Week Ten

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(No Transcript)
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Globalisation and free trade

• Big Brother in disguise

And the weakest link
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Trust us, were economists

• Belief in superiority of free trade near
  universal amongst economists, but cant convince
  the public
• Economists blame
• Ignorance of public
• Although perhaps the area of economics least
  understood by laymen (and, alas, many
  undergraduates), the theory of comparative
  advantage is essentially very simple (Dixit
  Norman 1980)
• Myopic self-interest of politicians
• in recent years there has been a growing
  awareness of why legislators are prepared to
  supply protection in order to promote their
  selfish political interests (Lloyd 1987)

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Dont trust them, theyre politicians

• Advantages of free trade/disadvantages of
  protection
• cant be explained to public
• wont stop selfish interest groups successfully
  lobbying selfish politicians
• Solution?
• Take trade policy out of the hands of the public
  and politicians
• MAI, GATT, GATS tactical response of economists
  to political opposition
• Sidestep democracy for the common good
• So free trade is like castor oil?
• Good for us, but we have to be made to swallow
  it
• Really?

Skip to Ricardo
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In the beginning was the hoard

• Feudal era trade ideology was Mercantilism
• National object the accumulation of gold
• Policy sell as much as possible, buy as little
  charge as much as possible, pay as little
• suppose Pepper to be worth here two Shillings
  the pound constantly, if then it be brought from
  the Dutch at Amsterdam, the Merchant may give
  there twenty pence the pound, and gain well by
  the bargain but if he fetch this Pepper from the
  East-Indies, he must not give above three pence
  the pound at the most, which is a mighty
  advantage (Mun 1664, The Ballance of our
  Forraign Trade is The Rule of our Treasure)
• Restrictions galore on commerce

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A change of system, a change of ideology

• Mercantilist restrictions inhibited business
• Tariffs on imported inputs made re-exports
  expensive
• (but high tariffs maintained against Indian
  textiles well into free trade era)
• In particular, economists alleged that laws
  against importation of foreign wheat (Corn
  Laws) made UK wages too high, inhibited
  manufacturing
• But how to defeat Mercantilist ideology?
• Enter the Invisible Hand

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Free Trade and Specialisation

• Theoretical argument provided by Ricardo
  Comparative Advantage
• Took case Mercantilists argued would mean rival
  (Portugal) would defeat England in open trade
• Portugal assumed better than England at producing
  everything
• Argued that England would still benefit from free
  trade
• The Model

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Free Trade and Specialisation

• Two countries producing 2 commodities
• Ricardo assumed Portugal
• Absolutely more efficient at producing both wine
  and cloth
• Relatively more efficient at producing wine than
  cloth
• More of both wine and cloth produced if
• England specialises in cloth
• Portugal specialises in wine
• Countries trade surpluses and increase
  consumption of both goods in both countries

Skip to Graphs
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Comparative Advantage

• Portugal (per 1000 men)
• 90 men to produce x units of cloth
• 80 men to produce y units of wine
• can produce
• 11.1 units of cloth or
• 12.5 units of wine or
• any straight line combination of the two
• England (per 1000 men)
• 100 men to produce x units of cloth
• 120 men to produce y units of wine
• can produce 10 units cloth, 8.5 units of wine, or
  any linear combination

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Comparative Advantage

• So with no trade
• Portugal Max. 11.1 cloth, or 12.5 wine
• England Max 10 cloth, or 8 1/3 wine
• Trade
• Portugal 12.5 wine, England 10 cloth
• Exchange surpluses, total output greater
• Economists think using diagrams putting
  Ricardos arguments in this form

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Comparative Advantage
Wine

• World output with no trade

Wine output without trade

• and then trade...

Portugal
England
Cloth
Cloth output without trade
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Comparative Advantage
Trade England produces only Cloth, Portugal only
Wine
Wine
Wine output with trade
Total output higher, surpluses traded
Wine output without trade
Portugal
Cloth output with trade
England
Cloth
Skip to Modern
Cloth output without trade
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Comparative Advantage

• Under a system of perfectly free commerce, each
  country naturally devotes its capital and labour
  to such employments as are most beneficial to
  each. This pursuit of individual advantage is
  admirably connected with the universal good of
  the whole. By stimulating industry, by regarding
  ingenuity, and by using most efficaciously the
  peculiar powers bestowed by nature, it
  distributes labour most effectively and most
  economically. (Ricardo 1817)
• Clever logical argument aided repeal of Corn Laws
• Identical to modern economic belief
• (Ricardos model is economics one big trick)
• But behind Ricardos rhetoric, a Realpolitik

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Ricardos Realpolitik

• It has been my endeavour to shew throughout this
  work, that the rate of profits can never be
  increased but by a fall in wages, and that there
  can be no permanent fall of wages but in
  consequence of a fall of the necessaries on which
  wages are expended. If, therefore, by the
  extension of foreign trade, or by improvements in
  machinery, the food and necessaries of the
  labourer can be brought to market at a reduced
  price, profits will rise. (Ricardo 1817)
• Ricardos real interest not efficiency, but
• shift income distribution from landlords to
  capitalists (workers irrelevant to Ricardo)
• increase rate of investment

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Ricardos Realpolitik

• If price of wheat falls
• Rents fall
• Money wages fall (cheaper wheat) while real wages
  remain constant
• Increased profits
• Greater accumulation
• Objective promote growth by redistributing
  income
• Modern economics loses this completely
• Instead, efficient allocation of (existing)
  resources

• Warning, warning intellectual spaghetti
  approaching

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Comparative Advantage
Productionpossibilitycurve
Consumptionoutside PPC!Yippee
Trade price ratio

• Add Free Trade...

