The Global Free Trade Error

The Infeasibility of Ricardo’s Comparative Advantage Theory

Ron Baiman

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9780367872359
• eBook ISBN: 9781317527015
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The doctrine of "free trade" is second only to that of "free markets" in undergirding ideological support for our current global economic structures and rules. From David Ricardo's "comparative advantage principle" to James Meade's Neoclassical or mainstream economics proof of self-adjusting free trade equilibrium, the free trade doctrine has had a lasting and destructive hold on Neoclassical economic thinking since its inception.

The Global Free Trade Error provides a detailed analysis of these foundational models and counter-poses these to alternative Neo-Marxist "unequal exchange" models of global trade and finance. In the first part of the book the three core free trade models alluded to above are respectively demonstrated to be: overdetermined, inapplicable, and infeasible. In particular, Ricardo's parable is shown to support managed trade rather than free trade as Ricardo and two centuries of economic texts have claimed. In the second part of the book, unequal exchange analyses of global trade are shown to provide logically coherent and useful insights into global trade and finance. In the third and final part of the book, this unequal exchange perspective is used, within a general "demand and cost" setting, to develop a set of global managed trade principles for a more equitable and sustainable world trade regime.

This book will be of great interest to those who study political economy, history of economic thought, and international trade, including trade agreements and tariffs.

p.5

Part I

The illogical foundations of free trade ideology

The fact that international trade does not follow textbook models, and that efforts to apply these models in practice often end up causing more harm than good to national economies, and to the global economy and planetary sustainability, is no secret. The following three chapters include numerous references to empirical and practical critiques of the effects of “free trade” policy on individual countries and on world development. The weight of the evidence is abundantly clear. The global push toward ever “freer” trade and capital flows has subverted democracy and led to an unsustainable world economy with historically unprecedented and unimaginable levels of inequality and stagnant growth that appears to be careening toward global environmental catastrophe.

Mainstream Neoclassical (NC) economics has played an outsize role in legitimating the ideology of “free trade” that has so distorted the world economy and undermined democratic ideals. Regardless of the abundant empirical and historical data to the contrary, NC textbook theories and ideologies endure in the minds of world political and business leaders, mainstream media, elite academic and educational curricula, legal practice, and mainstream civil society leaders. There is no question that free trade thinking serves the interests of the wealthiest and most powerful individuals and transnational corporations that increasingly dominate global economics and politics. But a key factor in maintaining the ideological dominance of free trade in support of the “inverted tyranny” (Wolin, 2008) that characterizes modern capitalist democracies is the perceived ideological power of the free trade doctrine.

The following three chapters address the ideological foundations of free trade thinking and show that even under the most idealistic textbook assumptions, the doctrine is mathematically infeasible.

In the first chapter, “The infeasibility of free trade in classical theory: Ricardo’s comparative advantage parable has no solution,” formal models of Ricardo’s comparative advantage parable that include general forms of consumer price-response behavior are constructed from a detailed textual exegesis of Ricardo’s story. Using these models, the comparative advantage parable is shown to be mathematically overdetermined and therefore generally unsolvable. To reinforce this conclusion, a numerical solution is derived for a constant elasticity version of the model. A necessary condition for the existence of a solution to the constant elasticity model is that two price elasticities of demand must be functions of the other two price elasticities of demand. General formulas are derived expressing this dependency. When realistic elasticities for wine are set, the model can only be solved if Portuguese demand for English cloth is unrealistically elastic. This demonstrates that sustainable and mutually beneficial trade between England and Portugal can only be realized through managed trade. Thus, contrary to Ricardo’s belief, and to the statements of almost every textbook and academic treatise on international trade for the last two centuries, the parable of comparative advantage supports managed rather than free trade.

p.6

The second chapter, “The limits of free trade in Neoclassical theory: from Heckscher-Ohlin to unequal exchange,” addresses the NC version of free trade ideology. This chapter first summarizes the conditions underlying the “modern” algebraic Heckscher-Ohlin model (AHO) and points out that this model does not prove that free trade will generate a balanced and mutually beneficial international trade equilibrium, and that its assumptions of identical technologies, and perfectly competitive marginal product returns and consequent “factor price equalization,” are so restrictive that they render the AHO largely irrelevant even within the context of already highly idealized NC trade theory.

