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July 01st 2011 print

Peter Smith

The Debate That Never Dies

It would be a pity, wouldn’t it, if radical, callow anti-globalisation demonstrators had a point, even if they didn’t know what it was. Would they, I wonder, be potential fans of Marine LePen or Donald Trump? Strange bedfellows all, you might think. David Ricardo’s theory of comparative advantage—explaining the scope for and benefits of foreign trade—provides a window into this potential ménage à trois and into understanding the way the Western world is developing both economically and culturally.

I was looking over some old copies of Quadrant. Being an erstwhile practising economist, I flicked to sections dealing with economics. I fixed on an article by John Carroll, “The Case for Protection”, and a reply from N.R. Evans, “The Charm of Genteel Decline”, in the January-February issue of 1991 when self-confessed political flip-flopper Robert Manne was editor. In his editorial, he welcomed the debate in the spirit of Quadrant’s commitment “to the ideal of free, vigorous and civilised debate on matters fundamental to the nation’s future”. A noble sentiment of lasting application but surely the “economic” debate on free trade versus protectionism had long since been put to bed. David Ricardo (Principles of Political Economy) had done this in 1817 with his theory of comparative advantage; described by Robert Findlay in the New Palgrave Dictionary of Economics as the “most beautiful result in all of economics”.

Twenty years on from the Quadrant debate, Marine Le Pen, the leader of the French National Front Party, and perhaps the next president of France, and Donald Trump, who flirted briefly with running for president of the United States, would like to see less free trade and more protection.

By 1991 my economic and political position had well flipped and hasn’t since flopped. At the time, as a conservative and supporter of capitalism I would have favoured Evans’s free trade sentiments over Carroll’s protectionist sentiments, without qualms or doubts. Why then am I now wobbling? Is it the force of Mr Trump’s personality or Mme Le Pen’s Gallic charm and good looks? Maybe, when Ricardo’s theory is chased down to its logical conclusions in the modern world, Carroll’s arguments have more force than I realised. In any event, the debate does not want to die. Many debates are like that.

Sometimes ideology and different patterns of thinking ensure their survival. Historiography provides a rich example. If all historians dug around original historical records in search of objective truth, so far as it was discoverable, and stuck strictly to the evidence, there might possibly be, to stretch credulity, at some point, a meeting of minds of sorts. Not all historians approach their work in this way. Some let their imagination do some of the work. There are many examples of course, but as very much a non-historian I recall viewing a series on Elizabeth I, narrated by historian and broadcaster David Starkey, and being told exactly what Elizabeth momentarily thought about something. It struck me at the time because no subsequent action or written word evidenced this apparent thought. How did the narrator possibly know what Elizabeth thought at that moment? He didn’t, of course. He provided some plausible possibility dressed up as fact. While historians use their imagination, inevitably geared to their ideology, perhaps to fill gaps, or to make it all more exciting, the profession is condemned to everlasting debate about almost everything. Perhaps they like it that way.

Sometimes, as in the physical sciences, the truth is only elusive for a time, due to the state of knowledge, and debate eventually coalesces to a point of agreement. No one now seriously doubts that the passage of time for two observers depends on their speed of movement relative to each other. Einstein’s theoretical explanations were conclusive enough and it didn’t hurt that they put an atomic clock on a plane to “prove” it. Sometimes scientific debates suffer the same fate as history debates. Climate change is a prominent example. It is clear that different ways of thinking and ideology infect the debate. If the alarmists are right it will have to get very hot before the sceptics will believe it. If the sceptics are right it will have to stay cool for a very long time before the alarmists believe it. The weather will probably not oblige to the extent required, at least for a very long time, so the debate will continue.

Ideological differences can clearly fuel ongoing debates of strident and often acrimonious character across different subject matter. Economics is replete with never-ending debates, for good reason. In a sense history and hard sciences are self-contained. Did that massacre occur or did it not? Is the climate materially warming because of man-made carbon dioxide emissions or is it not? Historians and scientists will say that it is more nuanced than that. It probably is but, at the same time, it often appears more many-layered than it is simply for lack of knowledge. Once something becomes known, myriads of interesting hypotheses become redundant.

