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Source link: http://archive.mises.org/1397/trade-and-unresolved-issues/

Trade and Unresolved Issues

January 14, 2004 by

It is gratifying that so many libertarians took time to give me the benefit of their thoughts on my recent commentary about the case for free trade. I am grateful to the von Mises Institute for posting these comments and for forwarding to me additional comments excluded from posting by resource limitations. The numerous comments are a tribute to a lively and flourishing libertarian culture that was so sorely missing in America for so long.

I cannot answer everyone who offered points and posed questions. I will limit myself to generally addressing three confusions.

A number of commentators misread what I was saying and thought I was refuting the doctrine of free trade. That is not the case. Free trade theory is sound. It will produce shared gains as long as the specified conditions hold. Many libertarians believe that free trade is an absolute good independent of any conditions. They are entitled to that view, but it is not the view of international trade theory. According to trade theory, free trade produces shared gains when individual trading countries allocate their factors of production internally to where they have comparative advantage. In order for countries to have comparative advantages, factors of production must be internationally immobile. Absolute immobility is not required; however, factors of production must have less mobility than traded goods.

My commentary reminded people that the case for free trade rests upon specified conditions. I noted that these conditions do not hold today. The collapse of world socialism and the advent of the Internet have made factors as mobile as goods.

Some libertarians responded to this by explaining to me how free trade produces mutual gains. They did a good job, but, of course, the analysis they provided assumes the workings of comparative advantage. My point was that we cannot assume comparative advantage if the conditions specified for its existence are not met.

Others informed me that trade takes place between individuals or firms, not between countries. Ricardo knew that, as do I. Why, then, do I talk about trade among countries? If I would only look at trade as what takes place between individuals, I would realize that it is always beneficial or it would not happen, unless coerced. Surely I don’t think buyers and sellers are being coerced to harm themselves by trading.

In making this argument, libertarians are summing up partial equilibriums while ignoring the general equilibrium effects. Let me explain. Consider the case of an American consumer who decides to purchase a product from a Chinese supplier instead of an American one. The impact on the American supplier, employment in his business and so on is imperceptible. In effect, there are no general equilibrium effects. We see only that the American and the Chinese person benefitted or they would not have made the trade.

Now assume that all American consumers purchase the product from China. The American suppliers go out of business and experience capital losses. The workers are unemployed. The effects move beyond the buyers and the seller. Suppose the product is brasseries. 20,000 employees lose their jobs, but 100 million American women benefit. The gains to the multitude are greater than the losses to the displaced workers. Moreover, if we assume the displacement reflects free trade governed by comparative advantage, we can argue that the displaced workers are reallocated to industries in which America has comparative advantage.

Contrast this example with another that looks to be the same on the surface. In order to lower costs and to sell more cheaply in US markets, the American manufacturers of brasseries remove their capital and technology to China, displacing 20,000 American workers and replacing them with Chinese workers who can be hired for a fraction of the cost even though the American factors of production make them equally productive as the displaced US workers.

Libertarians have pointed out to me that there is no difference in the two cases, and they are correct–as long as it is only one or a few industries that remove their capital from the employment of Americans. The general equilibrium effects of 20,000 displaced workers are as likely to be as immeasurable in the overall economy as the effects of the example of the one buyer who deserts his American supplier for a Chinese one.

Nevertheless, there is a fundamental difference between the two examples despite the fact that the American women have the same gains and the brassiere workers the same lost. In the first example, the displacement resulted from import competition under comparative advantage. In the second example, the displacement resulted from capital migration to lowest labor cost in another country. The first example is governed by comparative advantage. The second by absolute advantage. Ricardo and trade theory recognize that there is an important difference.

What is the difference? Factor mobility. If the brassiere manufacturer can move to the country with the cheapest labor, so can every other producer of tradable goods and services. This is why Ricardo and subsequent trade theorists specify factor immobility if free trade is to produce shared gains.

Ricardo’s example uses England and Portugal and cloth and wine. Portugal has absolute advantage in cloth and wine, that is, Portugal can produce both goods cheaper than can England. Ricardo notes that if English factors of production are mobile they will remove to Portugal and both commodities would be produced in Portugal. Portugal would prosper and England would decline.

However, as factors of production were in fact immobile, Ricardo showed that each country could be better off by trading than by self-sufficiency even though Portugal could produce both goods more cheaply. This is because the internal cost ratios–the opportunity cost of wine in terms of cloth–likely differ between the two countries. In Ricardo’s example, the ratios differ such that Portugal ends up with more cloth and wine by focusing on wine where its comparative advantage lies. England gets the same result by focusing on cloth. The ratios that establish comparative advantage and lead to shared gains from trade are undone if English factors can relocate in Portugal.

The reason Ricardo and subsequent trade theorists speak of trade among countries is to ensure that the general equilibrium effects of individual trades are not overlooked. On the surface it seems completely compelling that trade always benefits the individuals or firms that engage in it, or they would not trade. However, even though individual acts of trade continue to benefit both parties, as domestic labor in general is substituted out of production functions by cheaper foreign labor, the general equilibrium effects on the domestic economy overwhelm the individual gains to consumers. The categorical libertarian statement that “it is absolutely true that any non-coerced trade benefits both parties” is true only in a partial equilibrium sense.

Libertarians understand that factor mobility within a country can leave regions impoverished while other regions prosper. International factor mobility can do the same thing.

The honest libertarian case for free trade under conditions of global factor mobility is that the gains for Asians will outweigh the losses of Americans. Although the gains are not shared, the gainers outweigh the losers as happens in countries operating under conditions of comparative advantage when an industry is displaced by cheaper imports. This is not the traditional case for free trade. The case for free trade has never been that it would improve overall world welfare at the expense of some countries. Moreover, it is not an argument that will be politically salable.

The problem would disappear under world government as all trade would be reduced to regional trade. International trade theory would have nothing to explain. But as we still live in countries, libertarians will not endear themselves to their fellow countrymen by telling them that they must accept free trade because it benefits the Chinese more than it hurts them.

Instead of trying to refute the obvious–that the case for free trade is undermined by global factor mobility–libertarians should turn their efforts to determining how best to recreate the conditions under which free trade produces shared gains. Some solutions are better and less intrusive than others. Libertarians should join this debate before it is too late. There is nothing to be gained from an insular and isolated libertarianism.

Posted by Paul Craig Roberts

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