Dispelling lazy thinking on trade deals



The recent furore about Donald Trump's imposing of tariffs on steel, from which Australian companies have been exempted, raises an interesting question about the economics discipline. Which is better, an oxymoron or a tautology?

Rolled Chinese steelThe oxymoron in question is 'financial deregulation'. This is a logical impossibility, because finance consists of regulations, rules. To deregulate finance is like taking the hydrogen and oxygen out of water, or the narcissism out of Donald Trump. It cannot be done.

The tautology is the doctrine of comparative advantage, which is the basis of modern trade theory and the dogma that underpins the belief that all trade protections are, ipso facto, wrong. First devised by David Ricardo in the 18th century, this theory is described by the Nobel Prize winning economist Paul Krugman as a 'badge of honour': a cornerstone insight of the discipline that only a true economist would understand.

He makes the claim in his book Peddling Prosperity, and accompanies it with a table to show its mathematical force. It is superficially compelling, but a little examination of the arithmetic reveals that the whole thing is circular. It says that if countries transact more by specialising in what they do best, then the GDP (transactions) of both countries will rise. Restated, this is: 'the more transactions there are, the more transactions there are'. The disguised circularity is then used to argue that high wage countries specialise in high wage tasks and low wage countries do low wage tasks, with both sides benefiting.

In truth, comparative advantage theory says nothing about the consequences of trade, only that trade has occurred (which is hardly surprising, given that that was the starting point).

So, which is better? This writer's conclusion is that a tautology beats an oxymoron, because although it is telling us nothing, it is at least necessarily true, whereas an oxymoron is necessarily false. Financial deregulation is a dangerous lie; the theory of comparative advantage is really telling us nothing at all. Its danger is that it tricks governments into thinking they have done the hard policy work when they have not.

We see this laziness in the uncritical acceptance in Australia about trade agreements. Proponents enthusiastically confect dollar figures about the alleged benefits, which usually turn out to be chimerical. Take, for example, the Australia-US Trade Agreement (AUSFTA) in 2005, which was touted as a great positive for the Australian economy. According to Shiro Armstrong, a researcher at the Australian National University, the agreement coincided, after ten years, with a fall in Australian and US trade with the rest of the world.


"For each country, trade strategy should match their unique circumstances, which requires doing some real intellectual work."


Armstrong concluded that after the deal, Australia and the United States reduced their trade by US$53 billion with rest of the world and are worse off than they would have been without the agreement. But of course no-one remembers the original euphoric claims; we have all moved on.

Worse, much of 'trade' is not trade at all. It is global companies moving things around in their own supply chains (half of Chinese-US trade is this type). That has nothing to do with comparative advantage theory, but it has proven a very successful way to suppress the wages of workers in developed economies, who have in effect found themselves competing with cheap overseas labour. This has a negative effect on economic growth as workers' spending power is reduced. So much for 'trade' creating economic growth.

The economist Michael Hudson comments: 'Of all the branches of today's mainstream economics, free-trade theory is the most unrealistic. If it were realistic, Britain, the United States and Germany never would have risen to world industrial power.' Hudson adds that Trump's steel tariffs are self defeating, because the idea of industrial protectionism is to obtain raw materials cheaply and protect high-technology industries domestically.

For each country, trade strategy should match their unique circumstances, which requires doing some real intellectual work. For example, Japan and South Korea last century used a mercantile trade strategy, which enabled both countries to become fully developed economies.

China, however, was too large to adopt a mercantile strategy — it is a continental economy, like the United States, which means trade can only be on the margin — and it also could not replicate Japan and Korea's approach. So instead China opened its markets for investment, not in order to use trade and foreign exchange to become wealthy, but to suck in knowledge and technology to serve its domestic market. The result has been the most sustained economic advance in the modern world.

There is even an argument that trade can be bad for a country. Russia, which has taken a short term hit from the sanctions, is beginning to emerge with a stronger and more diverse economy because of the west's 'punishments.'

Australia's trade strategy should be similarly nuanced, rather than an unthinking adherence to circular theories. The Australian economy has a dangerously narrow industry base, with an excessive dependence on commodities exports and a giant property bubble that has fed a bloated financial sector. Manufacturing has withered, the closure of the car industry being only the most high profile event.

Taking an intelligent approach to broadening the local industry base, and crafting trade strategy accordingly, would at least mean attending to the actual realities of commerce.



David JamesDavid James is the managing editor of businessadvantagepng.com. He has a PhD in English Literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Topic tags: David James, Donald Trump, free trade, tariffs, China


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Existing comments

An instructive article, useful for non-economists. But this sentence: "First devised by David Ricardo in the 18th century" aroused the pedant in me--it should be 19th century.
Thomas Mautner | 21 March 2018

And, of course, free trade agreements are a form of favouritism, and are not neutral. They exclude others, effectively being a non-financial tariff.
Peter Horan | 21 March 2018

Free trade is a nonsense peddled by an out of touch bunch of narcissistic politicians in Canberra who are only interested in power and one upmanship. This government let go the the car industry without a whimper. Now those jobs have gone to USA, Thailand and Korea and Japan. We should boycott cars imported from those economies. But will we? Hardly. It's a bit like SeaShepherd. We applaud their efforts to protect the whales but dare not offend Tokyo. Our Navy ships could be built here. The car production lines could be reopened under licence. But no , we give our sub contracts to France. Our frigates to Trieste and design capability to Spain. We let Uber, Amazon and Google, Facebook shred our economy. Brisbane airport is run by the Dutch. China leases our ports and buys our mines and farms. Canada builds our trains and India builds our trams. We whinge about Trumps nationalism while Australia's industries slid irrevocably into oblivion and the only thing Canberra can pat its own back on is marriage equality. What this country needs is a revolution.
Francis Armstrong | 21 March 2018

A couple of other things wrong with the theory: communities are diverse, and healthier for it - so a wide range of occupations need to be available, not a few 'specialised' ones. Also it is environmentally unsustainable to ship/fly so much stuff around the world. My local shop has asparagus from Peru, garlic from China, oranges from the USA etc. etc. The real environmental costs of that transport are not included in the price.
Russell | 21 March 2018

Ricardo's work was early nineteenth century, when the Industrial Revolution was starting to get properly under way. Apart from the fact that he made a vast fortune speculating on the outcome of the Battle of Waterloo, spreading fake news that the French were winning so that British bond prices fell through the floor, allowing him to pick them up at bargain prices and sell when they rose after the French lost, the world trade picture today looks nothing like it did then. Politicians here, the vast majority never having studied any economics, are not only lazy in thinking, but ignorant, as well as gullible in the trust they place in "advice" given by vested interests. The bluster about "free market" economics is patently in the face of large scale market failure, and simplistic appreciation of how the world operates. Unfortunately, Francis Armstrong, if we did what you suggest re cars, who do you think would take up the licences if plants were re-opened? Politicians no longer look to the advice of informed public servants or even home-grown experts, but to lobby groups who laugh all the way to the bank. No free market here!
Dennis | 21 March 2018

Trading together is the imperfect substitute for praying together. And if praying together can only be done today with caveats, that it’s no less so for trade should be unsurprising.
Roy Chen Yee | 24 March 2018