Economics, on the other hand, is intrinsically nuanced. Economic propositions often depend crucially on the assumptions being made—stated and implicit—and are only ever partial in explaining human events and human aspirations. Economics cannot provide a self-contained explanation of anything. Ideological differences have no more fertile field on which to play out and, because of this, it is at the top end of subject matter engendering and prolonging debates. This is why free trade versus protection will ever be debated despite Ricardo’s beautiful result. And, in this particular case, there is point to the debate that goes beyond theoretical economic niceties to events which will continue to shape the course of Western civilisation. I don’t think Ricardo had that in mind at the beginning of the nineteenth century in the (economic) world of his time.

Then, trade formed a small part of total output. Greenwald and Kahn (in their book Globalization) provide an estimate of global trade as being just 2 per cent of global output in 1820. Agriculture employed more people than any other sector. It accounted for close to 40 per cent of employment in England, which was by far the most advanced industrial and urbanised country of the time, and for a much larger proportion in other European countries. Agricultural production, as distinct from its output, can’t be easily moved geographically for obvious reasons. There were no well-developed international currency and bond markets. Private financial capital was therefore largely employed within national borders. Though border controls were lax, the absence of communication technology (the telegraph had still to be invented) would have had an insulating effect on local populations and it would have been safe to assume that different cultures and languages would keep them largely at home.

Industrialisation resulted in internal migration from rural areas to towns and there was seasonal cross-border movements of labour in continental Europe, but large permanent cross-border movements were largely, though not totally, confined to migration to the new world. Manufactured goods were relatively costly to transport compared with their value. This imposed a high hurdle on manufactured exports. While none of this prevented the development of opinion, beginning as early as the seventeenth century, characterised as “mercantilism”, by Adam Smith, which sought the imposition of tariffs on imports; this was not primarily driven by protectionist sentiment, as we now understand it. As Mark Blaug (in Economic Theory in Retrospect) explains, mercantilists saw advantage in a favourable balance of trade and the treasure (gold reserves) it brought to the country. Adam Smith saw virtue in the counter development of the physiocrats in France in the mid-eighteenth century, under the leadership of Francois Quesnay who, in pointing to the deleterious effects on French agriculture of various restrictions on the internal and external trade in corn and other agricultural products, argued for their removal. However, the physiocrats were almost exclusively preoccupied with agriculture, not with manufactured goods.

Now the world is quite different. Trade at 2 per cent in 1820 had risen to 30 per cent of output by 2000. Manufacturing production far outstrips agricultural production in developed economies—leaving aside for the moment that the provision of non-government services now outstrips both combined. Financial capital moves seamlessly between countries. National borders have become more porous, de facto and de jure; the European Union presents an extreme example of the latter. Communications technology has demystified alien cultures. Almost everyone anywhere probably knows someone who can speak English. Tariff walls, so long in place, have progressively fallen away since the Second World War as bilateral and multilateral agreements through the GATT have lowered and removed barriers. All of a sudden, when measured in historical terms, the theory of comparative advantage has fertile ground on which to play out and, moreover, there is undoubtedly much more to come. We are perhaps only on the threshold of its influence despite the great changes it has already wrought. A comment by Niall Ferguson (in The Ascent of Money) is instructive on the newness of globalisation in its current phase: “From the 1930s until the late 1960s, international finance and the idea of globalisation slumbered—some even considered it dead.”

The theory of comparative advantage demonstrates that specialisation and trade between two countries always increases total output and therefore always has the potential of making both countries better off economically, even if one country can produce everything at less cost than the other. Before Ricardo it was appreciated that trade would be beneficial between countries if each could produce a mutually desired product at materially less absolute cost than could the other. It was not appreciated that gains would still be made in circumstances where one country had an absolute cost advantage across all products. It is a powerful result.

