Economic Populist Commentary

Economic commentary by a pro-capitalist, economic populist. Demand-Side Economic theory. Consists of author's economic views. Questions & comments appreciated. Dissenting views are VERY welcome and encouraged. Main "agenda" is crafting and advocacy of a "populist" economic agenda. A secondary goal is prevention of an economic Armageddon. Encouraging open discussion of US economy.

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Location: Southern California, California, United States

The author is a physician by profession, and a "student economist" by necessity. The current status of our economy necessitates the latter. The intent of this blog is to explain and discuss economics in layman terms. It is designed to promote thought and discussion. It is written by a layman. Comments and critiques of these theories and letters are welcome and ENCOURAGED. Dissenting comments are also WELCOME! They form the basis for discussion.

Thursday, June 16, 2005





FREE TRADE, GLOBALIZATION, & COMPARATIVE ADVANTAGE

Many economists appear to have a blind spot when it comes to free trade. Free trade advocates are like a religious cult. Their advocacy is based on pre-conceived theory with little regard for actual reality. They just keep chanting "free trade is good. Free trade is good. Free trade is good." Some economic theories are based on a carefully selected set of facts and concepts, while completely ignoring others. In addition, the application of some of these theories does not work in reality. This also seems to be ignored. The benefits of unrestricted free trade, along with unrestricted free flow of capital, is one such phantom belief.

The argument frequently used is that of "comparative advantage." Modern economists often ignore one important aspect of this theory. It requires that CAPITAL AND LABOR CANNOT BE INTERNATIONALLY MOBILE.
Let me repeat this. In order for the "Comparative Advantage" theory to work, CAPITAL AND LABOR CANNOT BE INTERNATIONALLY MOBILE.

Here is the quote from Paul Craig Roberts article regarding David Ricardo's original Comparative Advantage theory:

"For comparative advantage to reign, two conditions are necessary:
One is that capital and labor must be mobile within each country so that the capital and labor employed in England in the production of wine can flow into the production of cloth, where England’s trade advantage lies. In Portugal capital and labor must be able to flow from cloth to wine where Portugal’s advantage is greatest.


The other necessary condition is that capital and labor (factors of production) cannot be internationally mobile. If the factors of production are internationally mobile, capital and labor would move from England to Portugal, where both commodities can be produced the cheapest. Both wine and cloth would be produced in Portugal. Portugal would gain and England would lose.
Ricardo makes it clear that for trade to make both countries better off, trade must be based on comparative advantage. Ricardo gives reasons why, in his time, factors of production are internationally immobile.

Since the time of Ricardo, the key assumption of trade theory remains, in the recent words of trade theorist Roy J. Ruffin, "the inability of factors to move from a country where productivity is low to another where productivity is higher." In a recent article in History of Political Economy (34:4, 2002, pp. 727-748), Ruffin shows that Ricardo’s claim over Robert Torrens as the discoverer of the principle of comparative advantage lies in Ricardo’s realization that comparative advantage, the basis of the case for free trade, lies in "factor immobility between countries." Ruffin notes that "of the 973 words Ricardo devoted to explaining the law of comparative advantage, 485 emphasized the importance of factor immobility."

If factors of production are as mobile as traded goods, the case for free trade--that it benefits all countries--collapses. There is no known case for free trade if factors of production are as mobile as traded goods.

For some time I have been pointing out that the collapse of world socialism and the advent of the Internet have made factors of production as mobile as traded goods. Indeed, factors of production are more mobile. Capital, technology, and ideas can move today with the speed of light, whereas goods have to be shipped.

The collapse of world socialism has made Asian countries, such as China and India, receptive to foreign capital, and it has made first world capital willing to migrate beyond first world countries. The Internet makes it possible for a country to hire knowledge workers anywhere on the globe.

The Internet and the international mobility of capital and technology have, in effect, made labor internationally mobile, especially labor that is paid less than the value of its marginal product or its contribution to output. The huge excess supplies of labor in countries such as China and India ensure that it will be many years before labor in those countries, both skilled and unskilled, will be paid the value of its marginal product.

The international mobility of factors of production is a new phenomenon. It permits first world businesses, seeking lower costs, greater profits, and a stronger competitive position, to substitute cheap foreign labor for the entire range of domestic labor involved in the creation of tradable goods and services. Only labor involved in non-traded goods and services is safe from foreign substitution. It is not yet possible to package hair cuts, surgical operations, dentistry or home repairs as internationally tradable services.

Many people confuse the workings of capitalism that lead to lower costs and greater profits with free trade. They overlook the necessary conditions for free trade to be mutually beneficial. The same people tend to confuse the free flow of factors of production with free trade. I have been amazed at the number of fierce adherents of free trade, even among economists, who have no idea of the necessary conditions on which the case for free trade rests..."

