Je m’appelle comparative advantage et je suis tombé

Travis Fast

Some months ago I gave a talk on “what is neoliberalism.” And there I made reference to the curious mental gymnastics now being played by liberal economists in their attempt to square their faith in free trade with the actual outcomes being generated by free trade. Shameless I know, but I am going to quote myself at length.
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Save one critique I will not take the time here to rehearse all the limitations inherent to the basic neoclassical model as they are well known and described elsewhere in great detail. The neoclassical methodology necessarily leads to a process of abstraction that produces an ‘other-worldly’ ontology of capitalism. That is, the neoclassical model starts not with an axiomatic reduction of existing capitalism(s) and the behaviour of different classes and countries who occupy different structural locations and therefore have widely diverging utility functions on that basis alone, but, rather, with a series of axioms derived from an idealized economic system and a single representative agent. There is a basic problem involved when deriving an analysis not from what ‘is’ but from what ‘ought to be’ and declaring what ‘is’ to be a aberration from the ‘ought.’ To be clear, this is not a problem of modelling: all models are a parsimonious rendition of more complex phenomena. The neoclassical problem resides with deriving one’s analytical model from a trans historical and trans spatial meta-model when one’s object is both time and space bound.

For example, take the theory of comparative advantage upon which arguments for free trade are based. When Adam Smith outlined his defence of free trade he did so by making both a political and an economic argument. Economically he built his case on considerations of absolute costs (the idea that between two identical products the cheaper of the two should be purchased without regard to its national origins). Smith argued:

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not thereby be diminished, no more than that of the above-mentioned artificers; but only left to find out the way in which it can be employed with the greatest advantage. It is certainly not employed to the greatest advantage when it is thus directed towards an object which it can buy cheaper than it can make.

Equally important however, Smith also argued for free trade on political grounds. He argued that a policy of free trade would prevent particular interests (one industry or sector) from gaining tariff protection and thereby directing a greater part of the social surplus into their pockets at the expense of society as whole. Free Trade was to be supported as a political principle because it prevented the formation of domestic monopolists who would not only use their privileged status to capture more of the social surplus but would also use their enhanced standing and resources to capture the state. Smith summarizes his argument thus:

This monopoly has so much increased the number of some particular tribes of them that, like an overgrown standing army, they have become formidable to the government, and upon many occasions intimidate the legislature. The member of parliament who supports every proposal for strengthening this monopoly is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance. If he opposes them, on the contrary, and still more if he has authority enough to be able to thwart them, neither the most acknowledged probity, nor the highest rank, nor the greatest public services can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes from real danger, arising from the insolent outrage of furious and disappointed monopolists.

We can conclude with Giovanni Arighi that it is a pity that Smith is often quoted but never read by our beloved liberal economists. By using Smith’s simple axiom about the tendency of powerful cartels of capital to capture the state and thereby shape public policy with respect to their own benefit we are moved closer to the reality of the political economy of liberal democracies then any axiomatic description of comparative costs will ever take us.

We can usefully contrast Smith’s promotion and defence of free trade with that offered most famously by David Ricardo and which has subsequent to Ricardo been turned into the iron law of comparative advantage upon which the near universal dogma of free trade is today based. Ricardo’s defence of free trade represents a hollowing-out of the substantive content of the reality of the political economy of capitalism. The Ricardian argument for free trade is grounded not on a general political insight about the realities of the tendency of individual capitalists to capture the state in pursuit of their narrow self-interest; nor on the real processes of capitalist competition which is ruled by considerations of absolute costs but rather on the technical merits of specialization and the potential gains from trade rooted in the concept of comparative advantage and relative prices.

As is well known, Ricardo demonstrates that gains from trade can be made even if one of the two nations involved entering into a free trade agreement is relatively backward in all branches of industry. To make a long story short, for Ricardian comparative advantage (and all subsequent iterations) to hold there must be a monetary mechanism which adjusts the terms of trade between two countries such that eventually at least one good in the least developed country can be exported competitively. Should this monetary mechanism not operate as such then the whole Ricardian law of comparative advantage is rendered nothing more than a scholastic enterprise with some merit as an intellectual puzzle which is applicable to a null domain. In order to illustrate more clearly what I mean here it is useful to provide a contemporary example.

One of leading lights of American neoliberalism, Brad Delong recently penned an article entitled “Has Neo-Liberalism Failed Mexico?” Delong’s immediate answer to his question is ‘yes free trade has failed Mexico’, as he observes:

…the 3.6% rate of growth of GDP, coupled with a 2.5% per year rate of population increase, means that Mexicans’ mean income is barely 15% above that of the pre-NAFTA days, and that the gap between their mean income and that of the US has widened. Because of rising inequality, the overwhelming majority of Mexicans live no better off than they did 15 years ago. (Indeed, the only part of Mexican development that has been a great success has been the rise in incomes and living standards that comes from increased migration to the US, and increased remittances sent back to Mexico).

Delong tellingly goes on to reflect:

Intellectually, this is a great puzzle: we believe in market forces, and in the benefits of trade, specialization, and the international division of labor. We see the enormous increase in Mexican exports to the US over the past decade. We see great strengths in the Mexican economy – a stable macroeconomic environment, fiscal prudence, low inflation, little country risk, a flexible labor force, a strengthened and solvent banking system, successfully reformed poverty-reduction programs, high earnings from oil, and so on. Yet successful neoliberal policies have not delivered the rapid increases in productivity and working-class wages that neo-liberals like me would have confidently predicted had we been told back in 1995 that Mexican exports would multiply five-fold in the next twelve years.

