers to produce them. Without demand, no amount of investment creates jobs.

[robcon]

4. The thesis you propose is totally invalid - almost preposterous.

If all factors of production were freely mobile, there would be no international trade.

If we could grow bananas in Minnesota, or wine grapes in Alaska, or dig up iron in Puerto Rico or coal in Brazil, or grow coffee in Ireland, or attract ocean-seeking tourists to Switzerland, or grow pine trees in the Sahara, for example, there would be no need for international trade.

This is counter to the truth. International trade is the only way to provide goods to the world. Free trade is the best solution for maximizing income, employment, prosperity and world peace, IMO.

[unlawflcombatnt]

6. "Preposterous" Thesis?

The "comparative advantage" theory, as proposed by David Ricardo, requires that factors of production (and capital) be internationally IMMOBILE. The theory is INVALID if there is free, international movement of capital and factors of production. This is not my "thesis," it is the thesis of the British economist who proposed the theory. Though the unrestricted free flow of capital and "factors of production" was not really possible in his era, Ricardo realized that such free flow would invalidate his theory. This would have been even more apparent, had he envisioned production factors being relocated strictly to reduce labor costs. Ricardo stated that factors of production must be mobile within a country, but NOT moveable out of the country. Whether he was aware of it or not, the movement of production factors internationally results in movement of labor & consumer income internationally. Moving that income internationally, when done exclusively to reduce labor costs ( and wages), reduces global ability to buy production.

Corporate America has continued to use the "comparative advantage" theory to justify outsourcing. Such misapplication is dishonest, opportunistic, pseudo-economic mythology. This deception is the product of the economists who are paid by Corporate America, as well as the pseudo-think tanks they have created to distort economic thinking.

Historically, domestic industry's labor supply was limited by that country's borders. A limited labor supply maintained labor price ( and wages). Thus, the limitation on labor supply forced employers to pay higher wages. These supply limitations prevented industry from destroying their own domestic market. It maintained the number of those working, and kept their average wages. These domestic wages provided the income that purchased that country's production. Thus, by keeping jobs in their own country, they maintained consumers' ability to buy their own production.

When production factors and capital became internationally mobile, it allowed industry to shop globally for the lowest-wage workers. As I previously stated, replacing a $90/day American worker with $2/day foreign worker, reduces global labor income by $88. This constant flow of production factors to the most impoverished countries leads to global reduction in aggregate wages. This DECREASES the size of the global consumer market. Markets are NOT determined by the NUMBER of consumers, but by their aggregate income. Decreasing aggregate American wages decreases the size of the American consumer market. This doesn't increase economic "growth," it reduces it. Less aggregate American income causes less aggregate consumer demand. It reduces the dollar-value of goods that can be purchased. It reduces the domestic market for American production, as well as the market for foreign imports. This helps no one. Again, profits are NOT made by producing goods, they're made by SELLING goods. Reducing consumers' abiltiy to buy products shrinks our economy.

Outsourcing is bad for America. Justifying outsourcing with the "comparative advantage" theory is simply economic chicanery. Outsourcing hurts American workers. It hurts the rest of the world as well. Though it may increase Corporate America's short-term profits, it will ultimately destroy it as well. Sale of products is necessary for profits. Will Corporate America continute down the road to self-destruction? Will it cut off its nose to spite its face? Only time will tell.

unlawflcombatnt

EconomicPopulistCommentary
http://www.unlawflcombatnt.blogspot.com/

_________________________
Investment does NOT create jobs. It only "allows" for their creation. Increased Demand for goods creates jobs, because it necessitates hiring of workers to produce more goods. Investment "permits" job growth. Demand necessitates it.

Building a factory does NOT create jobs. Demand for production DOES create jobs. Goods are not produced if there is no demand for them. Without demand for goods, there is no demand for workers to produce them. Without demand, no amount of investment creates jobs.

[Solon]

8. We're not talking about all production...

but production of refined products. This excludes resources that are geographically limited(mines, oil fields), and also food sources dependent on certain climates. If free trade is to work, then it should be limited to those particular items and resources, refined products, however, are different. Rings aren't made where the diamond and gold mines are located, neither is oil refined in Saudi Arabia for the United States to use. As far as the evidence suggests, the most free trade has to offer, as practiced right now, is causing the middle class to disappear, worldwide, and permanently impoversioning the poor in third world countries, mostly in Central/South America and Africa.

Even more atrocious is this, in many of these places, while it was no paradise before, at the very least, there were substinence farmers. Now, they are practically outlawed, and boys and girls as young as six years old, from these families, are now forced to work over 12 hours a day to provide one meal a day for the family. That's progress?

[atommom]

5. Very interesting. Thanks for reposting!

I've also bookmarked your blog. Welcome to DU!

[emcguffie]

7. Lou Dobbs gets this.

I'm not a great fan of Lou Dobbs, but this is something he understands.

[ebayfool]

10. kick n/t