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Mikah
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24 Oct 2019, 10:23 am

Ricardo’s Vice and the Virtues of Industrial Diversity
Steve Keen August 2017

https://americanaffairsjournal.org/2017 ... diversity/

That specialization is the primary source of economic gain has been accepted by economists ever since the famous example of the pin factory with which Adam Smith opened The Wealth of Nations:

One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; . . . ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. . . . But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day.1

David Ricardo extended Smith’s vision of specialization within a given industry to specialization between industries and nations, and made the argument that two countries can benefit from free trade even if one country is absolutely less competitive in both industries than the other. In his hypothetical example, Portugal could produce both cloth and wine with less labor than England. If England specialized at the industry it was comparatively better at (cloth, obviously) and Portugal specialized in wine, then the total output of both industries would rise.2

This concept of the advantages of specialization became the core insight of economics, and it continues to be ingrained in and promoted by economists today. Lionel Robbins’s proposition that “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”3 is the dominant definition of economics. It implicitly emphasizes the importance of specialization, so that those “scarce means which have alternative uses” can be efficiently allocated to achieve the maximum level of output.

This belief in the advantages of specialization lies behind the incredulity with which economists have reacted to the rise of populist politicians like Donald Trump in the United States, as well as the United Kingdom’s vote for Brexit. They have, at their most self-righteous, blamed the rise of anti-globalization sentiment on the public’s irrational failure to appreciate the net benefits of trade. Or, more commonly, they have conceded that perhaps the electorate has reacted negatively because the gains from trade have not been shared fairly.

There is, however, another explanation for why anti–free trade sentiment has risen: the gains from specialization at the national level were not there to share in the first place, for sound empirical reasons that were ignored in Ricardo’s example. That ignorance has been ingrained in economics since then, as Robbins’s definition—dominant and superficially persuasive, but fundamentally limited—gave economists a starting point from which they could not properly perceive either the advantages or the costs of globalization.

Deus Sine Machina

Robbins’s definition codifies arguably the most egregious oversight in economic theory. It omits a realistic treatment of resources that do not “have alternative uses,” by which the great wealth of modern society has been created: machines. Today, with 3-D printers, increasingly adaptable robotics, and the beginnings of AI, we can contemplate the eventual creation of a single machine that could be deployed across a range of industries. Yet for the foreseeable future, most machines are tailored for specific tasks in specific industries and are useless in any others, as was also the case in the distant past when the theory of comparative advantage was invented. Smith acknowledged the need for specialized machinery in pin production (and attributed the development of that specialized machinery to the division of labor itself, though it can just as easily be argued that the specialization of machinery is what gave rise to the specialization of labor):

A workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty.4

Ricardo also acknowledged the need for machinery. But in considering not one industry but two, Ricardo assumed a crucial and false equivalence between physical machinery and monetary capital that has bedeviled economics ever since: he treated the specialized machinery in different industries as if it were equally as liquid (and so could be as easily repurposed) as the money with which it had been purchased.5

The gain from trade arose, Ricardo asserted, because of different production technologies in different countries (whether that was due to different labor skills, different weather, or different machinery).6 These differences could not apply within one country, but did apply between them, so that “the produce of the labour of 100 Englishmen may be given for the produce of the labour of 80 Portuguese, 60 Russians, or 120 East Indians.”7 The reason for this difference between domestic and international trade was, he claimed, because capital moved easily within a country, whereas it was effectively immobile between them.8

This is a confusion of monetary capital (which Ricardo, as a stockbroker by trade, knew intimately) with the physical machinery in factories (about which he knew very little). Yes, monetary capital moves easily in search of a profit—today, even internationally. But machinery is specific to each industry, and the crucial machines in one industry cannot simply “move” to another without loss of productivity.

The archetypal machines for cloth and wine manufacturing in Ricardo’s time included the spinning jenny and the wine press. It is stating the obvious that one cannot be turned into the other, but stating the obvious is necessary, because the easy conversion of one into the other was assumed by Ricardo, and has been assumed ever since by mainstream economic theory.

In fact, the relative mobility which Ricardo assumed for his ubiquitous concept of “capital” is the opposite of what applies to machinery. Machinery designed for one industry simply cannot move to any other, even in the same country; but machinery in one industry can (and frequently is) shipped between countries.

Ricardo’s Vice

By not calling out Ricardo’s confusion of physical machinery with monetary capital, economics fell into what Schumpeter later called “the Ricardian Vice”: the practice of deriving logically watertight conclusions from impossible premises that today economists euphemistically call “simplifying assumptions.” Schumpeter eloquently characterized Ricardo’s method as follows:

The comprehensive vision of the universal interdependence of all the elements of the economic system that haunted Thünen probably never cost Ricardo as much as an hour’s sleep. His interest was in the clear-cut result of direct, practical significance. In order to get this he cut that general system to pieces, bundled up as large parts of it as possible, and put them in cold storage—so that as many things as possible should be frozen and “given.” He then piled one simplifying assumption upon another until, having really settled everything by these assumptions, he was left with only a few aggregative variables between which, given these assumptions, he set up simple one-way relations so that, in the end, the desired results emerged almost as tautologies. . . . The habit of applying results of this character to the solution of practical problems we shall call the Ricardian Vice.9

The Ricardian Vice is well evidenced by Ricardo’s arithmetic example that became the foundation of international trade theory. If it were true that the machinery for producing wine could be converted (at no cost and with no loss of productivity) into machinery for producing cloth and vice versa, then it would also be true (assuming continued full employment, and less controversially the capacity for a vigneron to retrain as a shepherd, and vice versa) that the ending of autarky and the overnight opening up of free trade between England and Portugal would have increased the aggregate output of both industries across the two countries. Ricardo’s conclusions follow from his premises. But his premises are manifestly false.

What would have been the realistic sequence of events following the change from production of wine and cloth in England and Portugal under autarkic conditions, to free trade? Firstly, it was not the case that Portugal was more efficient at both: for climatic reasons, wine production in Portugal was highly developed, whereas in England it was barely feasible (as Ricardo’s own language attests: “England . . . if she attempted to make the wine . . . might require the labour of 120 men”); cloth production, on the other hand, was far more efficient in England than on the continent because higher wages in England had encouraged the development and adoption of machinery there, rather than on the European mainland.10

Had there been any English vineyards, they and their attendant machinery would have been rendered worthless and scrapped. Portuguese vineyards would have expanded their production to take advantage of a new market. Similarly, Portuguese cloth manufacturers would have found their machinery—what there was of it—rendered valueless, for England’s far more mechanized cloth manufacturers would have expanded their output as well.

Whether the aggregate production of wine and cloth increased or decreased now depended both on economies of scale and the macroeconomic effects of changes in trade policy.

Economies of scale can arise if the increase in the size of the respective markets causes a significant fall in production costs, or if it encourages the development of new technologies that would have been too expensive without the larger market generated by exports. Economists have considered this issue to some extent (work in this area led to Paul Krugman’s Nobel Prize in 2008) but without escaping the limitations of Ricardo’s 1817 model in which the role of machinery in production was ignored: “There will be assumed to be only one factor of production, labor. All goods will be produced with the same cost function.”11

Of course, the most complex issues surrounding the impact of trade are macroeconomic: will trade liberalization lead to higher or lower employment, to higher or lower investment, to higher or lower growth? Here, economists have not disappointed: from Ricardo on, they have completely shirked these issues.