To partially use Ricardo’s example: if because of the relative disposition of advantages, England requires 2 resource units (RUs) to produce one unit of cloth and 8 to produce one unit of wine, while Portugal requires just 1 RU to produce either one unit of cloth or wine, Portugal can produce both more cheaply. However, the overall production of cloth and wine would rise if England concentrated on producing cloth and Portugal wine. To make the arithmetic simple, for each 8 RUs that England switched to cloth from wine, 4 additional units of cloth would be produced for the loss of 1 unit of wine. For each 2 RUs that Portugal switched to wine from cloth, 2 additional units of wine would be produced for the loss of 2 units of cloth. An aggregate gain to be shared would result, of 2 units of cloth and 1 unit of wine.

The world is a complex and dynamic place and economists, particularly of mathematical bent, revel in complexity, so Ricardo’s model has been tugged and pulled to try to fit it into a world of many countries, many products, different kinds of resources, and ever-changing conditions. While this is important work, and has its fascination for some, none of it takes away from or substantially modifies the Ricardian insight. This insight carries two implications, though perhaps portents would be a better word. One is that there is not necessarily any limit to complete specialisation. In other words, inside the constraint of world demand for any particular product and barring diseconomies of scale, each product will tend to be all produced in one place. And moreover, economies of scale are more likely to predominate and therefore to reinforce the process towards specialisation. The second portent arises from Ricardo’s assumption that resources, particularly labour, are trapped within national borders. If labour were not so trapped it would tend to flow to where it was most productive. In the England–Portugal example above, labour would flow to Portugal until England was empty. Literally speaking this is silly of course, but the tendency has force and validity and we are seeing it being played out.

It is time to bring in Carroll’s arguments in favour of tariffs. They are familiar. He did not originate them. One is the need to have a dispersion of industries for strategic reasons—for relative self-sufficiency in times of war and to have an industrial structure and range of skills which can be turned quickly into producing armaments. To this he added the social psychological argument that a wide range of work, particularly making things, is fulfilling and adds to a society’s wellbeing and, moreover, helps match employment opportunities with the different aptitudes of different sections of society. Carroll understood the arguments against tariffs and therefore noted that their application must be “selective and judicious”. There’s the rub, and Evans exploited it. He noted, apart from the impoverishing economic impact of tariffs, that disinterested decisions would be required which would reward some industries and penalise others. “It is impossible to conceive of a situation in which corruption can flower more quickly,” he said; and he was surely right.

Generally tariffs make us poorer, free trade makes us richer. It is true that tariffs can potentially improve one country’s position acting in isolation. However, retaliation inevitably leads to everyone being worse off. Tariffs are a boon for lobbyists; they produce special pleading and featherbedding as a result of cosy arrangements between business owners and unions; and they corrupt the political process to an even greater extent than is the norm. And eventually they simply don’t work. In the end result, economic forces are too powerful to resist. So why am I wobbling?

I am wobbling because the world seems to be heading in the direction comparative advantage says it will at great speed: to ever greater specialisation. Moreover, comparative advantage, when economies have absolute advantage across most products, is working to draw people to where they can add most economic value. People are not as trapped within borders now as Ricardo was safe in assuming in 1817. People movements are presenting Western economies with cultural absorption challenges which go to the heart of their national character. Time to bring in Marine Le Pen and Donald Trump.

Marine Le Pen’s most telling influence was to lead her party away from her famous father’s destructive extremism. Having done that, she has been able to present a “patriotic” face freed of the distracting and debilitating baggage of fervent Catholicism and nasty anti-Semitism. Marine Le Pen is twice divorced and in favour of gay rights and abortion and disavows anti-Semitism. She presents her views wrapped up in patriotism. The two Ps go together. Protectionists are inevitably patriots. Their aim is to protect their country’s industry, culture and institutions. That is not to say that free traders are not patriots, simply that they are rationalists first and foremost.

Le Pen observes entrenched unemployment in France, a large ethnic North African Muslim immigrant population out of tune with French values, and porous borders with control ceded to the EU. Among other measures, Le Pen would like to reinstate border controls, to largely stop immigration, and to renegotiate the terms of the EU to increase France’s independence; parts of which would find expression in being able to protect French industry and bring back the franc.