The following is the link to the article:http://www.mises.org/fullstory.aspx?control=1420&id=64

It truly is amazing that economists constantly regurgitate the free trade mantra, and attempt to support it by misapplying the "comparative advantage" theory.

A big problem with some economists is that they "miss the forest for the trees." They often develop complicated mathematical equations to explain theories that don't make any sense. It's almost as if they try to prove mathematically that the sky is red, instead of blue. Then they ignore the fact that most non-economists agree that the sky is actually blue.

I'm going to take a stab at disproving the benefits of unrestricted "free" trade, using a simple equation -- the GDP equation. I think economists will agree that it goes as follows:
GDP=Consumption+Invstmt+GovSpending+TradeBalance

If applied globally, "trade balance" should be zero (unless Martians are buying some of our goods.) Therefore, this should be the "global" GDP equation:
GlobalGDP=GlobalConsumption.+GlobaInvestmnt+GlobalGovtSpending

Economists state that consumer spending, or consumption, is 2/3 of all economic activity. Thus, global consumption is 2/3 of all global economic activity. It's the generally accepted consensus that consumer income is the biggest determinant of consumer spending. Logically, it is essentially the only long-term determinant of consumption. (Consumption financed by borrowing cannot last indefinitely) Thus, global income is the biggest determinant of global GDP. If the aggregate loss of American wages is not compensated for by aggregate foreign wage increase, global income goes down. So does global GDP.

How does global income decrease affect the remaining factors? Let's start with global investment. Global investment will not make any real contribution to GDP if global consumer spending declines. Increased investment is supposed to increase production. If global income falls, so does global demand for production. If global demand falls, there is NO benefit to increased investment. There is no need to build more production facilities or provide more services, if there is no demand for them. Excess "investment" would simply go into corporate coffers, in the form of CEO salaries, stock holder dividends, "cash-on-hand" and bank accounts. In actual reality, as opposed to economists' "pseudo-reality," this investment would add absolutely 0 to global GDP in the long-term. (It's mis-allocated money that would have contributed to global GDP, if it had it gone toward global consumer spending.)

How about government spending? Government spending is financed exclusively from taxes. Taxes subtract directly from private wealth. Thus, government spending reduces private wealth, dollar-per-dollar. However, the "marginal propensity to consume" concept needs to be considered here. ( Which basically states that the more affluent devote a smaller percentage of their wealth towards consumption. The more affluent they are, the smaller the percentage.) Taxes on lower income individuals reduce consumption more than those on higher income individuals. Taxes directed mainly at consumers, such as sales tax, reduce consumption spending dollar-for-dollar. In contrast, taxes on corporations primarily reduce investment spending. Thus, the type of taxation affects how much it subtracts from consumer spending. But it is clear that government spending subtracts significantly from consumer spending. In addition, reduced consumer income reduces the money availabe for taxation. Government spending cannot make up for consumer spending reduction. Not only does it depend on consumer income, it subtracts from consumer spending.

In summary, the global GDP equation is almost overwhelmingly dependent on global consumer income. Labor cost reductions reduce global income, and global GDP. When $90/day workers are replaced with $2/day workers, global consumer income drops. Global consumer spending then drops as well, further reducing global demand for goods and services. The increased profits made from the labor cost reduction do NOT help the world economy. The increased investment capital that results has NO benefit when global consumption drops. It merely provides a short-term gain in profits, at the expense of a long-term loss in global GDP. Unfortunately, many economists DO have a blindspot to this simple mathematical reality.

unlawflcombatnt

HOME: http://www.unlawflcombatnt.blogspot.com/

21 Comments:

Anonymous Anonymous said...

Mike, stick to medicine. You don't know anything about economics. I seriously recommend reading a basic macroeconomic textbook. You might even want to pick up Krugman's.

I'm not some right wing nut, I'm a Democrat and it's very unfortunate that misinformed views such as yours are fundamentally distorting the debate on free trade among Democrats.

In free trade, some people win and some people lose and there are certainly ways to ameliorate those losses. But, to do so you really have to understand the dynamics of free trade -- and you sadly do not. Seriously, buy a book. Here's a link to Krugman's http://www.amazon.com/exec/obidos/tg/detail/-/0201770377/qid=1119386855/sr=8-5/ref=pd_bbs_ur_5/103-7512663-5947864?v=glance&s=books&n=507846

1:48 PM  
Blogger unlawflcombatnt said...