Ricardo set the standard in a tangential observation about one potential riposte to his case: if Portugal were genuinely better at everything than England, would not English industry simply decamp from England and move holus bolus to Portugal if free trade were allowed? He conceded that it could do so, but then asserted that, if this happened, it would be advantageous not merely to English capitalists but to English and Portuguese consumers as well:

It would undoubtedly be advantageous to the capitalists of England, and to the consumers in both countries, that under such circumstances, the wine and the cloth should both be made in Portugal, and therefore that the capital and labour of England employed in making cloth, should be removed to Portugal for that purpose.12

This could only be advantageous “to the consumers in both countries” if their incomes were unaffected by the shift—and Ricardo simply accepted that they would be. Here he was probably relying on his expressed belief in “Say’s Law” that “demand is only limited by production,”13 but without considering whether, if production fell in England by the transfer of all its wine and cloth production to Portugal, employment, wages, and consumption in England would also fall.

On the issue of the relocation of production from high-wage First World to low-wage Third World countries, modern economists have pushed Ricardo’s Vice past even Ricardo’s limits. While he did contemplate the possibility of capitalists moving production offshore, Ricardo was of the opinion that this was both unlikely and undesirable:

Experience, however, shews, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and intrust himself with all his habits fixed, to a strange government and new laws, check the emigration of capital. These feelings, which I should be sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign nations.14

Trade Theory’s Adverse Effects on Policy

Ricardo cannot be faulted for not anticipating a future in which, shorn of the need for the owner of capital to emigrate with his money, financial capital would be as mobile as it is (and often accompanied by the movement of physical capital as well). But his followers can be faulted for dismissing the macroeconomic and social consequences of practices that Ricardo was unable to contemplate.

My first professional exposure to economists and policymakers simply assuming that trade and the relocation of production would have no deleterious macroeconomic effects came when I organized a conference on trade between Australia and Asia in 1979.15 In a presentation entitled “The Case for Trade Liberalisation,” Alan Powell (then director of the Australian government’s trade modeling group) showed the simulated effects on employment of a severe shock to Australia’s economy: “a cut of one quarter in the tariff levels of Australia’s most highly protected industries.” Employment, the modeling exercise asserted, would fall by as much as 5.5 percent in car manufacturing, but rise by as much as 2.3 percent in coal mining.16

What about the aggregate effects? Powell noted that the main underlying assumptions were:

(a) Good macroeconomic management prevails throughout;
(b) The adjustment takes place over a period of about two years, so that changes in the capital equipment of different industries over the adjustment period may be neglected.17

Assumption (b) continued Ricardo’s practice of ignoring the impact of trade on machinery. When pressed as to the meaning of assumption (a), Powell explained that it meant the modeling exercise assumed that aggregate employment would be unaffected by the tariff cut: the modelers simply assumed that falls in employment in once-protected industries would be precisely offset by gains elsewhere.

Even papers published as recently as 2016 admit that, two centuries after Ricardo, the macroeconomic dynamics by which trade policies actually operate have not been considered. Hirokazu Ishise notes that investment and growth are normally ignored in trade models by the Ricardian Vice of assuming “an endowment economy”—that is, an economy in which no production occurs at all, and countries simply exchange goods as “manna from heaven.” When they do consider production and investment, they explicitly assume that a machine can produce any commodity, and not a specific good alone:

While investment drives several aspects of aggregate economy, trade models frequently abstract [sic] investment decisions regarding capital goods by considering an endowment economy. In models that do include investment decisions, capital goods are commonly assumed to be homogeneous.18

Diversity Is Strength

Thus, although they claim to be experts on the effects of trade policy and argue almost unerringly for liberalization over protection, economists have not yet even asked the questions that are crucial to the real-world impact of trade liberalization: what does it do to the level and distribution of output, income, and employment?

Given that economists have not even considered these issues, it is not surprising that other researchers who have done so have reached conclusions that are diametrically opposed to the biases of economists. By analyzing the enormous Standard International Trade Classification database of international trade flows, data scientists at Harvard University, working on what they have christened The Atlas of Economic Complexity,19 have found that diversity, rather than specialization, leads to national success in international trade.

Their methodology was to classify products on the basis of their “ubiquity,” which they defined as how many countries exported the product, and countries on the basis of “diversity,” which they defined as how many products a given country exported.

The theory of comparative advantage would lead you to expect that in a world with very low trade barriers—basically the modern globalized world—most countries would have specialized trade profiles, so that they would score low in both ubiquity and diversity. This proved to be true of underdeveloped economies like Ghana, in which the top three exported products—fuels, precious metals, and cocoa—make up 81 percent of its exports. But it was not true of advanced economies like Germany, where the top three products account for only 46 percent of its exports. Nuclear reactors and boilers accounted for 18 percent of Germany’s exports, but Germany also exported a wide diversity of goods—including “pearls, stones, precious metals, imitation jewelry and coins” at almost 1 percent.

Image

The message that comes through loud and clear in this empirically grounded analysis is that, for countries to succeed at both growth and trade, specialization is essential at the individual level, and diversity matters at the level of the nation-state:

Modern societies can amass large amounts of productive knowledge because they distribute bits and pieces of it among its many members. But to make use of it, this knowledge has to be put back together through organizations and markets. Thus, individual specialization begets diversity at the national and global level. Our most prosperous modern societies are wiser, not because their citizens are individually brilliant, but because these societies hold a diversity of know how and because they are able to recombine it to create a larger variety of smarter and better products.22

The researchers used the measures of ubiquity and diversity to develop a composite index they called “complexity,” which quantified “the amount of productive knowledge” products and economies contain.23 This complexity metric correlated well with living standards—with countries like Japan and Switzerland at the head of the 2015 index (at 2.47 and 2.18 respectively) and Papua New Guinea and Nigeria at its tail (–1.81 and –2.18 respectively). But movements up the complexity scale also correlated strongly with improved growth performance:

An increase of one standard deviation in complexity, which is something that Thailand achieved between 1970 and 1985, is associated with a subsequent acceleration of a country’s long-term growth rate of 1.6 percent per year. This is over and above the growth that would have been expected from mineral wealth and global trends.24

The success of this index in predicting which countries are likely to outperform growth expectations in the future was related to the role of product diversity within a country, which enable new products to be invented. The authors of The Atlas found that a country was more likely to develop a new product if the country had other industries which were close to that product in a third metric they called “proximity.” Technically this was measured as the likelihood that a country exported one product given that it exported another; practically, it indicated that invention of new products required knowledge of existing, closely related products. A country with a diversified export profile (and by implication a diversified industrial base),25 rather than one with a specialized portfolio, is more likely to have the product proximity that allows new products to be invented and the economy to grow.

Innovation versus Allocation

These empirical conclusions point out the key blind spot in the conventional definition of economics. Robbins’s definition emphasizes allocation over innovation: the better allocation of existing, multiple-use resources to the satisfaction of existing, known wants. But real-world growth comes from innovation rather than allocation—the development of new products via the combination of knowledge from different but related industries. It relies upon combining knowledge embodied in single-use resources—in the form of both highly specialized workers and highly specialized machines—rather than multiple-use ones. This knowledge is more likely to exist in countries with diversified industrial systems, rather than specialized ones.

These empirical findings also cast a very different light on the populist revolts that are currently disturbing the pro-globalization consensus, which has dominated economic policy for the last thirty years. These revolts are not unthinking reactions against rationality, as mainstream economists like to believe, but reactions to the failure of the real world to conform to the irrational thinking of economists, and the damaging policies that have been imposed by politicians following their advice.