Donald Trump observes correctly that USA’s unemployment is stubbornly high and that the USA is losing manufacturing jobs to China. He sees urban decay and despair as jobs are lost in areas like Detroit. China clearly has a comparative advantage in producing traditional high-volume manufactured goods. That advantage is likely to grow if economies of scale work in the usual direction because its own domestic market for manufactured goods has enormous growth potential. Trump as a businessman sees that a deal can be done right now when China depends on the USA for much of its market. He probably realises that this advantage will grow less as time goes on. He proposes that a 25 per cent tax (in other words a tariff) be imposed on Chinese imports unless the Chinese play ball and allow their currency (the yuan or renminbi) to rise in value (resulting in a similar effect of increasing the price of Chinese goods). Trump does not seem as concerned with Mexican immigrants and future immigration as is Le Pen with North African Muslim immigrants and future immigration. That is understandable; he is a businessman and is likely to mix his patriotism with economic rationalism when it comes to migrant workers.

A number of questions arise. Is unfettered trade damaging France’s and the USA’s economies and by extension other Western economies? If it is, how is it doing this and what if anything can or should be done about it? How do people movements fit into the picture?

First, it is necessary to deal with the obvious defence of free trade. This is that industries lost will be replaced with new industries and the expansion of others, adding greater value than the industries lost and, for Western economies, creating more pleasant employment conditions. The book I referred to above, Globalization, sets this out as well as any other authority. In the USA, as in other Western economies, services and high-technology manufacturing have replaced the high-volume traditional manufacturing lost to China. Working conditions on the whole have become pleasanter and real wages much higher. I used to buy this argument in its entirety but, while it is true, it also turns out to be tautological and incomplete. It is true as a matter of economic logic. Quite simply it would be of no use to China to capture traditional manufacturing industry if those from whom it were taken were not able to buy its products by producing alternative products of their own. It takes two to tango and industries would not escape Western economies if they were not replaced by industries producing broadly equivalent value. It is the side effects which are important to consider. These are the dislocation effects and social psychological effects (both touched on by Carroll, albeit using different terminology).

Dislocation has two components: industry moving geographically, leaving workers behind, and technologically, leaving prevailing skills behind. What matters here is the speed of change and the incentives for workers to adjust. The speed of change has been rapid. To use the USA as a representative example, there were one and half million well-paid auto workers in 1970; fewer than half this number remained by 2007. From 1970 to 2005 while people in managerial and professional roles grew by 153 per cent and those in service occupations by 123 per cent, those employed in traditional manufacturing roles fell by 10 per cent; against an overall rise in all occupations of 80 per cent. The incentive for workers to adjust to these changes comprises a carrot and stick. The carrot is clear enough—the opportunity for more highly paid and pleasant work. The stick is the penury of unemployment. Growing, and apparently intractable, long-term unemployment suggests that the incentives are just not strong enough when set against the speed of change. A persuasive case can be made that the growing welfare state bears considerable responsibility.

It is arduous to learn new skills after many years of practising old ones, and it is arduous, as Mrs Thatcher colourfully put it, to get on your bike and move from where you have lived, sometimes well into middle age. Welfare provides a second-rate escape hatch but an escape hatch nonetheless. Ljungqvist and Sargent, “The European Unemployment Dilemma” (in Federal Reserve, 1991), suggested that the welfare state in Europe, when contrasted with the situation in the USA, accounted for the growing rise in long-term unemployment in countries like France, West Germany and the UK between 1979 and 1989. Those out of work for more than twelve months as a percentage of total unemployment (which had also grown) rose in those three countries from 30 to 44, 20 to 49 and 25 to 41 per cent respectively over the period. Brought up to date, the USA has not nearly caught up with Europe (in this race to the bottom) but it is now in the race. As the USA increased and extended welfare entitlements to the unemployed, so long-term unemployment rose to an average of 12.3 per cent of unemployment in the five years to 2009 from an average of 8.5 per cent over the previous fifteen years. What this means is that the adjustments demanded by comparative advantage may not be consistent with a growing welfare state. In these circumstances, entrenched unemployment and urban decay and all of the ills they produce (intergenerational poverty and crime, among others) have to be set against the undoubted economic gains. It won’t do to simply record the gains in GDP without taking account of the adjustment costs, and these are largely ignored in calculations of GDP; in fact, in a statistical irony, money spent to combat them is added to GDP.

