1,000,000 econ­o­mists can be wrong: the free trade fal­lac­ies

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Not only did the global finan­cial cri­sis catch the vast major­ity of econ­o­mists com­pletely unawares, they instead expected tran­quil and even buoy­ant times just as the biggest eco­nomic cri­sis since the Great Depres­sion began. My favourite such obser­va­tion is from the OECD’s Eco­nomic Out­look for June 2007—in which the Chief Econ­o­mist sug­gested that, “the cur­rent eco­nomic sit­u­a­tion is in many ways bet­ter than what we have expe­ri­enced in years … Our cen­tral fore­cast remains indeed quite benign.” But there are count­less other such utterly wrong prog­nos­ti­ca­tions about the econ­omy, from the pro­fes­sion that is sup­posed to be the font of wis­dom on the econ­omy.

Those “in the know” under­stand that this is not an iso­lated fail­ing. The Neo­clas­si­cal model that dom­i­nates eco­nom­ics today is riven with log­i­cal and empir­i­cal fal­lac­ies. If eco­nom­ics were a real sci­ence, it would have long ago been over­thrown and replaced by some­thing more real­is­tic.

Yet at least 90% of aca­d­e­mic econ­o­mists believe in this model, as do almost all econ­o­mists work­ing in gov­ern­ment and pri­vate indus­try. Left to their own devices, they will con­tinue think­ing that this model does describe the econ­omy as the real econ­omy falls deeper and deeper into a cri­sis, even though their model says that this can’t even hap­pen.

Since eco­nom­ics has failed to clean out its own intel­lec­tual sta­ble, it will be the pub­lic that finally forces reform upon it — as once-sup­port­ers like Ana­tole Kalet­sky of The Times calls for “a rev­o­lu­tion in eco­nomic thought” and George Soros funds an Insti­tute for New Eco­nomic Think­ing. With luck, in a decade or two, a more real­is­tic approach to eco­nom­ics might emerge. But in the mean­time, here’s a sim­ple guide for the pub­lic: Any­thing the vast major­ity of econ­o­mists believe is likely to be wrong.

Which brings me to “Free Trade.” The belief in Free Trade is one of the hall­marks not just of the Neo­clas­si­cal school which began in the 1870s, but also of the orig­i­nal Clas­si­cal school which began with Smith in 1776. It argues that almost everyone’s mate­r­ial wel­fare will be increased if all coun­tries spe­cialise in what they are good at—a propo­si­tion that on the sur­face seems plau­si­ble, and a for­mi­da­ble body of math­e­mat­i­cal eco­nomic the­ory has been erected to sup­port it.

Unfor­tu­nately, like so much else in eco­nom­ics the model of Free Trade is, to quote the humorist H.L. Mencken, “neat, plau­si­ble, and wrong.” The the­o­ret­i­cal fal­lac­ies at its core have been there since David Ricardo first coined his model of com­par­a­tive advan­tage dur­ing the polit­i­cal bat­tle to repeal the “Corn Laws,” which restricted the import­ing of cereal crops into Eng­land.

The argu­ments in favour of the Corn Laws included the belief that if trade were unreg­u­lated, Eng­lish industry—in par­tic­u­lar its agriculture—might be wiped out by for­eign com­pe­ti­tion. Ricardo, in a bril­liant debat­ing ploy, con­ceded his oppo­nents’ case that a rival coun­try (Por­tu­gal, which was then one of Britain’s major rivals) was bet­ter at both agri­cul­ture and man­u­fac­tur­ing than Eng­land and then pre­ceded to “prove” that Eng­land would still ben­e­fit from Free Trade.

He assumed that in Por­tu­gal 80 men could pro­duce a quan­tity of wine (say, 1000 gal­lons), whereas Eng­land would need 120 men to pro­duce the same amount and that Por­tu­gal was more effi­cient too at pro­duc­ing cloth—needing 90 men to pro­duce a quan­tity of cloth (say, 100 square yards of cot­ton) whereas Eng­land needed 100.