Thirty years of trade policies pursuing the false promise of specialization have meant that residents of the Rust Belt states of the United States, and the economically depressed regions of the United Kingdom, can now compare the promise of globalization with the reality. They voted against globalisation, not because they were too intellectually limited to perceive its benefits, but because experience gave them the lens through which to reject the Ricardian Myth of the advantages of national specialization.

Policymakers should too. The empirical research that underpins The Atlas of Economic Complexity—as opposed to the armchair speculation that has characterized the development of economic theory—provides strong guidance on how to achieve economic development. It starts from an understanding of where the increased prosperity of the last two centuries has come from. It has not come from specialization in the allocation of existing resources, but from acquiring and developing new knowledge over time:

During the past two centuries, the amount of productive knowledge we hold expanded dramatically. This was not, however, an individual phenomenon. It was a collective phenomenon. As individuals we are not much more capable than our ancestors, but as societies we have developed the ability to make all that we have mentioned—and much, much more.26

Expanding the knowledge that a country contains is thus key to growth, but this does not happen in a haphazard way. Rather, economies can progress by combining knowledge resident in closely related industries, to develop new industries and thus new knowledge:

Industries cannot exist if the requisite productive knowledge is absent, yet accumulating bits of productive knowledge will make little sense in places where the industries that require it are not present. This “chicken and egg” problem slows down the accumulation of productive knowledge. It also creates important path dependencies. It is easier for countries to move into industries that mostly reuse what they already know, since these industries require adding modest amounts of productive knowledge. By gradually adding new knowledge to what they already know, countries economize on the chicken and egg problem. That is why we find empirically that countries move from the products that they already create to others that are “close by” in terms of the productive knowledge that they require.27

Thus it is not undifferentiated “knowledge” per se that enhances growth and development. As the authors of The Atlas quip, “if a country were to achieve the goal of having everybody finish a good secondary education and if this was the extent of its productive knowledge, nobody would know how to make a pair of shoes, a metal knife, a roll of paper or a patterned piece of cotton fabric.”28

Instead, the successful expansion of knowledge comes from the development of new products that are closely related to products that a given country currently produces. The “proximity” measure developed in The Atlas can then be used to derive an “opportunity” indicator that shows how easily a new industry can be developed, and how likely it is to succeed. This gives an empirical basis on which to conduct industrial development policy—and the message is to diversify intelligently, based on the industries that you currently have:

Create an environment where a greater diversity of productive activities can thrive and, in particular, activities that are relatively more complex. Countries are more likely to succeed in this agenda if they focus on products that are close to their current set of productive capabilities, as this would facilitate the identification and provision of the missing capabilities.29

The fundamental message of The Atlas is the opposite of the dogma preached by economists ever since Ricardo—and given the flimsy foundation of the comparative advantage argument, this is hardly surprising. But it is revelatory nevertheless: the secret to success in trade and economic progress, in general, is not specialization, but diversity.

------
Notes

1 Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations: A Selected Edition, ed. Kathryn Sutherland (1776; Oxford: Oxford University Press, 1993) 12–13.
2 “England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time. . . . To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England.” David Ricardo, On the Principles of Political Economy and Taxation, vol. 1 of The Works and Correspondence of David Ricardo, ed. Piero Sraffra (Indianapolis: Liberty Fund, 2004), 135.
3 Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: Macmillan, 1932).
4 Smith, Wealth of Nations, 15.
5 Luigi L. Pasinetti et al., “Cambridge Capital Controversies,” Journal of Economic Perspectives 17, no. 4 (Autumn 2003): 227–32.
6 Ricardo, Principles, 135.
7 “The difference in this respect, between a single country and many, is easily accounted for, by considering the difficulty with which capital moves from one country to another, to seek a more profitable employment, and the activity with which it invariably passes from one province to another in the same country.” Ibid., 135–36.
8 Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), 472–73.
9 Robert C. Allen, “The Industrial Revolution in Miniature: The Spinning Jenny in Britain, France, and India,” Journal of Economic History 69, no. 4 (2009):
901–27.
10 Paul Krugman, “Scale Economies, Product Differentiation, and the Pattern of Trade,” American Economic Review 70, no. 5 (Dec. 1980): 950–59.
11 Ricardo, Principles, 136.
13 Ibid., 290.
14 Ibid., 136–37.
15 Steve Keen, ed., Trade: To Whose Advantage? (Canberra: Centre for Continuing Education, 1980).
16 Alan A. Powell, “The Case for Trade Liberalisation: A Brief Statement,” in Trade: To Whose Advantage?, 99–112.
17 Ibid., 102.
18 Hirokazu Ishise, “Capital Heterogeneity as a Source of Comparative Advantage: Putty-Clay Technology in a Ricardian Model,” Journal of International Economics 99 (March 2016): 223.
19 Ricardo Hausmann et al., The Atlas of Economic Complexity: Mapping Paths to Prosperity (Cambridge: MIT Press, 2014).
20 The Atlas of Economic Complexity, online visualizations, http://atlas.cid.harvard.edu/explore/tr ... show/2015/.
21 Ibid.
22 Atlas, 6.
23 Ibid., 44.
24 Ibid., 27.
25 There is no comparable database of domestic production to the SITC database of international trade broken down by product type, but the authors infer that a diversified export portfolio implies a diversified system of domestic production.
26 Atlas, 6.
27 Ibid., 7.
28 Ibid., 34.
29 Ibid., 57.


_________________
And the end of all our exploring
Will be to arrive where we started
And know the place for the first time.


Mikah
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29 Dec 2019, 2:57 am

Part 2 in my great ignored series on international trade. More Brit centric this time, apologies for those not interested. It's an American publication, yet somehow they identify issues that are rarely, if ever, spoken about in the UK. It also includes a bite size history lesson of the true American attitude towards Britain (pretty hostile), which may shock those still labouring under the delusion that our countries have long been best buddies.

https://americanaffairsjournal.org/2019 ... t-economy/

Today Britain finds itself in an odd position. In the wake of the vote to leave the European Union and its aftermath, the Conservative Party has been given a new mandate. A substantial portion of the voting public wants a more independent Britain to pursue national restoration and regeneration. On an emotional level, most of the Conservative Party has been won over by this vision. Rallying around the departure from the EU, Conservative Party politicians have signaled to their party membership, as well as the voting public, that they are willing to lead the country in a new direction.

This Damascene conversion has, however, generated contradictions. On the face of it, the vote to leave the EU was one motivated by skeptical attitudes toward the laissez-faire policies that have dom­inated British political life for decades. The most obvious out­come of the exit from the EU will be to halt the “free movement of people”—that is, mass migration—and increase trade barriers with Britain’s largest market. Yet at the same time, the leaders of the Brexit move­ment—from Nigel Farage to Jacob Rees-Mogg to recent convert Boris Johnson—typically champion Thatcherite free market policies.

The economic policies of these pro-Brexit Tories, however, are ill-suited to the Britain of 2019. Given the degree of political upheaval and change surrounding Brexit, such a deep disconnect between Tory free market ideology and the stated goal of independence could gen­erate chaos. Thatcherite free market policies will almost certainly make the situation worse, not better, especially given Britain’s fragile position. Britain must instead pursue an aggressive industrial and manufacturing policy in order to avert economic crisis after Brexit. To take this path, Tory leaders must follow their better instincts and craft policies that actually match their goals. British independence depends on British manufacturing and domestic consumption. But the free market nostrums of the 1980s will not get us there.