To turn to social psychology briefly; making things was important, Carroll thought. Is it? I don’t know. My perusal of the literature, though admittedly not exhaustive, suggests there is a lot written about the influence of personality and temperament on occupational choice, but not a lot on the effects, if any, of occupation-type in moulding temperament and personality. This may be because longitudinal studies of substantial length would be required to tease out the answers. Kohn and Schooler (“Job Conditions and Personality: A Longitudinal Assessment of Their Reciprocal Effect”, American Journal of Sociology, 1982) did find (relevantly) that personality was affected by job conditions; however, their assessment focused on employment criteria other than occupation-type. Nevertheless, it is worth speculating on whether occupations in Western societies, in becoming more genteel, with less tangible output, might produce an evolving effect on personality and temperament towards a more passive and less goal-oriented population. The strong trend in Western societies towards professional and service occupations, including government employment, is I think worth bearing in mind as a possible contributory factor, in considering the evident decline in the self-belief and assertiveness of Western societies since the Second World War. Let’s put aside professional studies on the matter; pound for pound, is a miner or traditional manufacturing worker likely to be a more comforting companion in a dark alley than a computer analyst or financial consultant?

In sum, free trade may be having a range of deleterious and costly consequences for Western societies. What is the answer? There probably isn’t one when it comes to the movement of goods and services. Evans was right. Whatever is done leads to corruption and, moreover, in the end, fails. Trump’s 25 per cent tax on Chinese goods, to the extent importers and the Chinese were not successful in evading and avoiding it, would not be enough. The Chinese would get even more efficient and slow even more the gradual appreciation of their currency. It really is a King Canute situation. However, the costs need to be better understood and combated and not buried under an economic tautology that industry lost will be replaced. Nor are there ready answers on other fronts. Providing generous benefits to the unemployed is counter-productive and damaging in a world where comparative advantage is moving so quickly to change the industrial landscape. They should be replaced with generous benefits tied to efforts to find new work, whether that involves re-skilling or resettling. But which political party would have the will to cut unemployment benefits or limit their life? If the evolving pattern of occupation is lessening national self-belief and assertiveness, it can probably only be countered at a political and educational level. Is there any prospect of national life in any Western society celebrating the virtues of Western history and its institutions starting at schools? The answer is no. The prospects are therefore unpromising, to say the least, and they become more so when the people-movement implications of comparative advantage are brought into view.

As already noted, when a country has an absolute advantage in all products, labour will tend to flow to the more productive country unless trapped within its own borders. Economies of scale come into play again to reinforce the effect once it has begun. And any cultural barriers equally diminish as immigrants establish their own presence in host countries, providing a home from home as it were for those otherwise reluctant to leave. Castles and Miller (The Age of Migration) observe: “International migration has increased steeply since 1945 and most particularly since the mid-1980s … the closing years of the twentieth century and the beginning of the twenty-first will be an age of migration.” The dominant component of this upsurge in migration is economic migration from poor to rich countries. Europe and the USA, of course, have figured prominently as destination areas. While the ending of colonial rule pre-dated migration flows to Europe, this in itself did not prompt migration; economics did. As noted by Christopher Caldwell (Reflections on the Revolution in Europe: Immigration, Islam, and the West): “The vast majority of international migrants move in search of better economic opportunities.” To illustrate, as Castles and Miller point out, the relatively wealthy “Japan, Hong Kong, Taiwan and Singapore, have all joined the ranks of immigration lands”.