With­out trade, both coun­tries would have to pro­duce both goods for them­selves so that per 1,000 work­ers, Por­tu­gal would pro­duce some com­bi­na­tion lying between the extremes of 12,500 gal­lons of wine and 1,100 yards of cot­ton, while Eng­land would pro­duce a com­bi­na­tion lying between 8,333 gal­lons of wine and 1,000 yards of cloth.

If how­ever Por­tu­gal spe­cialised only in wine and Eng­land spe­cialised only in cloth, the total out­put would be 12,500 gal­lons of wine and 1,000 yards of cloth. This is more than the total out­put of the two coun­tries in the absence of trade. With Free Trade, they could spe­cialise in their com­par­a­tive advan­tages and wel­fare in both coun­tries would be higher.

This argu­ment was so clever that it aided the cam­paign to repeal the Corn Laws and it has seduced almost all econ­o­mists ever since.

But there is an obvi­ous fal­lacy to this neat and plau­si­ble argu­ment: To effect spe­cial­i­sa­tion, Eng­land has to shift labour and cap­i­tal from wine to cloth (and Por­tu­gal has to do the oppo­site). Arguably labour can be retrained—a vigneron can become a machinist—but how do you con­vert wine press into a spin­ning jenny?

The obvi­ous answer is that you don’t. Instead, you sell the wine press and buy a spin­ning jenny with the pro­ceeds. But because of the intro­duc­tion of trade, the price of wine in Eng­land would have fallen, so that the sale price of the wine press will also fall (econ­o­mists have mod­i­fied Ricardo’s model to intro­duce curves where Ricardo had straight lines, so that total spe­cial­i­sa­tion is no longer required and there would still be some wine pro­duc­tion in Eng­land under the “new” model of Free Trade), while the price of spin­ning jen­nies will have risen, given the new export mar­ket to Por­tu­gal. Some cap­i­tal is nec­es­sar­ily destroyed by the open­ing up of trade and it applies in reverse in Por­tu­gal as well.

Since cap­i­tal is destroyed when trade is lib­er­alised, the water­tight argu­ment that trade nec­es­sar­ily improves mate­r­ial wel­fare springs a leak. If eco­nom­ics were a real sci­ence, this real-world com­pli­ca­tion to Ricardo’s argu­ment would be con­sid­ered, but it has never been seri­ously addressed.

These and many other fail­ings that explain why, when Dani Rodrik took a care­ful look at the empir­i­cal record of trade lib­er­al­i­sa­tion, he found that it had fre­quently reduced mate­r­ial wel­fare rather than increas­ing it. Writ­ing back in 2001, he sum­marised his find­ings for For­eign Pol­icy mag­a­zine with the state­ment that:

Advo­cates of global eco­nomic inte­gra­tion hold out utopian visions of the pros­per­ity that devel­op­ing coun­tries will reap if they open their bor­ders to com­merce and cap­i­tal. This hol­low promise diverts poor nations’ atten­tion and resources from the key domes­tic inno­va­tions needed to spur eco­nomic growth.”

As an econ­o­mist who has spe­cialised in dis­sect­ing the empir­i­cal claims for the role of free trade, Rodrik has the might of the major­ity of the pro­fes­sion against him. As noted above, that’s a good rule of thumb that Rodrik is right.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • The prob­lem with peo­ple like War­ren is that when some­one chal­lenges their the­o­ries, they indulge in some spe­cial plead­ing, add an epicy­cle and sim­ply end up mud­dy­ing the waters.

    Your “refu­ta­tion” of Ricardo is laugh­able.’

    You could be a bit more civil. This is why peo­ple don’t like to engage with lib­er­tar­i­ans, par­tic­u­larly Aus­tri­ans.

    Since Eng­land was more indus­trial, they would have a com­par­a­tive advan­tage in the man­u­fac­ture of wine presses. The pro­duc­tiv­ity gains in both coun­tries would enhance the pur­chas­ing power of every­one. The glut of wine presses in Eng­land would be exported.’

