Hardly any other topic brings more people to the streets than the TTIP, the planned free trade agreement between the US and Europe. People understand that something very important risks being sacrificed here. Our democracy would lose important regulatory capacity in many spheres. On the other hand, the vast majority of economists defend free trade with teeth and claws. Free trade is considered absolutely crucial for economic growth and innovation. If every country, so the idea goes, would specialise in the production of goods that it can produce the cheapest, the world as a whole would benefit because all of us will become more productive.
To liberal economists and politicians free trade is sacrosanct. Criticise free trade and according to Krugman you become one of these ‘protectionist barbarians’ who do not know what they are talking about. In effect, free trade is the only thing that the liberal economists ever brought to the table in order to explain the wealth of nations. Essentially, the theory is still based on 200 years old work by the English economist David Ricardo. At that time, economists generally feared that countries could be faced with a situation where other countries would have advantages in virtually every tradable product. To compensate for such absolute advantages, the losing country had to become protectionist, so that its producers had a chance to survive.
David Ricardo disagreed. He introduced his famous principle, stating that what matters in international trade are not absolute but comparative advantages. If – this is one of Ricardo’s examples – in a certain country someone is particularly good in producing shoes and in another country someone else efficiently produces cloth, it is advantageous to both that the two trade with one another, even if the producer of footwear would also be able to produce cloth for a lower price than his trading partner. According to Ricardo, both have to specialise in what they are best at (the one in shoes and the other one in cloth) in order to optimise the outcome for both.
This single example already shows how unrealistic Ricardo’s idea is. Ricardo assumes that the shoemaker is at the maximum of its capacity to manufacture shoes and that therefore he does not consider producing both shoes and cloth. But there are no fully underutilised economies in the world. Everyone will, if he has an absolute advantage, make full use of it. Neoclassical trade theory assumes that at any time productive forces are optimally utilised and that capacity expansion is impossible. That is absurd.
Currencies are pawns of speculation
What is more, Ricardian trade theory also assumes that – in a situation of full employment – the remuneration of the workers in all countries exactly reflects the respective shortages of both labour and capital. This is a no less heroic assumption. For international trade nominal wages are crucial because they – together with the exchange rates – set prices for products that are to be traded internationally. But what happens if, as is almost always observed, inflation rates between countries widely diverge?
Then there has to be at least one functional mechanism which ensures that these widely diverging prices and wages (which are being calculated in international currency) remain balanced. The exchange rate between national currencies can be such a mechanism. But it does not work at all. In today’s world, currencies have become the playground of speculation. Over the years, currency values have been gone in a completely wrong direction as speculators exploit inflation and interest rate differentials to make short-term profits. And so, there is no rational basis for free trade to be found here either.
This is not all yet. The neoclassical theory of international trade also assumes that direct investment made by producers from countries with high productivity in countries with low productivity and low wages are at any time determined by the relative costs of labour and capital. In theory, neo-classicists hold that a producer of mobile phones in the west, which relocates its production to China, develops a completely new, much more labour intensive productive technology than the one at home in order to maximize profit under conditions of law wages in China. This can no longer be taken serious. It is ridiculous.
Neoclassical equilibrium theory hypothesises that companies do not make any extra profits. In particular, companies will not make a profit that results from a monopolistic advantage. That is why, according to mainstream theory, if mobile phones are being produced in China, successful Western technology is being discarded and new labour-intensive technology is being developed. This new technology then produces the same identical product and is being offered on the world market at exactly the same price and without additional profits to companies.
According to neoclassical theory, entrepreneurs renounce the profit that they would make if they would combine high western productivity with low wages in China. Doing that would enable them to reduce labour costs and therefore increase their profit tremendously. But the entrepreneur does not use this opportunity because the theory tells him not to consider extra profits or monopoly rents at all.
Today, direct foreign investments create extremely powerful effects for trade. For example, the trade with China can no longer be compared with the normal trade between the western industrialised countries. The Chinese trade consists namely in large part of western companies based in China. It has been estimated that 60 to 70 per cent of total Chinese exports are not exported by Chinese companies, but exported by outsourced western companies. This proves that the justification for free trade does not stand on its own two feet, but that there are in reality no feet.
It follows that the entire global free trade ideology is based on a theory that is not only unrealistic, but plainly wrong. Consequently, international trade may become free, but we do not know yet whether it is efficient. However, in free trade negotiations (and also in the TTIP), freedom and efficiency are being considered as identical or seen as very much in line with one another.
We do not know if trade liberalisation is efficient. But we know very well that the idea that any interference in free trade is harmful and inefficient is clearly wrong. For example, a country which protects itself against massive imports from another country in which monopolistic companies realise very high profits and combine high productivity with low wages is not to be condemned. Protectionist measures directed against such practices can in effect improve the welfare of the whole world because they prevent that monopolistic companies damage or destroy healthy ones.
Even worse than all of what has been mentioned already is that a few countries, in pure mercantilist fashion, are trying to export more than they import. This phenomenon is called ‘global imbalances.’ It stands in stark contrast to the doctrine of free trade. Germany is the greatest sinner worldwide. To determine the economic success or failure that international trade brings to countries that participate in it, trade surpluses or deficits are much more important than the potential ‘productivity effects’ of a liberalization of trade. In reality, once appreciable and lasting foreign trade imbalances occur, there remains no incentive whatsoever for trading partners to conclude a trade agreement with a country that defends its trade surpluses.
Neither massive exchange rate changes, nor direct investments, wage dumping or social consequences of trade are the object of free trade ideology. Pro trade politicians make their judgments on the basis of a doctrine that has nothing to do with the real world. Today, trying to steer trade policy and trade flows is like trying to repair a car using watch tools. What the global economy needs much more urgently than a doctrinal debate on trade policy is a monetary system that prevents individual countries from accumulating unjustified advantages over time through absolute wage dumping or similar measures.
This article was first published in Die Tageszeitung (TAZ). The original article can be found here.