Economic migration has both a push and pull factor. Migrants seek economic advancement. Businesses in host countries seek labour and cheaper labour. You will usually find business lobby groups arguing for increased immigration. This is an economically rational stance, fine so far as it goes, but it pays little or no heed to social and cultural matters. Back to Mme Le Pen. She is most concerned about Muslim immigration in France, and with good reason. Muslim leaders talk about the introduction of sharia law wherever they are. Even in Australia, where Muslims form a much smaller part of the population than in most West European countries, the Australian Federation of Islamic Councils in a submission in May to a parliamentary inquiry into multiculturalism argued that Muslims should enjoy “legal pluralism”. The organisation’s president, Ikebal Patel, reportedly said that a moderate interpretation of sharia could co-exist with the Australian legal system. Talk about the thin end of the wedge, never mind the shameless and outrageous chutzpah (to use an appropriate Jewish word).

In France and in other European countries, where past immigration and fecundity promise to take Muslim numbers to politically influential levels and beyond, there is particular reason to be concerned. Muslims continue to form a large proportion of total immigration. According to the Pew Research Centre (“The Future of the Global Muslim Population”, January 2011) Muslims constituted an estimated 69 per cent of immigration into France in 2010, 42 per cent into Holland, 31 per cent into Belgium, 28 per cent into the UK and 45 per cent into Sweden. And the reason for this is clear enough. Islam appears to be inconsistent with economic progress and therefore tends to produce a situation of absolute economic disadvantage and backwardness where it holds sway. When you look across the poorest countries in the world, the Muslim world bulks large (sans pockets of oil beneficiaries). All forty-seven non-European Muslim-majority countries are, in the words of the Pew Research Centre, “in the less developed regions of the world”. In these circumstances comparative advantage suggests that their inhabitants will move if possible, and they are. The same reasoning applies to other relatively impoverished states such as Mexico, but while Mexicans might want to foist some Spanish on the USA, they do not want to foist primitive medieval religious law—though it may be worth bearing in mind that criminal cartels are now smuggling Middle Eastern and North African migrants across the Mexican border into the USA, as well as drugs.

Leaving Australia aside and perhaps Canada as the only large developed countries remaining which are still effectively in their growing and developing phase, severely restricting economic migration is an option for developed countries. It would be far more feasible, even if still difficult, and far less economically damaging, than restricting trade flows. To that extent, Le Pen has it right. Deficiencies of natural population growth in Europe would be better countered by domestic policies to encourage the formation of traditional families with children rather than by producing a younger demographic through importing people whose culture is resistant to adopting Western values.

Comparative advantage has come of age in an era where communications technology has demystified the world for even remote villagers in remote countries; where tariff protection has been dismantled: where developed countries have advanced to widen the gap between the haves and have nots; and where borders are porous. Only comparatively recently have the full effects become evident. Sure the world is wealthier because of specialisation, but it has left people and communities and towns behind. The welfare state has entrenched disadvantage by lessening the incentives for those displaced to adjust and move on. There is no simple answer. Attempts to restrict trade are corrupting, damaging and ultimately unsuccessful. What can be done is to restrict the flow of people moving from less developed economies to developed economies, which left unhindered amplifies the inexorable force of comparative advantage.

Restricting immigration to negligible levels serves four purposes. First, it protects the cultural traditions and institutions of Western societies that, after all, represent the best than human beings have ever achieved, and are ever likely to achieve. Second, it at least takes the edge off the march of comparative advantage. Specialisation as it proceeds eventually requires additional labour in the right spot, as businesses know. Making imported labour harder to get slows the process down and leaves more time for adjustment. Third, following from the second, it encourages businesses to find ways to use home-grown labour left behind geographically and functionally rather than taking the easier road of importing labour. Finally, it allows comparative advantage to play out as it was envisaged by Ricardo. Less-developed countries have the scope to specialise in activities in which they have a comparative albeit not an absolute advantage. Simply exporting labour undercuts and limits the opportunities and scope less-developed economies have to develop their own competitive industries.

Peter Smith is a frequent contributor to Quadrant and Quadrant Online.

Peter Smith, a frequent Quadrant Online contributor, is the author of Bad Economics