    This has noth­ing to do with what he said. He was talk­ing about a world where cloth and wine are being pro­duced by Por­tu­gal and Eng­land, and point­ing out that het­eroge­nous cap­i­tal causes prob­lems in the short term. You have not chal­lenged this idea; in fact, your sce­nario suf­fers from a sim­i­lar prob­lem as new wine presses would need to be cre­ated.

    The Key­ne­sian the­ory of every­thing pre­sumes a ris­ing price level, ie. a dimin­ish­ing pur­chas­ing power as excess credit pur­sues degraded work­ers. Ricardo’s argu­ment pre­sumes hon­est money.’

    Irrel­e­vant.

  • War­ren* Jees I really need to proof read bet­ter.

  • The argu­ment as set up is that even though net out­put after spe­cial­iza­tion is 1.5 times higher than before, that there is a net destruc­tion of cap­i­tal because the sur­plus wine presses in Eng­land would have a lower sell­ing price than before. Of course, the sell­ing prices of sur­plus spin­ning jen­nies would have a higher sell­ing price as well which would be a cap­i­tal gain, so the cap­i­tal destruc­tion claim is washed out.

    The work­ers of both coun­tries would enjoy a 1.5 times gain of pur­chas­ing power which, I rudely point out, would allow them to hoard a por­tion in their mat­tresses, fur­ther depress­ing prices and enhanc­ing pur­chas­ing power, unless a mad­cap Key­ne­sian were to come along and con­vince them that some­how that is a bad idea.

  • SeanS

    An econ­o­mist that ques­tions the Free Trade mantra? You just went up 50 points on my esti­ma­tion scale.

    There are just so many fal­lac­ies with the free trade agenda it ceases to be amus­ing.

    Those espous­ing the ben­e­fits of free trade the­ory (and these are usu­ally peo­ple who do not and have never worked in the real world of inter­na­tional com­merce) sim­ply choose to ignore the real­i­ties of the prac­ti­cal appli­ca­tion of such poli­cies. Free trade works in the­ory because, like in many eco­nomic the­o­ries, there are crit­i­cal assump­tions that are made and have to be made to enable these prin­ci­ples to func­tion in a ben­e­fi­cial rather than detri­men­tal way.

    Of course there are numer­ous exam­ples of coun­tries that have not adopted free trade poli­cies and, as a result, have been enor­mously suc­cess­ful at dif­fer­ent stages of their devel­op­ment.

    Those that advo­cate free trade appli­ca­tion gen­er­ally fall into 2 cat­e­gor­eis:

    Cat. 1. Those that con­sider their coun­try will, over­all, be a big win­ner from the appli­ca­tion of such poli­cies — mean­ing that other trad­ing part­ners will come off sec­ond best. This is the cat­e­gory that the United States tra­di­tion­ally con­sid­ered itself to be in whilst simul­ta­ne­ously adopt­ing some highly pro­tec­tive trade poli­cies in cer­tain areas to sat­isfy a domes­tic polit­i­cal agenda.
    For many years in this worked but of course the US has for some years been very much on the sucker end of the deal.

    Cat. 2. Those that are too lazy and inel­lec­tu­ally stu­pid to set appro­pri­ate trade poli­cies and to nego­ti­ate trade agree­ments with part­ners that will oper­ate in the best inter­ests of their economies and pro­vide equi­table and fair access for all par­ties. This is the hard option. Yes Gov­ern­ments and their offi­cials have to work very hard to adopt this line and some are basi­cally too lazy. This is most def­i­nitely the cat­e­gory Aus­tralia falls into — which fre­quently advo­cates a uni­lat­eral free trade agenda for heav­ens sake.

    Those advo­cates of Free Trade (it can never be prop­erly free by the way), just love to ignore the prob­lems with such poli­cies when applied to the real world economies. For exam­ple (and this is not exhaus­tive):

    1. You can­not achieve free trade because of hid­den sub­si­dies, or even trans­par­ent ones, that you are forced to accept and there­fore should respond to in a bal­anced way. Such sub­si­dies do not exist and acn­not be estab­lished in the the­ory.