Britain’s Decline: From Imperial Grandeur to Tony Blair

To under­stand what must be done, let us first consider how the coun­try arrived in such an economically dire situation. In the early 1910s, Britain was on top of the world. It had a huge empire and the world’s most sophisticated economy. Its military spending, which approached £65 million, was the highest in the world—although Ger­many, now unified and interested in mimicking the British Empire, was a close second. Just prior to the outbreak of World War I, Britain’s per capita GDP was nearly $5,000, far out­pacing Germany ($3,650), France ($3,500), Austria-Hungary ($2,000), and Russia ($1,500). It was only really matched by the rapidly grow­ing United States.

By the end of the war, however, Britain was in tatters. The Allies had won the war, but at massive cost. Throughout the 1920s and into the 1930s, Britain tried to maintain its international prestige by jeal­ously defending its gold standard—much to the detriment of the British economy. Policymakers reasoned that what had worked in the past—an imperial economic system based on intraimperial trade, cen­tered on the gold standard and London-based banking, would work in the future. Critics pointed out that the high imperial era was over, and that Britain would do better to focus on its domestic market.

Britain fumbled throughout the interwar years, gradually giving way to the new economic ideas and dropping the gold standard in 1931. But no fundamental reform was undertaken, and the British economy languished. For this reason, Britain went into World War II with significant economic disadvantages. What happened next was all but inevitable: the United States, now with global ambitions, financed British war expenditure knowing full well that the resulting debt would destroy Britain’s global reach.

After the war, the script played out as if pre-written. Britain found itself totally overshadowed in the global arena by the United States. The debts that Britain owed hung over her head like a glistening sword, and the Americans were eager to use the leverage they had gained to encourage the unraveling of the British Empire. This came to a head in 1956 when the Egyptians nationalized the Suez Canal, a key trading route required for the British imperial economic system to function. The British knew that they had to respond militarily, but the Americans were happy to see them lose their empire. President Eisenhower warned the British that if they carried through with an invasion, he would sell the debt that the British owed the Americans, thereby crashing the sterling and sending the country into financial ruin. Eventually the British backed off and watched as their empire fell apart in the ensuing years.

Since the nineteenth century, Britain’s economy had been based on the imperial system. Trade would occur within the system, and the City of London would make the necessary financial arrangements. The British never admitted to themselves that their economic success was based on empire, however. During the imperial era and after, they clutched at the myth that the system was based on so-called free trade. British political economy even turned this mythology into a pseudoscientific theory. It was the very essence of ideology: it was designed to reassure the British people—and the world—that Britain had not achieved success through conquest and military force, but rather through hard-fought economic competition.

This ideology was harmless when Britain was in its ascent. But it became toxic when Britain started to decline. It blinded the British from seeing that, as their empire collapsed, so too did their economic system. In the decades after World War II, this ideology was mainly focused on maintaining the gold standard—just as it had been in the 1920s. As other economies were racing ahead, using Keynesian eco­nomic programs to push high rates of economic growth and full employment, Britain got stuck in the dreaded “stop-go” cycle. The British would encourage economic growth but, as imports were sucked in to fuel the growth, the sterling would wobble and the British authorities’ attempts to protect the gold standard would lead to recession.

In the imperial era, Britain would grow in lockstep with the rest of the empire. And since the empire was a closed system, as British imports from the empire increased, so too did British exports. In the postwar world, however, Britain was facing international competition, especially from the United States, and its exporters were only competitive in underdeveloped colonies like India. Since Britain was never the free market success story that it claimed to be, it languished in this new world. It was unable to keep up with the other developed economies because of its tendency to suck in imports as it grew.

The stop-go cycle of the postwar era fell into terminal crisis in the 1970s. British workers had had enough with multiple governments’ unkept promises, and they turned to radicalism. This radicalism mani­fested in mass strikes which generated supply shortages and inflation. This situation was exacerbated by the oil price shock in 1973, when oil prices soared as the newly formed OPEC halted production in response to the Yom Kippur War. By the late 1970s Britain was a mess. Garbage went uncollected, inflation was running in double dig­its, unemployment was high, and maintaining the sterling was all but impossible. The British went, cap in hand, to the IMF in 1976 and took out a loan—a true signal of national humiliation and defeat.

If the postwar Keynesian era was one of mild misrecognition of the problems Britain faced, what followed was a descent into full-on delusion. When the politicians of the 1920s tried to force the British economy back into its prewar state, it was at least somewhat understandable. After all, the empire still existed and the past that they pined for was not all that distant. The Thatcherites who climbed to power at the end of the 1970s wanted to return to the same era—but they had never lived in that world, and the empire that it relied upon was almost completely dissolved. What had been a sort of reactive conservatism in the 1920s became a nostalgic fantasy in the 1980s.

The immediate goal of the Thatcherites was to bring down infla­tion and create a nineteenth-century-style “free market.” Under the sway of ideologues like Milton Friedman, they thought that they could achieve this by controlling the supply of money. As the Bank of England experimented with this policy, interest rates went haywire and entered double-digit territory. This generated a massive recession and accelerated the decline of British manufacturing, though it suc­ceeded in stamping out inflation through massive declines in spending growth.

Between 1948 and 1978 the decline of British manufacturing was gradual and was driven by competition from abroad. As I noted earlier, British manufacturing could only successfully compete within the imperial system. When it was subject to global competitive forces, it floundered. After 1978, however, this decline sped up enormously—primarily due to the Thatcherite policies.

In the first place, interest rates rose precipitously, and this rise generated a massive recession that pressured many British businesses to close their doors. In addition, sterling rallied throughout the 1980s. Financial investors saw that Britain offered much higher interest rates than other countries, and foreign capital flowed in. This was exacerbated by the Thatcherites’ deregulation of the British financial sector in the late 1980s—the so-called Big Bang. Unable to compete in global markets for goods and services, Britain turned back to its old imperial banking system and restructured it to make it a center for global finance. The resulting rise in the value of sterling made British manufacturing even less competitive.

By the 1990s, the new model for Britain was clear. The British economy would be totally reliant on financial services. Even the Labour Party embraced this model under the leadership of Anthony “Tony” Blair. Blair was a vacuous liberal left-winger who governed the country through his public relations machine. He portrayed him­self and his party as the embodiment of a “cool” new country—one geared toward personal freedom and license. What was supporting this phase of decadence, however, were financial inflows that were anything but stable. These inflows propped up the sterling and allowed British consumers to spend more on goods made abroad. Consequently, during this period, there was a serious deterioration in the British current ac­count.

By the time Tony Blair left office in 2007, Britain was running a current account deficit of around 3.5 percent of GDP and manufacturing had fallen to around 11 percent of total value added, down from around 27 percent in 1978 and 36 percent in 1948. This was an economy running on borrowed time.

The Lion Eats the Unicorn

Cracks appeared in the Thatcherite banking-and-import model when the financial sector started to collapse in 2008. The action was mainly centered around a bank called Northern Rock which, like many of its European and American counterparts, had bought more bad debt than it could handle. As the financial sector melted down, sterling took a hit. After all, strong sterling relied on a vibrant financial sector that could attract foreign capital so that British consumers could live beyond their means. Between January 2008 and January 2009, sterling collapsed by 20 percent. The next hit came in the wake of the vote to leave the EU, which occurred in June 2016. Between May and Octo­ber 2016, sterling fell an additional 14 percent.

