Business & Economy

Some free truths about free trade

The reality is that all successful economies grew up behind walls of protectionism.

Alexander Hamilton and Abraham Lincoln were great advocates of tariffs, government spending on infrastructure, and support of domestic industries, writes Beinhart [Hulton Archive/Getty Images]

Paul Krugman, the Nobel Prize-winning economist and columnist for The New York Times, whose academic specialty was free trade, wrote that, "If there were an Economist's Creed, it would surely contain the affirmations 'I understand the Principle of Comparative Advantage' and 'I advocate Free Trade.'" He puts it in that order because one rests on the other.

The concept of "comparative advantage" imagines everything as closed and static - nations, industries, technology, and methods of doing business - and also, as very, very simple. Then it says that a nation should determine what it can produce most efficiently, give up anything it does less efficiently, and put all its resources into the thing it does best.

This refers to opportunity cost and it implies that putting effort into anything except its most efficient product diverts capital and labour, thus losing the "opportunity" to invest in its most super-special product.

Then they make lots of their special commodity and trade it for the things they gave up on, which they can now buy for less than what it would have cost them to make it themselves. There's more of everything and everything is cheaper and everyone makes out.

Why the theory cannot always work

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The original example, from David Ricardo in 1817, used two countries to illustrate the principle of comparative advantage, England and Portugal, and two products, wine and cloth. He concluded that England should just make cloth and Portugal should concentrate on wine.

At first glance, that seems to make sense. As ordinary thinkers, we rather automatically put that into our more general vision of the economic universe. Wine production depends on natural resources of a special kind, sun and soil, which can't be imported. Since it was lacking those, England should have never been competitive, although the English seemed to be a more "industrial" sort of people.

However, as soon as we insert the example into the real history of the real world, it ceases to work. England's textile industry - once upon a time a giant - has virtually disappeared. (It currently ranks behind Zimbabwe.) So it would have been a very bad bet indeed.

However, the Portuguese either had the wisdom to ignore classical economists, or had the luck of the less literate and failed to read Ricardo, and they're still making money from wine today.

In Ricardo's time, England did have a comparative advantage in textiles. In his illustration it's simply there, in much the same way that Portugal's come from geography.

But it wasn't either an accident of location or a gift from God. That advantage was manufactured by technology, domestic infrastructure, naval supremacy, and imperialism.

The reality is that all successful economies grew up behind walls of protectionism. Alexander Hamilton and Abraham Lincoln were great advocates of tariffs, government spending on infrastructure, and support of domestic industries.

When we look at the actualities of history, theory shatters on the rocks of reality. Yes, there are moments when comparative advantage seems to exist. But if a nation throws all its resources into the best industry, it will, in the long term, be a disaster.

Also, and this is more important, comparative advantage - and absolute advantage versus other nations - can be, and is, manufactured.

In the 19th and 20th centuries, natural resources were presumed to be the key to economic dominance. The fight was on, in particular, for coal and iron, for fuel and steel. Yet Japan, which had neither, emerged as one of the great manufacturing powers in the world. Through policy, intent, and war.

Bad logic, sloppy science.

The reality

Nonetheless, free trade became dogma in economics and among the political and financial elites. It was virtually unchallenged in politics and business.

Until Donald Trump. With a nod to Bernie Sanders.

This immediately prompts two very provocative questions.

Can Donald Trump be right about anything?

Can virtually the entire economics profession be wrong about something? Not just for a few years, or a couple of decades, but for somewhere between 70 years (since the end of World War II) and 240 years (since the publication of Adam Smith's The Wealth of Nations).

The reality is that all successful economies grew up behind walls of protectionism. Alexander Hamilton and Abraham Lincoln were great advocates of tariffs, government spending on infrastructure, and support of domestic industries.

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Germany lagged behind Great Britain until Bismarck switched from free trade to protectionism. A few decades ago, when the United States was quivering and quaking over the rise of the Japanese economy, the bestseller list was littered with books about their Eastern methods of protectionism.

No underdeveloped country has ever moved from the bottom rungs to the top tier while operating under free trade rules.

"Free trade" can only be practised successfully by dominant economies. When Britain was dominant, when the US was dominant, free trade was great for them. And painful for countries they managed to impose it on.

But what happens to a mature economy when developing nations - working behind their protectionist walls - become developed nations, and compete? There are really only two examples - Great Britain and the US. Both experienced rapid and severe industrial declines and great increases in income inequality.

Is that the "natural" result of competition and globalisation?

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Or is it the result of policy? It happened to both nations with the rise of Ronald Reagan and Margaret Thatcher, both of whom broke unions, got government out of industry, and embraced financialisation.

The US government stayed heavily involved in one business sector - the military. The result is that it remains the world leader in military hardware, software, and military operations. By huge margins.

Germany resisted financialisation and, as a matter of policy, focused on industry and on its workforce, and kept its labour unions strong. Industry and the middle class are both thriving.

Policy can create, or preserve, a sound economy. It can also help destroy one.

Free trade is the ultimate weapon in the perennial war between capital and labour.

Think of those old movies about the Great Depression. Hundreds of men gather at the factory gate. The foreman looks the crowd over and picks out four. Who will, obviously, work for whatever pittance is offered. Free trade puts the whole world of workers at the factory gates.

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What lies ahead?

Is the answer to return to tariffs and trade wars?

In a modern, integrated economy, especially with the free flow of capital (no restrictions on taking money out of or into a country), probably not. America pulls out of the Trans-Pacific Partnership, China suggests they'll lead an alternate version. The US raises tariffs, another nation retaliates.

What's required are investments in areas that can't be outsourced, in the technologies of the future, and in physical and social infrastructure because that makes all business easier, more efficient, and more profitable.

It's not about manufacturing. Car-making jobs are already returning. They often pay less than the recommended minimum wage. Wages and salaries are not about manufacturing, per se, or about market value. They're about power. That means support of unions and government support of labour.

Income inequality is worse than self-perpetuating. Concentrated wealth buys politicians who will pass laws that hurt the 90 percent and further enrich the top 0.1 percent. The only way to halt it is with higher taxes.

As to Trump, he can be right about problems. Though all his solutions will make things worse. As to economists, they can be wrong about an idea for centuries. Which is a shame, because their intellectual ineptitude created the great vacuum in which a Trump could blossom.

Larry Beinhart is a novelist, best known for Wag the Dog. He's also been a journalist, political consultant, a commercial producer and director.

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera's editorial policy.

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