Thanks for reading my blog. Unfortunately, you have posted nothing but the worn-out argument that "I don't know what I'm talking about." That's the classic response I get from someone who doesn't like what I said, but can't find any argument against it. Since you have no argument, you have posted no argument.

I HAVE read basic macroeconomics books and I have read the writings of MANY economists. I have taken the time to read extensively on Ricardo's "Comparative Advantage" theory.

It is YOU who doesn't know what you're talking about. You have proven this decisively by not contesting one single point that I made.

I DO understand the simple mathematics of it, and none of the convoluted explanations can contest what I've said.

I am also very much aware that Nobel Prize winning economist Joseph Stiglitz had come out against unrestricted free trade, as well as economist Paul Samuelson.

It is you who does not understand. You haven't taken the time to read what I wrote, or read the reference I posted.

You are simply one of the economic traitors who constantly repeats the worn out dogma that "free trade is good, free trade is good, free trade is good."

I suspect your own special interests are being served by perpetuating this lie. It's clear you're afraid to stand behind your comments, since you post as "anonymous."

I don't care in the slightest that you claim to be a Democrat. I doubt you really are.

I hope you took the time to check the link I posted. I have plenty of supporting evidence for what I have written, if you have taken the time to read it.

My views are also supported by one of Ronald Reagan's former appointees, Paul Craig Roberts.

I suggest that YOU do some more reading, and a LOT more thinking. What I've written has been vetted by several economists. The article and quotes that I cite, are also from noted economists, one of them being David Ricardo himself.

I suggest that you stick to whatever profession you're in. If you're an economist, you might want to read something besides literature that supports your own self-serving, incorrect view.

It's the ignorance, and misinformation from people like you, that forces me to delve into economics. Apparently it's necessary for someone outside the field, like myself, to apply some simple logic and reason to dispel some of the myths that have come out of the field of economics.

It's simply amazing to hear economists espouse the comparative advantage dogma, knowing full well it does NOT apply. It's simply dishonest to claim that it does, given the obvious caveats stated by the doctrine's originator, David Ricardo.

You should check out the links I have on my site to "PC Roberts." The dogma of "free trade" has so many holes in it that it's hard to know where to start.

I do want to thank you for validating what I've written, with your childish "you don't know anything about economics" comment. In fact, I know quite a bit, and several economists have verified that. And you have validated it as well, by posting your non-argument argument.

The biggest validation I ever receive on my blog or my postings, is the "You don't know what you're talking about" comment, followed by NOTHING to support your opinion. That's when I know I've hit paydirt.

unlawflcombatnt

11:55 AM

12:00 PM  
Anonymous Anonymous said...

Blindspot or not, there are two sides to every arguement. So here is mine. Started with comparative advantage requiring that capital and labor not be internationally mobile? Prove that it is. Last I checked many countries have immigration laws preventing labor to flow across borders. As for capital, Martin Feldstein and Charles Horioka showed in their 1980 paper that the savings and investment relationship for a closed economy is equivalent under open economies. That is capital does not flow across borders. This is one of the largest puzzles among international economics, almost 400 articles have cited the article attempting to explain capital mobility. The consensus opinion, capital may not be as mobile as people suspect. I am currently in the process of showing how free trade agreements promote the flow of capital, but the paper is going through some final revisions.

So yes, capital and labor are not as internationally mobile as you argue. I would go into detail, but I don't want to bore you with the complicated equations. But in this case the sky is blue!

On to the next arguement, wages. You talk until you are blue in the face that wages must be equal in all countries for free trade to be "good", but this is not the case. You are making an ignorant assumption that the price of consumers goods are the same in every country. Not true, law of one price, suggests that after controlling for the exchange rate prices are the same across all countries. Again another puzzle, why because it's not true. Remember $2 in the U.S. is not $2 in a developing country.

Under your theory, wages must not have increased over the past 15-20 years, but they have. You are right Americans are losing jobs in relatively low skilled sectors. Clearly, if this were the entire story than the unemployment rate would have sky rocketed. Hmmm, it hasn't, in fact more jobs have been created than lost. Americans are trading in those low skilled jobs, going to school, and getting higher paying jobs. The fact of the matter is college enrollments have increased over the past 20 years, especially in the midwest. Allowing people to get higher paying jobs.

Global income does not fall under free trade. It increases the quantity demanded of goods from foreign nations, goods are now cheaper. Prices of goods drop for the importing country, this is the same thing as income increasing.

Every year the average American pays close to $100 in hidden "taxes" because the U.S. government has a quota on the amount of sugar that can be imported. Who gains here? Sure in hell is not me, you, or the developing countries that would love to export sugar to the U.S. but are restricted to by the quota. How much more income would be generated if we didn't have to pay that tax, and the farmer in Central America could sell us sugar. Remove the quota, allow the U.S. to regain the billions of dollars we are losing, and let the developing country make some money. The billions of dollars saved by lower prices can easily compensate the few sugar farmers in the U.S.