Delong concludes his article without providing any indication of why he thinks free trade failed Mexico. Undoubtedly this is a complicated question of which no attempt will be made to provide a rigorous answer here. However, I would nevertheless like to suggest why neoliberal trade theory failed both the patient (Mexico) and the practitioner (Delong).

Where to begin? First off, leaving aside all the assumptions required to make the theory of comparative advantage yield its sanguine conclusions about the benefits of free trade – perfect competition between infinitesimally small firms that maximize profit and are price takers, perfectly mobile factors including labour, full employment of all resources in particular labour, zero transportation costs, homogeneous product markets, well behaved if not identical production functions and the like — there is the issue of the monetary mechanism which establishes relative prices between the two countries in such a way as to make the backward country competitive in a least one industry. Now even if we grant that something like the quantity theory of money is true or that some reasonable facsimile thereof (in terms of directing relative prices including interest rates) is the general case (which is empirically doubtful) there is simply no way in which the relationship between the US and Mexican currencies and interest rates can be said to mechanically adjust in that way.

The US dollar is not just any other currency, it is the international numeraire and fountainhead of the international financial system. And what is more, the US is not just any other country given its shear weight in the global economy. The US dollar enjoys the status it has, not because the US is the most productive country in the world, but, rather, because the US is the lone hegemon in a unipolar world. What attracts global savings to the US is only partly explained by economic fundamentals while the rest is explained by political realities which make US assets, in particular US treasury bills, some of the most risk free in the world. Hence, both the value of the US dollar and the US interest rate reflects an amalgam of factors that have almost nothing to do with the relative productivity between the US ands Mexico, nor with the health of their respective balance of payments. On this rather obvious observation alone (obvious insofar as even a cursory glance at the twin US deficits, US interest rates and the value of the US dollar reveals a less than tenuous link between them) it should be clear that the very mechanism that is said to reveal comparative advantage and force movement toward those industries, both in terms of capital and labour, does not exist.

If we were to add to the above observation all the ways in which the starting assumptions of the neoclassical trade model were violated it would not be long before our model became a near useless guide as to the likely path of adjustment upon the opening of free trade between Mexico and the US and its likely impact on income distribution. Even, however, if we are to disregard all these inconvenient facts there is the further issue of the substantive content of free trade deals. It is as if neoliberals like Delong think that free trade deals are an exercise in moving from a position of autarky to a position of complete free trade (the absence of any and all barriers to trade). As anyone familiar with NAFTA or indeed the present Doha round of world trade negotiations can well attest, free trade deals are anything but agreements to remove all the barriers to trade. Such deals decrease some tariffs, eliminate others, and leave others in tact not to mention all the ingenious forms of trade distorting policies nations come up with to protect particular industries and sectors after the deals are inked. Moreover, they do so in a way that reflects the relative hierarchy of the contracting parties in the international economy. In short, trade deals themselves have a political economy and this is nowhere truer than in ‘free’ trade deals that involve the US and the EU.

In such a world, a capitalist world I should add, the problem with neoliberal economics is not merely a problem of poor modeling but rather reflects a terminal problem with the very ontology of capitalism upon which its modelling exercises are carried out – the problem my dear Bradford is not in you but in the heavens of your ontology. All of the above speaks to the central reason why neoclassical (liberal) economics is not altogether very useful for understanding the political economy of neoliberalism although a critique of it can be quite revealing as an exercise in de-mystification.

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2 thoughts on “Je m’appelle comparative advantage et je suis tombé

  1. Interesting post. Maris Mies suggsets that neoliberalims is more religion than theory because it refuses to modify its premises in the face of real world evidence. Anyway, I will be coming back here – Iots to learn!

  2. Polly,

    I’ll only add one thing to Travis excellent exposition: Even if we go back to Ricardo’s day and use his example of comparative advantage (exchange of English wool for Portuguese wine, i.e. trade between those two nations), it failed to capture a reality brought on largely as the result of asymmetric commercial treaties, especially the Methuen Commercial Agreement of 1703.

    “The Methuen treaty itself was “the most significant and typical”
    stroke of the commercial diplomacy of the 18th century, aimed like
    the wars of that epoch chiefly at market monopolies.1° England agreed
    to buy Portuguese wine (“port” from Oporto) in preference to French;
    Portugal threw open its market to England’s more efficiently produced
    woollen cloth, with which its own could not compete. It thus condemned
    itself, partly in the hope of richer colonial spoils, to neglect of its
    manufactures and dependence on foreign products. This also meant
    benefits for the feudal landowning class and the crippling of the small
    industrial middle class, with blighting effects on Portugal’s subsequent
    political evolution, or rather its failure to evolve. It was not, however,
    the Portuguese home market alone that British enterprise was now in a
    position to dominate, but the Brazilian too.

    A hundred million pounds’ worth of gold are estimated to have
    entered Portugal between 1696 and 1726.12 They did no good to the
    inert economy, and a large proportion of the slave-mined gold was
    quickly drained off to England, where it contributed to the gestatory
    period of the Industrial Revolution. It enabled English goods to provide
    the bulk of the export trade from Portugal to Brazil, so that this rich
    colonial market was in effect part of England’s empire at second-
    hand.” (THE OLD ALLIANCE: ENGLAND AND PORTUGAL)

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