Incite -- (v) 1: give an incentive; 2: provoke or stir up; "incite a riot"; 3: urge on; cause to act
Tuesday, March 16, 2004

Rethinking "Free" Trade?
Written by: Answerman

Recent debates over steel tariffs and outsourcing certain IT jobs to India, as well as Democratic Senators Kerry's and Edwards' craven willingness to ride the populist, protectionist bandwagon when they see a political advantage in doing so, have called into question the theory of "free trade" that had come to dominate thinking in respectable economic circles by the 1990s. Because I have always believed in that theory, and yet always have an instinctive distrust for any theory that dominates thinking in "respectable circles" of any sort, I would like to take this opportunity to begin to rethink the whole issue.

I want to confine my rethinking largely to the economic realm. In my view, it goes without saying that despite the economic merits of free trade, the cultural and foreign policy tradeoffs of such a policy can be and have been devastating. Witness the demise of rural America and the economic stagnation of several states and communities throughout this country during the past several decades, as so many people have crowded into a handful of cities that sustain our orgiastic "New Economy." Witness the blow to American national interests that was the Congressional grant of Most-Favored-Nation status to Communist China.

But what about the economic theory itself? Is it still valid? Does it require revision in light of 200 years of history and, necessarily, contextual change? After all, we live in a very different world, based on very different assumptions, than did Adam Smith.

Free trade has always been based on the principle of comparative advantage. Comparative advantage requires two conditions to operate: (1) a country's factors of production must seek comparative advantage within the country and not move to absolute advantage abroad; and (2) countries must have different relative costs of producing different goods (Credit: Paul Craig Roberts). It strikes me right off the bat that the second condition may no longer obtain in the modern world economy. Climate and natural resources are not the important components of GDP that they were in Adam Smith's day; today, institutionally-acquired knowledge seems a much more important component. And institutionally-acquired knowledge is not limited by geography. As a result, modern production operates more or less the same regardless of location. Given this state of affairs, it seems to me that there is no necessary reason for relative production costs to vary from one country to another.

If relative production costs must not vary, then it follows that only absolute costs vary, according to what I will call "artificial" variables such as labor costs. If this is true, then countries with some form of an industrial policy can manipulate such variables (as it seems they do; witness China) to wrest control of whole industries from countries that cling blindly to their faith in free trade. These countries gain an ever-increasing share of the world's production, resulting in an ever-increasing share of the world's income.

But the free trader's response is, "Sure, such countries increase their share of the current pie. But the pie doesn't remain constant, and in fact free trade causes the pie that is the world's income to increase exponentially, drowning out any relative losses for the free trading country associated with other countries' increasing shares of the current pie." This response raises two points in my mind. First, can we see some empirical proof? It seems that the question is easily answered based on empirical study, and I can't say that I know the answer. Second, if shares of even the increased pie go disporportionately to countries with an industrial policy, then the free trading country is likely worse off depsite the increase in the overall pie. I guess what it comes down to in my mind is: How can we say that America exporting jobs, capital, and technology abroad is an unqualified good thing? What do we get in return? And is what we get in return such an advantage, and such an immediate and necessary consequence of 100% adherence to free trade dogma that these types of questions aren't even legitimate in the first place? I don't know the answers to all these questions, but I'm fairly certain that the answer to the last one is a clear "No." That's why this is an important subject of debate this election year. Too bad John Kerry is the crappy vehicle through which it's going to have to be raised.

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