Your arguement using global gdp is wrong. You need to consider different costs of living, exchange rates, and changing prices.

Unfortunately, you can't use simple mathematics to explain a complex world. The sooner you learn that, the better economist you will become.

You constantly focus on American job loss, but what about the massive amounts of income foreign direct investment. This comes from developed countries (Japan, Germany, South Korea, and others), investment in U.S. capital. If we place restrictions on the flow of capital, like you suggest, many more jobs will be lost without any gains. Think about both sides of the arguement. Do you want to live in autarky?

1:58 AM  
Blogger unlawflcombatnt said...

As you know, the quotation I posted is from David Ricardo. Since Ricardo's "comparative advantage" doctrine is often used to justify globalization and outsourcing, it is significant that he specifically excludes any arrangement where there was free flow of production resources (or capital.) The point is that Ricardo's doctrine of "Comparative Advantage" cannot be used to justify the current outsourcing phenomenon.

No doubt the world economy is very complex. However, certain things are not ultra complex. If an American company outsources its work to a foreign country to reduce labor costs, by definition it reduces wages paid for that labor. It reduces them by any definition used. If it did not, the job would not be outsourced. The company outsourcing the work is increasing its profit because of the difference in American wages and foreign wages. No matter how you alter the exchange rate, the wages of those workers are lower than the American equivalent. If they were not, there would be no cost savings and the jobs would not be outsourced. Furthermore, the entire savings from that labor cost reduction is NOT passed on to American consumers. If it was, there would be no benefit to outsourcing. There would be no increased profit.

Any effect of an exchange rate is going to be compensated for by what the American company pays the foreign worker. Regardless of any exchange rate considerations, the wages paid to foreign workers have less buying power in terms of American dollars. If those wages did not have less buying power, there again would be no increase in profit from outsourcing. The American outsourcer would simply be exchanging the same income/buying power of an American worker for that of a foreign worker's wage/buying power.

In terms of buying power in American dollars, the exchange of an American worker's higher wage for a foreign worker's lower wage leads to an aggregate reduction in global buying power, which is the equivalent of a global wage reduction.

Outsourcing unquestionably reduces aggregate global wages. Reducing American wages reduces American consumer income. Replacing higher paid American workers with lower paid foreign workers reduces aggregate global wages as well.

10:58 PM  
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1:44 AM  
Anonymous Anonymous said...

in a comment you replied "In terms of buying power in American dollars, the exchange of an American worker's higher wage for a foreign worker's lower wage leads to an aggregate reduction in global buying power, which is the equivalent of a global wage reduction."

I would like to point out that the issue you've failed to see is that the foreign worker will be earning a higher wage than what he would have made otherwise. For eg, A graduate working as a callcenter employee in India makes about Rs. 10,000 - Rs. 15,000 a month on average, while the same person if employed as say an accountant or in a bank would not make more than Rs. 7,000 - Rs. 8,000 a month.

And in the absence of offshore outsourcing this same person would have had no choice but to work as an accountant. And if he takes a job in a call center, the job in the bank is taken by someone else. So there is an increase in the buying power of the Indian employee and you might then say that this increase is still less than the decrease in buying power. But then the lower cost advantage that the american company gains by offshoring is passed on to either the american consumer by way of decreasing prices or to the shareholder as profit.

8:21 PM  
Blogger unlawflcombatnt said...

Anonymous,

I didn't 'fail to see that foreign worker wages would be higher than they would have been otherwise.'

The point (that I have already made at length) is that the increase in foreign worker wages is much less than the decline in American wages. This is simple common sense. Multinational corporations wouldn't outsource work to save labor costs if foreign workers were receiving as much in wages as American workers lose. The difference in American wages and foreign worker wages is the total aggregate global wage loss, as well as the increase in Corporate profits resulting from the elimination of American worker wages.

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4:12 PM  
Blogger unlawflcombatnt said...

Speedreading,

Thanks for visiting my blog. You might find my forum, Economic Patriot Forum, even more useful. You can start your own threads at the forum, as well as post graphics.

11:05 AM  
Blogger unlawflcombatnt said...

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Thanks for your compliment and for visiting my blog. The link you posted might have some useful information. I don't know enough about accounting to say for sure.

I'd also like to invite you to join my forum, Economic Patriot Forum. You can start your own threads, as well as post graphics and respond to others' posts. I think some accounting-related input would be helpful to the forum. As such, your input would be appreciated.

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