These events were only proximate triggers, however. Britain’s model was never sustainable. It always relied on offering investors incentives to move foreign capital to London. But this required either interest rates so high that the economy could not grow or financial bubbles that would never pop. Neither of these was possible in perpetuity. And so it was inevitable that sterling would eventually start to sink. The party over which Tony Blair had so carelessly pre­sided was bound to end.

At this point in the story, many economists would step in and suggest that things are not all that bad. After all, we have argued that a key driver of the rapid decline in British manufacturing and the reli­ance on imports that accompanied it was the overvaluation of the sterling. While it is true that a falling currency causes rising import prices for consumers, it is also true that the price of exports tends to fall. This makes the country more competitive in international mar­kets. In theory, then, what the British people lost in their ability to buy imports, they should have gained in higher value-added and hence higher-paid manufacturing jobs.

But this did not happen. Exports simply did not rise. The chart below shows the British current account as a percent of GDP against sterling since just before the first leg of sterling’s decline.

Image

The fall of sterling between 2008 and 2009 was accompanied by a decline the current account deficit. But this was due to the large recession that the UK experienced in this period. With unemployment high and people pulling back on spending, imports fell, and the current account closed. But once growth resumed in 2011, despite the new lower-valued sterling, the current account deficit opened once more—this time to record levels, hitting a peak of 6.7 percent of GDP in the fourth quarter of 2015. The same is true of the 2016 decline in sterling: An immediate impact is visible in the data. But it does not last long. By the first quarter of 2019 the current account deficit is back to an extremely large 5.5 percent of GDP.

Why is the decline in sterling not leading to a rebalancing of the current account deficit, as economists would predict? First, Britain has almost no manufacturing capacity. When the income of British people grows, they are forced to spend a good portion of this income on imports. Even if these imports rise in price, there is no alternative but to purchase them anyway (i.e., they are price-inelastic imports). This also means that the real spending power of the British people falls dramatically every time there is a depreciation of sterling.

While the real earnings of citizens in other countries have been growing in this period, in Britain they have been falling. Since 2008 real earnings for the average Briton have fallen 6.25 percent. At their trough at the end of 2014, they had fallen an enormous 11.5 percent—a substantial loss in purchasing power and an ominous sign of things to come.

Image

On the one hand, then, the depreciations of sterling were leading to a significant fall in the standards of living of the British people. But what about the export market? It expanded slightly as a percent of total income. But nowhere near enough to support the imports that the British people rely upon. Again, this is because Britain does not really produce all that much. Even if prices fall, there is nothing there to sell. Economists may imagine that currency depreciations cause new factories to pop into existence out of thin air. But after decades of deindustrialization in Britain, it is not surprising that this does not happen.

Britain is in a very difficult position. Unless it can find some way to wean itself off imports, it is sure to see a dramatic fall in living standards in the coming years. The fact that the economy relies almost completely on the fickle financial sector means that trigger events tend to knock real wages down every couple of years. And given Britain’s tumultuous exit from the EU, there are certain to be many trigger events lined up in the years ahead. A new path is needed.

An Escape Hatch

But perhaps it is wrong to view Britain’s exit from the EU as a harbinger of decline. Perhaps it should be seen as an enormous opportunity. To see why, we have to consider where Britain buys its imports, and with whom it runs its deficits.

What the following chart tells us is that, up until 2011, Britain ran large trade deficits with the EU, while trade with non-EU coun­tries was closer to being in balance. Since 2011, Britain is running a surplus with non-EU countries, but larger and larger defi­cits with the EU. The EU is clearly Britain’s most problematic trade partner.

Image

This situation gives rise to an irony that is not much noticed in British policy circles: net-net, trade with the EU is a bad thing for the British economy, at least from a macroeconomic perspective. Less trade with the EU is, then, from a purely macroeconomic perspective, probably better for Britain’s long-term stability. This fact contradicts almost everything we hear. Policymakers typically characterize any diminishment of trade between Britain and the EU as a bad thing. From the point of view of a British consumer who wants French cheese or Greek yogurt, a reduction in trade certainly is bad. But from the point of view of macroeconomic stability, a diminishment of trade is essential.

Let us step back and think this through for a moment. How could it possibly be a good thing for British consumers to have less access to the goods from the EU that they want? Consider what would happen if we completely cut off trade with the EU tomorrow: Consumers would not have access to EU goods. But they would then have to spend this money elsewhere and some of this—probably most of it—would flow back into the domestic market.

A microeconomist would now point out that consumer satisfaction has fallen. British yogurt and cheese are nowhere near as pleasant as Greek yogurt and French cheese. But if the above macroeconomic analysis is correct, the alternative is that British living standards are destined to fall regardless. The question then becomes, what is the optimal way to manage the fall of these living standards in order to generate the best possibility of subsequently raising them again?

Marching along, enjoying all the continental yogurt and cheese that the debt-soaked British consumer can afford is a path to econom­ic suicide. It is, of course, great for immediate consumption. But it provides no coherent plan for the future. When the continental goods become too expensive, the British consumer will have nowhere to turn, and British industry may take years to respond to the new situa­tion. On the other hand, if a government could look forward to the new alignment that is coming, it could plan for it. The state could direct investment spending into needed industries.

The departure from the EU could provide just the shock necessary for the British people to realize that the current model is not sustain­able. It might lead policymakers to ask some long-overdue questions: e.g., why do we assume trade with the EU is purely a good thing when they seem to be running rings around us, while we seem to be building up macroeconomic imbalances for which we will be severely punished in the future?

Buying British: A Platform for the Post-Brexit Economy

What would an appropriate reform platform look like? As noted earlier, the Conservative Party has inherited a political situation that cries out for action on a national level—and they have inherited an economic situation which requires the same. Were it not for free market ideology, the political and economic situations should tend toward parallel solutions. But the Tories are under the sway of an irrational nostalgia for free trade based on a nineteenth-century economy that never truly existed.

If they could overcome these ideological blinders, they could indeed pull Britain out of its rut. They would have to concentrate as many economic forces as possible into the domestic market. Every policy would have to be judged based on how much it led to internal development and avoided the purchasing of foreign products. Boost­ing exports could help too, but government-led export booms are more difficult to achieve.

The real key to British prosperity moving forward would be to have consumers buy British. At present, imports make up around 31 percent of GDP. Almost one in three goods or services purchased in Britain today is from abroad. Policymakers should try to get that number down to at least 20 percent.

The easiest way to do this would be to examine carefully what Britain is importing. Those products that can easily be produced do­mestically should be produced domestically. The government should incentivize and even subsidize domestic businesses to make products that can replace their international counterparts. To put it bluntly, there is no reason that Britain should not be producing its own cars and household appliances. They have done it before. If British engineers at Rolls Royce can make jet engines, they can figure out how to build a toaster or remember how to build a small car.

Microeconomists will complain that these products will likely be inferior to their international competitors. The British microeconomists will remind us of the days, not so long ago, when Britons drove shabby Rover cars instead of streamlined German models. But, again, British living standards are destined to fall regardless, and it is better that the British people have access to slightly inferior cars—while laying the groundwork for future growth—than it is that they find it hard to purchase a car at all.

A program of import substitution is urgently needed. The govern­ment should begin subsidizing British industry to produce goods that are currently purchased abroad. The exit from the EU in particular gives them ample scope to do this, now that they are not bound by arbitrary trade rules.