    2. Agri­cul­ture is a major trade sec­tor and a polit­i­cally sen­si­tive one. Where it has a choice, no sen­si­ble coun­try is going to allow a sit­u­a­tion where it is largely depen­dent upon for­eign­ers for it’s food sup­ply. (Just ask the EU). Of course in Aus­tralia our politi­cians and pub­lic ser­vants don’t care and are quite con­tent to pre­side over the near destruc­tion of entire sec­tors of agri­cul­ture only to see them replaced with huge vol­umes of food imports under our poorly and ineptly nego­ti­ated trade agree­ments.

    3. Coun­tries will abuse FTAs by export­ing items at below full cost in order to destroy the local com­pe­ti­tion. In Free Trade the­ory dump­ing just never hap­pens but unfor­tu­nately this does not match the real world. For exam­ple, Australia’s reponse to dump­ing is noth­ing short of pathetic and there is rarely any effec­tive action to stop it despite the protes­ta­tions of local firms. Indeed one line often dropped by the Can­berra trade elite types is that dump­ing is, in real­ity, good because the pro­duc­ers are offer­ing the prod­ucts at a very cheap price to the local mar­ket. Just a reflec­tion of their stu­pid­ity and typ­i­cal of their lazi­ness and inep­ti­tude in apply­ing anti-dump­ing reg­u­la­tions.

    4. Under Free Trade the­ory you will always export suf­fi­cient to pay for your imports. Unfor­tu­nately this does not match the real world. When you can­not pay for your imports you have to go into debt to main­tain the flow. Ulti­mately your freely float­ing cur­rency will devalue sub­stan­tially and those nice cheap imports that you were enjoy­ing so much are now so very expen­sive.

    Of course it is so much eas­ier and much quicker to dis­man­tle an entire indus­try than it is to re-estab­lish it. So rather than hav­ing the option of import sub­sti­tu­tion you are forced to con­tinue to pay for your very expen­sive imports. Those with cap­i­tal and try­ing to re-estab­lish local pro­duc­tion find that they are unable to find the essen­tial skilled empoy­ees as these have long since left the coun­try and gone over­seas to work or are now work­ing in other indus­tries. Essen­tially, the skills base you once had has been largely destroyed and takes many years to re-estabish.

    5. In free trade the­ory dis­placed work­ers in destroyed indus­try sec­tors always find employ­ment in alter­na­tive sec­tors. Hence the elec­tri­cal engi­neer can now now drive a trac­tor or the truck dri­ver will become a chem­i­cal engi­neer. It all works just fine. The real world? Go visit Detroit , MI.

    6. Free trade works if you are happy to accept a much lower stan­dard of liv­ing if you are on the los­ing side of the trade. In a free trade rela­tion­ship in the real world there is always a win­ner and a loser. Those with the pos­i­tive trade bal­ances are the win­ners. Rel­a­tively high cost coun­tries will often be the losers in such rela­tion­ships but are, of course, usu­ally unwill­ing to accept a lower stan­dard of liv­ing to rec­tify their lack of com­pet­i­tive­ness.

    I could go on but I am like an Aus­tralian gov­ern­ment trade spe­cial­ist. I am too lazy .….….….to write any­more on this. 

    I would like to leave you with a lit­tle gem told to me some years ago by a senior Aus­tralian gov­ern­ment trade nego­tia­tor. This guy was waf­fling on with the usual free trade reli­gion stuff . Inter­alia, I raised the issue of all of the pro­tec­tions, sub­si­dies and reg­u­la­tions estab­lished by so many of our trad­ing part­ners that make it impos­si­ble for our com­pa­nies to access for­eign mar­kets on any rea­son­ably equi­table basis. “Oh” he said “do you know what we do in our trade nego­ti­a­tions with these coun­tries.” “We tell them how eco­nom­i­cally inef­fi­cient such poli­cies are and how they will increase the wel­fare of their peo­ple by dis­man­tling all such poli­cies.” Wow. That must really con­vince them. How’s that been going then?

