2010-12-21

Social mood and free trade

It's important that the phenomena associated with rising or falling social mood be viewed objectively. A good approach is to think of social mood in terms of "too much of a good thing," rather than rising social mood good, falling social mood bad. The negative period of social mood is a chance to clear the decks, of bad debts and bad ideas. We focus on causes when a leader such as Hitler rises to power, but during a decline in social mood, sometimes this element is missing. We have economists critical of the public's newfound frugality, for instance, when this is a reaction to the spendthrift years that preceded it. I would argue that much of the Western world is not close to a rational level of xenophobia, given the extreme levels of immigration over the past few decades, but just as I expect the public to be irrationally frugal even when the economy has long since bottomed, similar to the people who lived during the Depression, so I anticipate that the public will become excessively xenophobic.

Excess becomes necessary though, when ideas are firmly rooted. The vast majority of the economic profession is in favor of free trade, while the general public is generally favorable towards it. Socionomics predicts a rise in protectionism during a decline in social mood and no doubt this will be portrayed negatively by the intellectual classes. Therefore, as with immigration, the Federal Reserve, and financial bailouts, excessive levels of general public anger are required to simply make a dent in the Ivory Tower.

Another factor to consider is mindless versus intentioned. The public can become thoughtfully frugal, or they can become paralyzed with fear and hoard cash. They can mindlessly attack foreigners on the street, or they can reform their immigration policies. And they can mindlessly throw up trade barriers in a fit of blame the foreigner, or they can examine their trade and economic policies. The negative social mood will be most effective when there are constructive outlets for public anger. A society without answers, or even able to ask the right questions, will have a recipe for instability and stagnation.

This is the roundabout introduction to what may be an important intellectual work during this period of declining social mood, Ian Fletcher's Free Trade Doesn't Work: What Should Replace it and Why. I have not read the book, having just come across it, but I have been reading a paper by the author which attacks the assumptions of Ricardian free trade.
Dubious assumptions of the theory of comparative advantage

Free trade squeezes the wages of ordinary Americans largely because it expands the world’s effective supply of labor, which can move from rice paddy to factory overnight, faster than its supply of capital, which takes decades to accumulate at prevailing savings rates. As a result, free trade strengthens the bargaining position of capital relative to labor. This is especially true when combined with growing global capital mobility and the entry into capitalism of large formerly socialist nations such as India and China. As a result, people who draw most of their income from returns on capital (the rich) gain, while people who get most of their income from labor (the rest) lose.
Capital is scare and takes a very long time to build up. Countries such as Korea and Japan were able to catch up very rapidly due to high savings rates and the built up experience and knowledge from developed economies. These countries began their improvements internally, however, and benefited from favorable bilateral trade deals with the West as part of Cold War economic policy. Opening the world to trade in the WTO era is slightly different, since it is much easier to participate and brings so many participants to the market at once. A country with no capital accumulation and no plan for capital accumulation can open up the domestic labor supply to foreign business and obtain an economic benefit (however short lived if there's no policy in place to take advantage of the benefits).

This ends up being very beneficial to capital immediately, since it can now seek the highest possible return anywhere on the globe. In contrast, low skilled workers are abundant, therefore wages should head towards a global wage rate—bad news for unskilled workers in the developed world. However, since many unskilled jobs require a physical presence, what ends up happening is that these jobs go to where ever returns to capital are the highest. If the economy that lost the jobs has a use for these workers, that is very good news, since they can possibly be employed in more productive lines of work. Here's the rub: increased labor productivity comes from employing capital. Capital just exited the country along with the jobs and the assumption is that capital will now come back in an even larger quantity to rehire these workers. Is this what we observe? Or do we observe global capital flows continuing in the same direction?

There's also the case of secondary and tertiary industries. This is probably one of the strongest cases against free trade that I've come across, something that Eamonn Fingleton argued in In Praise of Hard Industries: Why Manufacturing, Not the Information Economy, Is the key to Future Prosperity. Here's Fletcher:
Ricardo’s own favorite example, the trade in English textiles for Portuguese wine, is very revealing here, though not in a way he would have liked. In Ricardo’s day, textiles were produced in England with then-state-of-the-art technology like steam engines. The textile industry thus nurtured a sophisticated machine tool industry to make the parts for these engines, which drove forward the general technological capabilities of the British economy and helped it break into related industries like locomotives and steamships.24

Wine, on the other hand, was made by methods that had not changed in centuries (and have only begun to change since about 1960, by the way). So for hundreds of years, wine production contributed no technological advances to the Portuguese economy, no drivers of growth, no opportunities to raise economy-wide productivity. And its own productivity remained static: it did the same thing over and over again, year after year, decade after decade, century after century, because this was where Portugal’s immediate comparative advantage lay. It may have been Portugal’s best move in the short run, but it was a dead end in the long run.
A modern agricultural example completely within one country's borders is U.S. farming. See, Guest worker Programs: A Threat to American Agriculture. In the short-run, it is cheaper to allow low wage illegal aliens to pick produce by hand, but engineers are working on mechanized solutions. If the U.S. restricted the supply of labor to domestic sources, this would lead to investments in capital goods (I'm assuming that U.S. support for farmers would forestall outsourcing this sector of the economy) and eventually, an entire new industry to support the farm industry. The result would be high wage farming jobs, supported by high levels of capital investment. Instead, the country will rely on cheap labor.

In the case of manufactured goods, factories are supported by research & development and suppliers. Sometimes a plant will move overseas and only make use of low wages, but other times the research jobs and suppliers move as well, to be closer to the final production point. Therefore, in trying to gain a small advantage in the short-run, a country may be giving up much more in the long-run. On a larger scale, what happens to an area when the major employers leave is that much of the local economy eventually follows.

We've seen Austrian economics and heterodox economic theories attract greater attention in the wake of the financial collapse, since in many cases they focused on the debt problem and accurately predicted the crisis. Free trade is a far more hardened intellectual position, with more agreement than disagreement across the disciplines. The challenge to this orthodoxy arrived on schedule, aided by the decline in social mood. Declining social mood will increase the desire for protectionism and it will either be an organized examination and then reform of trade policy, or a slapdash trade war that would sour international relations. A couple years ago, Ron Paul was laughed at for questioning the Federal Reserve. Today, free trade remains a relatively unchallenged orthodoxy. I expect that we'll see a similar shift in opinion. Whether this ends up being a fig leaf for politicians to erect trade barriers or leads to genuine economic reform, is another matter.

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