Steel (capital intensive)
consumption

• Australia
• (more labour
• than capital)

production
Socialindifferencecurves
Price ratio
Sheep (labour intensive)
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Comparative Advantage

• That's clear, isn't it?

• "Any questions?"

• Yes
• How do you turn a steel mill into a sheep dip?
• Economic theory

• Reality?...

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Absolute Destruction of Capital
Pre-tradeprices
Less capacity,depressed areas
Steel pricefalls

• Economic theory ignores
• time
• uniqueness of capital
• specific skills of labour

Capitaldestroyed
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Comparative Reality

• Add free trade...

Unprofitable capitalin less competitiveindustry
destroyed
Steel (capital intensive)
Productive capacityfalls
Associated regionsdepressed, labour unemployed
Sheep (labour intensive)
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Comparative Reality

• Cant convert capital or labour from one use to
  another without loss
• Amount lost a function of speed of change
• Instant cut in tariff/trade barriers (as in 1973)
• destroys capital invested in less competitive
  industries, deskills workers (e.g., Steel in
  Australia, rice in Japan)
• Inflates value of capital in competitive
  industry, increases use of existing capacity, but
  significant time lag before new capacity built
• Need analysis of impact of trade on investment,
  innovation, employment, but economics doesnt
  provide it (except on rotten foundations)

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Can Australia survive on the bush alone?

• Rural prices have been pretty good lately,
  havent they?

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Neither a pretty picture, nor a new one
Todays globalisation also contradicts
comparative advantage assumptions

• Contrary to comparative advantage dogma,
  nationally successful globalisation requires
  manufacturing

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Inconsistent ideologies

• Theory of trade assumes
• Capital and Labour (factors of production)
  infinitely flexible within countries
• can move without loss between industries
• completely inflexible between countries
• all wages and profits remain in country where
  earned
• Globalisation as promoted involves
• Overriding rights for transnational corporations
• free movement of capital (but not labour)
• uninhibited repatriation of profits
• Theory (factor-specific free trade) and practice
  (capital mobility globalisation) completely out
  of whack

Conclusions
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Inconsistent ideologies

• Immobility assumptions needed, because without
  them
• Income earned in one country would not
  necessarily be spent there
• Mismatch between countrys productive potential
  (production possibility frontier) and
  expenditure (budget curve)
• Free trade with free movement of capital/labour
  could benefit one country, disadvantage another
• Further theoretical consequences would collapse
• E.g., theory predicts factor-price equalisation
• tendency for wages to converge worldwide
• (Key reason why economists believe free trade
  altruistic towards poor)

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Failed predictions

• Free trade theoretical predictions fail empirical
  tests
• Predicts capital intensive countries (e.g.,
  USA) will export capital intensive products and
  import labour intensive
• Empirical research (by Leontief) found USA on
  average exported labour intensive and imported
  capital intensive
• Similar results found for many other nations
• Should have been seen as disproof of theory
• Instead, labelled Leontief paradox
• economists tried to explain away result, rather
  than question the theory
• Ditto for wage profit equalisation predictions

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Failed predictions

• USA CEO pay rose 535 1990-2000 vs 33 av.
• Rising inequality the rule in globalised
  countries
• Many trade-oriented success stories breached
  most of economic guidelines re trade-oriented
  growth
• Japan, Korea, Singapore, Hong Kong, Thailand,
  Malaysia hardly free trade pin-up models
• If theory is a map, were on the wrong planet

Skip to conclusions
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Foundations of sand

• Components of economic analysis themselves
  unsound
• Representing societys wishes with smooth
  indifference curves?

Community indifference and utility possibility
loci are among the most useful concepts of
welfare economics. Their great disadvantage is
that they may intersect ... Thus the analysis ...
frequently becomes inconclusive. (Gorman 1953)
Two criteria lead to the possibility of
aggregation (1) identical preferences , and
(2) proportional incomes... These results have a
number of interesting applications in the pure
theory of international trade. (Chipman 1974)
What economistswant to draw
Wine
Cloth
What economistsare entitled to draw

• How do economists cope?

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Foundations of sand

• Representing output by another smooth curve?
• Only if economists conventional circular flow
  diagram is correct

• Firms supply goods to households no problem

Wages profits
Goods andservices
Labour capital
Paymentfor goods

• Households supply labour capital to firms
• OK for labour
• OK for capital as but
• but do dollars make goods?

• Tricky issues (see Debunking Economics Chapter 6)
• bottom line economic theory of production wrong
• Many other flaws in economic logic

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Hastening quickly

• Issues of concern to critics of globalisation
• What will it do to our assets?
• What will it do to unemployment?
• How will it affect innovation, investment?
• How will it alter the distribution of income?
• These dynamic issues ignored by economic theory
• Instead, theory
• Focuses on static gains from trade on nonsense
  assumption that capital and labour are
  indestructible and infinitely flexible
• Assumes dynamic outcomes same as static ones
• Economic theory wrong, so guidance re impact of
  globalisation useless

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Hastening quickly

• Speed of reduction of trade barriers directly
  influences rate of loss of productive assets
• Rapid reduction in trade barriers highly
  destructive
• scraps capital labour in less competitive
  industry
• depresses areas, diminishes investment
• The One Nation economy
• Paper wealth in the cities/finance markets
• Poverty in globalised industries
• Gradual change far preferable to rapid
• Dynamic right way forward can be diametrically
  different to economic theory
• 150 years ago, Japans comparative advantage
  was in silk

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Whether left or right

• Critics of globalisation
• right to reject assurances that globalisation as
  promoted will benefit all
• right to demand that policies protect the weak
• should also demand serious scientific analysis of
  issues, in place of simplistic dogma
• What to do?

• Over to you

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• www.debunking-economics.com

• www.plutoaustralia.com