A central body should be set up, staffed by market analysts and economists, to track imports and highlight potentially substitutable items. A development bank should also be set up to issue debt that can be bought by the Bank of England to pay for such import sub­stitution. A budget for this development bank should be set once every few years based on an annual target for import reduction. The market analysts and the economists will then direct this budget to the most promising industries.

Engineering and other relevant degrees should be subsidized by the government and secondary school students should be strongly encouraged to take classes to follow this degree path. Meanwhile, British engineers currently working abroad should be drawn home to work on the project. And those who are not doing actual engineering work, but are instead working on consulting jobs, should be brought into the fold. The effort should be done under the banner of national renewal and should have the same public spirit ethos that we saw in Britain during World War II.

It is an ambitious policy, to be sure, and it would require strong leadership. It would also require leaders to jettison the ideological baggage and the false economic history that many of them have learned from birth. But it can be done. Indeed, it must be done.

If Britain does not undertake a program of industrial renewal, the exit from the EU will be remembered as the start of a very sharp period of decline for the country. A major world power, albeit one that has already been languishing for nearly a century, will end up like one of those long dead, stuffed birds marveled at in a Victorian museum.


_________________
And the end of all our exploring
Will be to arrive where we started
And know the place for the first time.


Mikah
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14 Jan 2020, 2:25 pm

Thanks for the merge Skilpadde

Part 3:

http://voxday.blogspot.com/2019/12/nati ... omics.html

Nationalist Economics and the New Right
by Vox Day

It is one of the great ironies of modern politics that free trade and economic globalism have somehow become identified as not only right-wing policies, but right-wing dogma. This was not historically true, though, as from the very start, free trade has generally been a hallmark of the LEFT side of the political spectrum. If you recall, the infamous mercantilists attacked so furiously by Adam Smith in The Wealth of Nations were, almost to a man, royalists, not revolutionaries, while the great prophet of the Left, Karl Marx, openly advocated free trade on the grounds that it would help bring about world socialist revolution and the emancipation of the proletariat.

In the 240 years since Adam Smith triumphed over the mercantilists, the question of free trade has generally revolved around whether it is good for the nation concerned. However, this is not actually the right question to ask, as the more fundamental one is whether free trade and nations are even compatible. And, as it turns out, the answer is no.

But let us not get ahead of ourselves and instead begin at the historical beginning. It is vital to first understand that the intellectual foundation for free trade is considerably shakier than most conservatives realize, particularly those conservatives who believe that David Ricardo settled the matter once and for all with his articulation of the Theory of Comparative Advantage.

The Failure of the Free Trade Champions

David Ricardo was not an economist in the modern professional sense. He was a stockbroker, a successful con artist who put Michael Milken and Bernie Madoff to shame, a politician who purchased his seat in the House of Lords with his ill-gotten gains, and a pamphleteer. His works were not written with an aim of better understanding the matter addressed, but were primarily written as extended opinion editorials meant to advocate specific political policies. Moreover, his arguments were so heavily biased toward his preconceived conclusions that Joseph Schumpeter was moved to describe the custom of economists creating hopelessly impractical theories on the basis of heavily biased simplifications as "the Ricardian Vice".

Besides the Theory of Comparative Advantage, which Ricardo cribbed without attribution from “An Essay on the External Corn Trade”, a work that was published two years earlier by Robert Torrens, Ricardo's two other theories of historical note are the labor theory of value, which you may recall is the logical foundation of Marxist economics, and a highly peculiar theory of wages and profit that concludes the rate of profit ultimately rests upon the price of corn.

Seriously. I’m not kidding.

In fact, despite its massive influence on economists, politicians and trade policy for the last two centuries, the Theory of Comparative Advantage was never mathematically modeled or put to a serious theoretical test for 134 years. And although it was initially claimed that a comparison of textile and automobile production in the U.S.A. versus the United Kingdom broadly confirmed the Ricardian Model, more stringent tests soon demonstrated that neither the model nor the theory on which it was based had much application to the real world.

In his landmark book, Free Trade Doesn't Work, Ian Fletcher identified seven specific flaws in Ricardo's version of comparative advantage, which consist of assumptions that do not necessarily hold in any given trade environment, and in many cases, do not apply at all. These seven dubious assumptions are:

- Trade is intrinsically sustainable.
- There are no external costs.
- Production factors move easily between industries.
- Trade does not increase income inequality.
- Capital is not internationally mobile.
- Short-term efficiency causes long-term growth.
- Trade does not inhibit foreign productivity.

Of course David Ricardo is not the only economist cited by defenders of free trade. Another common right-wing reference is Henry Hazlitt, the Austrian economist whose Economics In One Lesson, published in 1946, is popular among homeschoolers for its clarity and brevity. Chapter 11 of that work, which is devoted to making the case for free trade, is easily the weakest chapter in the book, as it contains no less than 23 specific errors. Since this article is merely a contribution to an anthology and not a book in its own right, I shall restrict myself to pointing out seven of them.

Error #1: Hazlitt assumes that manufacturers are the primary beneficiaries of barriers to trade and therefore the leading advocates of them. This may have once been true, but it is clearly no longer the case. Economics in One Lesson was published in 1946, when the U.S. balance of trade ran a 35 percent surplus and trade amounted to 6.8 percent of GDP. Free trade was operating to the benefit of most American manufacturers and workers alike; since the industrial infrastructures of Europe and Asia were in ruins, few American sectors were at a competitive disadvantage. Like Ricardo, Hazlitt clearly never imagined a scenario when jobs would not be lost to foreign manufacturing competitors, but to the new foreign factories established by the former domestic manufacturers. The additional profit provided by a $5 tariff is now of less interest to the domestic manufacturer than the opportunity to set up a factory in Bangladesh, make the sweater at a lower cost, then import it and sell it for $25. If we leave out the distribution channel, which is the same for both foreign and domestic manufacturers, and assume a profit margin of 50 percent, we can compare the profit margins of the various alternatives.

At the 50 percent profit margin, we know that the manufacturer's domestic costs were $15 and his profit was $15 with the protection of the $5 tariff. But Bangladesh has a wage rate that is one-thirtieth that of the USA, so if labor is one-third the cost of production and international shipping is 10 percent of the manufacturing cost, his new production and delivery cost will be $11.17. This reduction of $3.83 in costs means the offshored manufacturer can now afford to sell the imported sweater for 22.34 and still make the same 50 percent profit margin he did before; without tariffs he can compete on price with the $25 English sweaters and actually increase his profit margin by nearly six percent. At the old $30 price, his profit margin has risen to 63 percent, thereby creating a serious incentive to move production to Bangladesh even in the absence of any price pressure from the English sweater makers. Either way, the consumers benefit, the manufacturer benefits, and only the thousands of workers, who lost their $5/sweater jobs, suffer.

So, the $5 tariff not only protects the domestic manufacturer from the English competitor, but more importantly, protects the worker from the domestic manufacturer as the tariff would reduce the domestic manufacturer's profit margin from 63 percent to 46 percent. With the tariff in place, the domestic manufacturer has no reason to go to all the trouble and expense to relocate his factory to Bangladesh simply to lose four percent from his profit margin. Hazlitt's error here is the result of the failure of the theory of comparative advantage to account for the international mobility of capital.

Error #2: Hazlitt asserts that the $5 left over from the reduced import price of the sweater will go to help employment in any number of other industries in the United States. It may. Alternatively, it may not. Also, it should be kept in mind that Hazlitt was writing when imports accounted for a trivial 2.9 percent of GDP. They now account for 16.3 percent, so that $5 is nearly six times more likely to go towards increasing employment in industries outside the United States than it was in 1946. Therefore, what was theoretically supposed to be $5 of the tariff going towards U.S. employment must be reduced to $4.19 on average.