  • Spot on Sean. Decades ago (1979 from mem­ory!) I ran a con­fer­ence on trade where one of the IAC types gave a paper show­ing what would hap­pen with a 25% tar­iff cut to Tex­tiles, Autos and a cou­ple of other sec­tors. There was a foot­note to their pre­dic­tions that said “Assum­ing good macro­eco­nomic management”–which was defined as “no net change in employ­ment as a con­se­quence of the tar­iff cuts”!!!!

  • pfitzsim­mons

    In Ricardo’s exam­ple there is a big advan­tage to mak­ing tex­tiles in place of wine. Devel­op­ment of the machin­ery for mak­ing tex­tiles allowed for pro­gres­sive gains in pro­duc­tiv­ity while wine mak­ing as an indus­try has remained sta­tic until very recently. Also the skills and tech­nolo­gies nec­es­sary for the tex­tile indus­try were trans­fer­able to other indus­tries giv­ing the nation com­par­a­tive advan­tage in these new indus­tries. As some­one said “Only God can cre­ate a tree but any gov­ern­ment can cre­ate a com­par­a­tive advan­tage”. There is a case to be made that a nation should apply its resources to those indus­tries that will yield the most in pro­duc­tiv­ity and growth even if it has lit­tle or no exper­tise in those indus­tries and shed other indus­tries with which it may have great exper­tise but which offer no evo­lu­tion to future pros­per­ity.

  • War­ren you are not engag­ing in argu­ment at all. You are going off on a tan­gent and mud­dy­ing the waters, whilst simul­tae­nously nurs­ing your fetish for using ‘Key­ne­sian’ as a self evi­dent insult.

  • Philip

    SeanS,

    A very good overview. This is not sur­pris­ing to eco­nomic his­to­ri­ans e.g. Paul Bairoch, who have exam­ined the his­tory of devel­op­ment and trade. The coun­tries that really devel­oped — UK, France, Ger­many, Nether­lands, later the US — all had enor­mous trade pro­tec­tion in place, with tar­iffs going up to 60–80%!

    Con­ven­tional eco­nomic the­ory would stip­u­late that these economies should be back­wa­ters, includ­ing Aus­tralia. But it is unsur­pris­ing that the real world is vastly dif­fer­ent to eco­nomic the­ory.

    Strangely enough, the free flow of highly-paid pro­fes­sional and man­age­r­ial ser­vices, gov­ern­ment monop­oly (IP), crim­i­nal­ized drugs, and rights for cap­i­tal in the form of cor­po­rate char­ters never come up in dis­cus­sion about the ben­e­fits of free trade. Per­haps its because these poli­cies ben­e­fit the rich but that could just be a con­spir­acy the­ory.

  • Derek R

    But if free trade is a bad thing surely that means that we should put trade bar­ri­ers and tar­iffs on trade between Vic­to­ria, Queens­land and New South Wales to improve the eco­nomic per­for­mance of the indi­vid­ual states. Log­i­cally speak­ing if free trade causes prob­lems then reduc­ing free trade even between the CBD, Para­matta and Chattswood should improve the over­all per­for­mance of Syd­ney.

    Tak­ing it to extremes, we surely end up say­ing that NIH syn­drome is actu­ally a ben­e­fit for an indi­vid­ual com­pany rather than a draw­back because NIH syn­drome is a bar­rier to free trade between com­pa­nies.

    Now I’m not try­ing to pre­judge the case in favour of Free Trade by the above points. I’m a firm believer that empir­i­cal evi­dence trumps the­o­ret­i­cal argu­ments. And if Steve says there’s empir­i­cal evi­dence against free trade, then I believe him. I’m just try­ing to point out that any the­ory of free trade which shows it to be bad at the level of coun­tries has also to be able to show why it is good within a coun­try. If it doesn’t (and it might be that it isn’t good within a coun­try either), then the log­i­cal response is that not only should we be using pro­tec­tion­ism at the inter­na­tional level: we also need to use it for inter­nal trade.

  • The proper log­i­cal deduc­tion Derek is that free trade is a red her­ring, because it focuses atten­tion on get­ting more out of your cur­rent resources and capa­bil­i­ties, rather than on devel­op­ing new ones.