The chapter next reviews the older but more theoretically grounded and less restrictive NC international trade models of Meade and Haberler, who, using graphical techniques in a two-country example, demonstrated that: a) free trade will produce a unique stable, sustainable, and mutually beneficial equilibrium; and b) “production possibility frontiers” reflecting comparative advantages likely to result from unequal factor endowments will lead to exports of goods produced with the relatively abundant factor and imports of goods produced with the relative scarce factor in both countries. Finally, the chapter demonstrates that: c) when trading partners have “highly unequal factor costs,” as is likely in “north–south” trade, the Meade-Haberler geometric Heckscher-Ohlin (GHO) model will produce imbalanced, and probably not mutually beneficial, “unequal exchange” that can only be sustained through active “trade management.”

This shows that even in the most general version of basic NC trade theory, free trade is inconsistent with comparative advantage and partial specialization when wage levels are highly unequal, as they are in most north–south trade.

p.7

Finally, the third chapter, “Globally sustainable and balanced international trade based on exchange-rate adjustment is mathematically unstable and therefore economically infeasible,” shows that textbook exchange-rate-based “free trade” is mathematically unstable and economically infeasible even under the most idealistic assumptions. Even if: a) Marshall-Lerner conditions are universally satisfied, b) bilateral trade universally responds effectively and efficiently to exchange-rate fluctuations, and c) freely floating or (individual country) administered exchange rates react quickly and in a “normal” direction to trade imbalances, exchange-rate “price signals” cannot be expected to produce globally balanced international trade. Since trade that is not balanced or moving into balance by means of exchange-rate changes after taking into account the impact of other “shift-factors” cannot be viewed as obeying underlying exchange-rate-based “fundamentals,” a global free trade regime is not feasible. The chapter shows this by proving under these assumptions that: a) if there is a globally balanced exchange-rate solution to an international trading system, this solution must be unique, and b) the unique solution to this kind of exchange-rate-based trading system will be mathematically unstable. Since the solution is unstable, there is no mechanism driving the system toward this solution. If it exists, this solution is therefore economically infeasible. The principal theoretical issue addressed in this chapter is whether “normal” exchange-rate responses to trade deficits, whether market-driven or administered, can, under the most ideal assumptions, move global trade toward a more balanced position than would otherwise occur. If this is not possible, the free trade doctrine has no theoretical legitimacy.

Reference

Wolin, S. S. (2008) Democracy Incorporated: Managed Democracy and the Specter of Inverted Totalitarianism (Princeton, NJ: Princeton University Press).

p.1

1 Introduction

The doctrine of free trade (FT) is second only to that of “free markets” in undergirding ideological support for our current global economic structures and rules. The central place that FT thinking occupies within mainstream Neoclassical (NC) economics is critically important to justifying FT policies, regardless of real motives. From David Ricardo’s “comparative advantage principle” to James Meade’s NC proof of self-adjusting FT equilibrium, to the broadly disseminated general introductory economics textbook version of FT accepted by most elite policy and business leaders, FT doctrine has had a lasting and destructive hold on economic policy for almost 200 years. In an earlier book I have attempted to make a case for a moral radical economics that roundly rejects the free market ideals and the presumption of “objective scientific” neutrality that lies at the heart of the NC self-conception of itself as “The Science” of economics (Baiman, 2016). This book is an attempt to apply moral radical economic thinking to global trade and finance.

The purpose of this book is not to develop precise mathematical models that describe, predict, and generate detailed policy options for world trade and finance. Rather its goal is to analyze in detail the foundational story doctrines, or “memes,” that inform the FT global economic ideal and counter-pose this to an alternative (revised) Marxist unequal exchange (UE) radical economic foundational story of global trade and finance. The idea is to show how these in many ways very simple and basic models, or memes, inform and misinform global economic policy.

The objective is to set economic guide posts and ideals that conform to widely shared universal moral economic goals for global trade and finance without an “objective scientific” pretense that any simple trade or finance model (and especially not the models disseminated in introductory economics textbooks that have the most impact on policy makers and policy) can realistically describe, not to mention predict, real current or future global trade and financial outcomes. Rather, models are posed as ideals or goals toward which policy should strive.

Because of their ultimate influence on policy, these fundamental doctrines are critical subject matter of a desperately needed value-based radical economics that seeks to improve the human condition and avoid planetary disaster (Baiman, 2016) as applied to global trade and finance.

p.2

In Part I, Chapters 2–4, the NC FT doctrine, in its various forms, is shown to be mathematically inconsistent,...

Table of contents

• Cover Page
• The Global Free Trade Error
• Routledge Frontiers of Political Economy
• Title
• Copyright
• Dedication
• Contents
• List of Figures
• List of Tables
• Acknowledgements
• Part I The Illogical Foundations of Free Trade Ideology
• Part II The Logical (and Moral) Foundations of Unequal Exchange Trade Theory
• Part III Globalization That Supports Human and Planetary well-being
• Index