Error #3: Hazlitt erroneously assumes that the British will buy more from U.S. manufacturers because their possession of U.S. dollars will force them to buy more American goods. This is untrue, however, because the dollar is the world's reserve currency and is frequently utilized for trade between foreign countries; the British are no more forced to buy American goods due to their possession of dollars than the Thebans were forced to buy Athenian goods due to their possession of silver Athenian talents.

Error #4: Hazlitt assumes that foreign dollar balances cannot remain perpetually unspent in the United States. But there are presently an estimated 1.25 billion in Eurodollars being held in foreign banks that will never come back to the United States, as they are presently used as the basis for 90 percent of all international loans. Furthermore, the United State has been running a continuous and growing balance of trade deficit in goods since 1976. The $9 billion that went overseas that year has not only not returned to be spent here, but has since increased to $750 billion. 41 years and counting is a long time to wait for this supposedly inevitable return, and moreover, is very unlikely to provide any comfort to the worker who lost his job as a result more than four decades ago.

Error #5: Hazlitt assumes that an American worker who loses his job in one sector will automatically find it in another sector. This repeats Ricardo's mistake and is the sixth false assumption identified by Fletcher. There is no reason to assume that the loss of a job in one sector will create any additional demand in another sector, indeed, to the extent there is worker mobility between industries, all the loss of a job in one sector will do is create downward pressure on wages in the other sectors. There is a hidden and implicit appeal to James Mill here, (or alternatively, to Keynes's critical formulation of Say's Law), in the idea that supply somehow magically creates demand. While this can be true in a technological sense, as there was no demand for CD players prior to their invention, it is most certainly not a reliable economic law, as the excess supply of U.S. housing or the dead inventory stock of any business will suffice to demonstrate.

Error #6: Hazlitt assumes that American employment on net balance will not go down, and that American and British production on net balance will go up. This is not necessarily true, being an erroneous conclusion based on the previous error. The American worker may well remain unemployed on a permanent basis, as have one-quarter of the formerly-employed male workers since 1948.

Error #7: Hazlitt assumes that consumers in both countries are better off because they are able to buy what they want where they can get it cheapest. But this is a false assumption because most consumers are also workers, or are dependent upon workers. The consumer who is employed can better afford the $30 domestic sweater than the unemployed consumer can afford the $25 import. Free trade does work to the advantage of a small number of Americans in the financial sector as well as to its foreign beneficiaries, but at an inordinately heavy short-term cost to around 25 percent of Americans as well as a severe long-term cost to the entire American economy.

The many flaws of Hazlitt's case notwithstanding, it should be noted that none of the traditional critiques of free trade even begins to address the most fundamental problem with the policy, which is the significant modern increase in the mobility of labor, a factor that has never been properly accounted for by economists or policymakers in the 200 years since David Ricardo published The Principles of Political Economy.

Five Arguments Against Free Trade

Nor is the inability to account for the technology-enhanced mobility of labor the only failure in the free trade model. There are actually five separate and specific arguments against free trade, each of which alone suffices to prove that free trade has had a negative effect on wealthy Western nations. Even more, they show that the freer the trade has been, the worse the effects. In order of their appearance, these five arguments are the empirical, mathematical, nationalist, practical, and logical arguments. And each of these five arguments represents a very serious and substantial challenge to the claim that free trade makes a nation wealthier or better off in the long term.

The empirical case against free trade addresses the conventional argument for it. This childishly simple pro-free trade argument has changed very little over the centuries, and was repeated last year in a major essay by Francis Fukuyama in Foreign Affairs. The conventional argument for free trade is a post hoc ergo propter hoc construction which states:

- International trade has become increasingly free over time.
- Wealth has increased during the same period.
- Therefore, free trade produces wealth.

But this is absolutely not true. We have considerable evidence that freer global trade does not necessarily make an individual country wealthier, and in many cases, actually makes it poorer. Although the free trade in goods has considerably increased over the last 50 years, average real wages are lower in the U.S.A. than they were 43 years ago. Still, even though wages are lower, could not the country still be wealthier? Proponents of free trade often cite growing GDP per capita as evidence of a country's wealth increasing, and it is true that since 1964, U.S. GDP per capita has risen from $3,500 to $54,600, a 15.6 times increase. Many interpret that rise in GDP per capita as proof that the U.S.A. is wealthier, but they are absolutely incorrect to do so because over that same 50-year period, total US debt per capita has risen more than twice as much, by a factor of 34.

If your income doubles, but your personal debt increases by more than twice that, are you genuinely wealthier? No, of course not! Your perceived increase in wealth is a mirage, and you are actually poorer than you were before. Freer trade has clearly not produced greater wealth for America or Americans, but has instead resulted in greater indebtedness. This is not to say free trade can never benefit a national economy, but we have clear empirical evidence that it has not in the case of the United States over the last five decades. Nor has it been of net benefit to any Western nation once debt is correctly accounted for. Therefore, the conventional pro-free trade argument is obviously and inarguably false on empirical grounds.

The mathematical case against free trade is an abstract one that is considerably beyond the ability of most individuals to calculate and confirm for themselves, but it nevertheless merits a brief mention. At its core, free trade theory relies upon the Law of Supply and Demand as articulated by Adam Smith. This well-known law dictates that as prices rise, demand will fall, given constant supply, thereby producing a downward-sloping demand curve. But in his revolutionary Debunking Economics, Australian economist Steve Keen cites the work of William Gorman, who in 1953 utilized mathematical logic to prove that the Law of Demand does not apply to a general market-wide demand curve, but only applies to individual demand curves. Moreover, it is not possible to derive a conventional downward-sloping market-wide demand curve by simply adding together the quantities demanded by all individuals at every possible price; the resulting curve that represents cumulative demand can actually be of almost any shape at all.

In other words, the combination of all rational consumer preferences results in an irrational market where lower prices may, or may not, increase demand at any given point of supply. This mathematical proof has many implications for economics that have not yet been properly explored by economists, but among the obvious casualties is the theory of comparative advantage. In summary, the math required for free trade to reliably operate in an economically beneficial manner according to the theory of comparative advantage literally does not add up.

The practical case against free trade turns the usual free trade attack on tariffs around on the attackers. It is extremely common for free trade advocates to point out that protective tariffs are taxes on domestic citizens, not on foreign producers, and this is true. However, it is false to conclude from this fact, as they do, that these taxes on domestic citizens make the country poorer by raising taxes, because this would only be true if the alternative to taxes in the form of tariffs was no taxes at all. That is obviously not the case, and it will never be the case in any country where the government is also funded by income, property, wealth, and value-added taxes.

It should be readily apparent that a nation possessing a government funded by tariffs will tend to be wealthier and more free than one with a government funded by income taxes and sales taxes, because tariffs are considerably less intrusive on the domestic citizenry, are considerably less expensive to administer, and are massively less economically disruptive than either personal or corporate income taxes. And tariffs are literally nothing more than a sales tax, albeit a very limited form of sales tax that only affects a small percentage of the goods that are available in the national economy.

In 2020, a complete reliance upon tariffs would mean that less than one-fifth of GDP would be subject to federal taxation instead of all of it being liable to multiple forms of taxation. Even from the conservative small government perspective, it should be entirely obvious that free trade cannot make a country any more wealthy if its import taxes are replaced with income and property taxes.