  • Cahal — The prob­lem I have with Key­ne­sians is that the infla­tion makes house­hold sav­ings impos­si­ble. This along with the dimin­ish­ment of the wage share reduces work­ers to the level of serfs.

    I don’t quite see what fal­lacy Steve is try­ing to point out.

  • Derek R

    I think I under­stand what you mean, Steve. I can see that Free Trade would have the side-effects that you (and SeanS and Pfitzsim­mons above) describe. But then you’ve got to ask why this is more of an issue for inter­na­tional trade than for inter­state trade. After all surely Queens­land is going to end up with a lack of devel­op­ment rel­a­tive to NSW under free trade, isn’t it? Assum­ing that Queens­land con­cen­trates on resource extrac­tion and that NSW con­cen­trates on man­u­fac­tur­ing.

    Of course the prob­lems might be mit­i­gated by other fac­tors such as the free move­ment of labour between Queens­land and NSW, the com­mon cur­rency, and the rel­a­tive ease of mov­ing intel­lec­tual cap­i­tal and the smaller phys­i­cal cap­i­tal items between the two states.

    There is a sim­i­lar issue where I live in Alberta. At the moment there is a plan to build a pipeline to pipe crude oil from the tarsands down to Texas for refin­ing. We could refine the oil in Alberta but we don’t cur­rently have the refin­ery capac­ity (not even in other parts of Canada appar­ently), hence the plan to ship the stuff to the US. I guess that the “free trade/comparative advan­tage” alter­na­tive would be to build a pipeline, whereas the “pro­tec­tion­ist” alter­na­tive would be to build extra refin­ery capac­ity in Alberta.

    So per­haps it really would be a good idea for Queens­land and Alberta to be more pro­tec­tion­ist. That way you are def­i­nitely going to have more local devel­op­ment and keep more of the added value in local hands, even if it’s just the wage ele­ment and the fixed cap­i­tal ele­ment.

    The US cer­tainly man­aged to fight Impe­r­ial free trade pol­icy using “the Amer­i­can sys­tem” to grow its econ­omy dur­ing the nine­teenth cen­tury. And that was basi­cally a pro­tec­tion­ist sys­tem. It’s only really dur­ing the late twen­ti­eth cen­tury that the US has switched to a free trade pol­icy. So there’s no doubt that pro­tec­tion­ist poli­cies can improve the eco­nomic health of a coun­try which uses them.

  • War­ren:

    Steve’s basic point is that CA depends on a start­ing point. Since cap­i­tal is het­eroge­nous, the removal of bar­ri­ers can wipe out indus­tries that will not imme­di­ately be replaced by that coun­tries ‘com­par­a­tive advan­tage’ indus­try, as Ricardo effec­tively implied.

    As for infla­tion, well I’m not sure why you attribute it to ‘Key­ne­sians’ — I’m fairly cer­tain you mean fiat cur­rency, which in itself is not a Key­ne­sian con­struct. In any case, it is not worth debat­ing that here.

  • Isn’t the case that great­est mod­ern fal­lacy about free trade arises from ignor­ing the flows of cap­i­tal and tech­nol­ogy that are asso­ci­ated with off­shoring jobs and out­sourc­ing ser­vices from high-wage to low-wage economies? 

    Ricardo was explicit that cap­i­tal­ists would not off­shore their cap­i­tal.

    This is clearly not the case today. So when peo­ple like Jeff Rubin, author of “Your World is about to get a whole lot smaller” tell you that Ricardo’s the­ory of com­par­a­tive advan­tage proves that off­shoring of jobs ben­e­fits us all, they are sim­ply lying about what Ricardo said.