The logical case against free trade is straightforward, and yet is frequently dismissed due to a failure to understand it.

As Ludwig von Mises wrote in Liberalism, “production is more restricted where the conditions of production are comparatively favorable than would be the case if there were full freedom of migration. Thus, the effects of restricting the freedom of movement are just the same as those of a protective tariff.” This means there is no credible way to rationally argue in favor of the free trade in goods without also accepting that those very same arguments apply to the free trade in services too. There is no meaningful way to distinguish between the argument for the free movement of goods and capital, and the argument for the free movement of labor. From the logical perspective, they are one and the same argument.

Whether it is their intention to do so or not, those who argue for unrestricted free trade are also arguing for unrestricted immigration. It is not a coincidence that everywhere free trade policies have been adopted, the level of immigration has increased while the native employment rate has declined. While free trade advocates claim America is wealthier as a result of its freer trade and more liberal immigration policies, the fact that 104 million Americans are now either unemployed or out of the workforce, that they are collectively $73.4 trillion in debt, and that all the jobs created since the 2008 recession went to immigrants are an eloquent and conclusive rebuttal to their assertions. Freer trade with China alone costs the USA 185,000 jobs per year; the resultant increase in the unemployment rate obviously does not make Americans wealthier.

And last, but most certainly not least, is the nationalist case against free trade. It is very common to hear free trade advocates wonder why we don’t look at international trade the same way we look at domestic trade. As the Austrian economist Robert Murphy put it, “someone might worry about trade deficits with China—whereas not lose a moment’s sleep over interstate trade deficits within the borders of the United States.” But the benefits of domestic trade require people moving from Michigan and Massachusetts to take jobs in California, where they make the goods that are subsequently shipped to Florida, Texas, and other states within U.S. borders. That movement that is required to efficiently provide workers with available jobs in locations that require them to change their residence is called labor mobility, and in the United States, the rate of labor mobility is 3.2 percent per year.

If we extend that rate of labor mobility to the world, which is absolutely necessary if the United States is to receive the the same benefits of international free trade that it presently obtains from domestic free trade, that rate of labor mobility mathematically dictates that nearly half of all Americans would have to emigrate to find jobs in other countries before the age of 35. The benefits of free trade depend upon the most efficient matching of labor with capital, which is why Americans with a talent for robotics would have to travel to where the robotics industry is operating at maximum cost-efficiency, which would presumably be Japan or South Korea, while talented young filmmakers everywhere from Albania to Vietnam would be moving en masse to Hollywood, or Vancouver, or wherever movies were being made most efficiently.

Is the United States genuinely better off if half its children have to leave the country and find jobs elsewhere in the world? Is any nation better off? No, obviously not. Free trade advocates cannot reasonably claim that the national economy will be materially better off if the nation ceases to exist.

A Closer Look at Comparative Advantage

Unit Labor Costs
Britain: 100 cloth, 110 wine
Portugal: 90 cloth 80 wine

A comparison of the unit labor cloths shows that in the absence of transportation costs, it is more efficient for Britain to produce cloth, and Portugal to produce wine. This is because if we assume that the two goods trade at an equal price of 1 unit of cloth for 1 unit of wine, Britain can obtain wine at a cost of 100 labor units by producing cloth and trading, instead of at the cost of 110 units by producing the wine itself, and Portugal can obtain cloth at a cost of 80 units through trade rather than 90 through domestic production.

So far, so good for the Ricardian model. But now let us introduce the free movement of labor into the equation. In this scenario, both wine and cloth workers will move to Britain, since by doing so they will receive an 11 percent raise and a 38 percent raise, respectively. However, once they get there, the doubling of the labor supply in Britain this immigration causes will quickly cause the price of labor to fall. It will fall considerably, so that Britain's labor costs are now actually half that of Portugal.

This is great for Britain! It can now produce the same amount of cloth as before for price of only 47.5 units of labor, and the same amount of wine for 47.5 labor units as well, thereby obtaining an equal quantity of both wine and cloth for less than what it used to cost to produce the wine alone. This will vastly increase profits in the British cloth and wine industries, as well as creating a windfall for the financial industry investing those profits! Granted, this has only happened because wages have fallen by 50 percent; other consequences include how all of the newly unemployed British workers go on the dole or turn to crime to making a living, how the new British voters are inordinately inclined to vote for the Labour Party, thereby imbalancing the British political system, and, over time, how many British women begin bearing half-Portuguese children and thereby reduce the average IQ of the next generation from 100 to 97.5. Fortunately for economists, these are all non-economic factors and therefore can be safely ignored in concluding that free trade and the free movement of labor are beneficial to Britain.

That sounds suspiciously familiar, though, doesn't it?

In conclusion, the addition of the free movement of labor to the Ricardian model mathematically proves that free trade combined with unrestricted immigration is not only economically beneficial, but is mathematically preferable to comparative advantage by a factor of 1.9, and to pure protectionism by a factor of 2. Quod erat demonstrandum.

What else can we conclude from this unseemly exercise of the Ricardian Vice?

- Ricardo implicitly postulated the immobility of labor.
- The mobility of labor not only fails to disprove comparative advantage, but actually strengthens the case for even freer trade so long as one only considers the case from the perspective of manufacturers in the country with higher labor costs, and the only factors considered are the labor costs and the manufacturer's profits.
- The mobility of labor will eliminate international trade since everyone will be living in Britain.
- The mobility of labor operates to the detriment of labor.
- David Ricardo and his fellow free traders are dishonest charlatans.

That being said, the strongest case against free trade does not rest on David Ricardo's intellectual corpse. It is not even, strictly speaking, entirely economic in nature.

The Vox Day Argument Against Free Trade.

- Free trade, in its true, complete, and intellectually coherent form, is not limited to the free movement of goods, but includes the free movement of capital and labor as well. The "invisible judicial line" doesn't magically materialize only when human bodies are involved.
- The difference between domestic economies and the global international economy is not trivial, but is substantive, material, and based on significant genetic, cultural, traditional, and legal differences between various self-identified peoples.
- Due to these differences, free trade will have varying effects on a nation’s wealth, and it can reduce, as well as raise, a nation’s standard of living.
- Regardless, free trade is totally incompatible with national sovereignty, democracy, and self-determination, as well as the existence of independent nation-states with the right and ability to set their own laws according to the preferences of their nationals.
- Therefore, free trade must be opposed by every sovereign, democratic, or self-determined people who wish to preserve themselves as a free and distinct nation possessed of its own culture, traditions, and laws.

Toward a Nationalist Trade Policy
To determine an optimal trade policy for a nation, it is first necessary to decide what the objectives of that trade policy will be. Furthermore, due to the number of rival interests involved, it is also necessary to order those objectives in terms of their priority.

- Maintain the population demographics of the nation.
- Increase per capita wealth without increasing per capita debt.
- Improve the state of the physical capital and infrastructure.
- Increase per capita income.
- Modify the amount of inequalities of wealth and income.

Before any trade policy can be adopted, the probable consequences for the nation and the economy must be understood and accepted by the people as well as the politicians and corporate leaders. To do otherwise is to risk imbalanced costs and benefits, political upheaval, societal instability, and long-term economic contraction.


Edit: redid the lists. They showed up in the previews, but didn't show when I actually posted.


_________________
And the end of all our exploring
Will be to arrive where we started
And know the place for the first time.