  • CA is also irrel­e­vant for devel­op­ing coun­tries if you buy the ‘infant indus­try’ argu­ment. To try and demon­strate this briefly, here is a CA exam­ple from Wikipedia:

    Sup­pose that in a par­tic­u­lar city the best lawyer hap­pens also to be the best sec­re­tary, that is he would be the most pro­duc­tive lawyer and he would also be the best sec­re­tary in town. How­ever, if this lawyer focused on the task of being a lawyer and, instead of pur­su­ing both occu­pa­tions at once, employed a sec­re­tary, both the out­put of the lawyer and the sec­re­tary would increase, as it is more dif­fi­cult to be a lawyer than a sec­re­tary.’

    What if the sec­re­tary trained to be an astro­naut? Both soci­ety and the sec­re­tary would clearly be bet­ter off.

  • The so-called ‘effec­tive demand’ con­cept is pure Keynes, and focuses on demand stim­u­la­tion while ignor­ing loss of pur­chas­ing power which goes along with ris­ing price level.

    I believe the GFC is caused by the pur­chase power reach­ing its lower limit. Entropy is a real thing. The GFC is not merely spec­u­la­tion run amok.

  • Nathan Scan­della

    The ide­al­ized exam­ple of Eng­land and Por­tu­gal trad­ing is also bogus, if it does not account for the costs of mov­ing goods from coun­try to coun­try. Ship­ping is not free. If you’re one of the com­pa­nies involved in mak­ing wine, or cloth, you might only con­cern your­self with the nom­i­nal cost to ship your goods. How­ever, pol­i­cy­mak­ers con­cerned with decid­ing on pro­tec­tion­ist vs. free trade poli­cies, must go a lot fur­ther than that sim­plis­tic cost ben­e­fit analy­sis.

    The true cost of trans­port­ing goods is not even close to accounted for in the nom­i­nal cost of inter­na­tional ship­ping. Inter­na­tional ship­ping tends to be the least reg­u­lated way to move goods. The ships tra­vers­ing our oceans use bunker fuel, which is basi­cally the dirt­i­est, cheap­est, most pol­lut­ing pos­si­ble kind of fos­sil fuel. The huge exter­nal­ity of cli­mate change, or other pol­lu­tion issues, is totally glossed over by the over­whelm­ing major­ity of econ­o­mists, whose over­sim­pli­fi­ca­tion of every­thing is one of the pri­mary causes of envi­ron­men­tal dam­age. Then, there’s coun­tries like the US, that actu­ally sub­si­dize oil com­pa­nies, to make the mar­ginal cost of oil for end-users appear even cheaper.

    Mar­ginal cost analy­ses are fre­quently com­pletely inap­pro­pri­ate. There’s no prob­lem with one com­pany using fos­sil fuels like there’s no tomor­row. It’s only an issue when every­one thinks that way.

    I often use the anal­ogy of an overly sim­plis­tic strat­egy in gam­bling. You play black­jack (or what­ever) by start­ing with a bet of 1 unit. If you lose, you dou­ble your bet. The idea is that even­tu­ally, you will win, and then you’ll always wind up ahead by at least the 1 unit. This strat­egy only fools sim­ple­tons, how­ever, as it neglects the logis­ti­cal detail of table lim­its, which ulti­mately will pre­vent you from achiev­ing your goal by keep­ing you from dou­bling your bet past the table limit.

    This, “dou­ble when you lose” type of think­ing is per­va­sive in eco­nom­ics. Easy to process, over-sim­pli­fied mod­els, that com­pletely fall apart in the real world.

    NOTE: you could cer­tainly argue that sim­ply tack­ing on the cost of exter­nal­i­ties to any con­sump­tion of fuel would be one way to imple­ment a more pro­tec­tion­ist strat­egy than the sta­tus quo, with­out resort­ing to explicit trade restric­tions. How­ever, deter­min­ing and enforc­ing the col­lec­tion of this cost is not some­thing the free mar­ket could do by itself.

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  • Suvy Boy­ina

    Dr. Keen,

    I know this post is from a while back, but I just saw it. My point is with some­thing like pro­tected indus­tries. How long can you pro­tect indus­tries from com­pe­ti­tion abroad? At some point, it does become unsus­tain­able and harm­ful right? You can­not keep pro­tect­ing indus­tries for­ever as they even­tu­ally start to fall behind.

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