Ed. note: The following is another extract (Chapter 5) from Brian Davey’s book Credo, which can be downloaded for free here. You can also see the list of contents and where this chapter fits into the book here.

In this chapter of Credo, Brian Davey explores the historical roots of the theory that free trade is inherently beneficial, and describes seven factors that tend to be left out of arguments in favour of free trade.

What Schumpeter called the “Ricardian Vice” was a mode of reasoning in which the required conclusions are buried in the assumptions of an argument. The free trade argument of David Ricardo are described in these terms and unpicked. The ideas of the German-American economist Frederich List challenged Ricardo’s view.

Initially technical improvement was seen as being rooted in increased specialisation. The famous example from Adam Smith was that of a pin factory. The production process was broken down into a succession of clearly defined modular steps: the wire was cut, the ends were sharpened, the head stamped, the head was soldered onto the pin.

Later economists like David Ricardo took the idea of specialisation and refined it into a theory of why free trade would supposedly improve everyone’s welfare because it led to specialisation between countries.

Economics was now more than a theory about the local butcher, baker and brewer. Economics was advancing a market agenda for international economic relationships. The idea of the division of labour, the specialisation of people’s work, is carried over into a specialisation of countries, of places.

The implications of spatial specialisation are considered later, for now let us notice that the Ricardian agenda favoured holding open the market for British manufactures, to be sold in exchange for cheaper imports, particularly grain imports, so as to keep down the price of food. Thus, it was also about making possible a cheaper price of labour. Naturally this was going to be in everyone’s interest…

Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically: while, by increasing the general mass of productions, it diffuses general benefit, and binds together by one common tie of interest and intercourse, the universal society of nations throughout the civilized world. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England. (Ricardo, 1819)

Ricardo gives a hypothetical example of England and Portugal who start out both producing cloth
and wine. A situation in which Portugal’s costs in labour inputs are lower for the production of both products compared to the situation in England, but most favourable in the production of wine. He then deduces that they would both gain from specialisation – England in cloth production, Portugal in wine production, followed by trade. Later, in a footnote to his text, he gives another, much shorter, example to make the same point, though not from foreign trade:

Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats, he can only exceed his competitor by one-fifth or 20 per cent, and in making shoes he can excel him by one-third or 33 per cent;—will it not be for the interest of both, that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats?

To this day most US and British economists are still enthusiasts for Ricardo’s argument of “comparative advantage”. As Paul Krugman put it in 1987: “If there were an economists’ creed it would surely contain the affirmations ‘I believe in the Principle of Comparative Advantage’ and ‘I believe in Free Trade’”.

Yet not all economists have been true believers and with good reason. From as early as 1790 Andrew Hamilton in the United States counterpoised the “infant industry” argument which pointed out that newly developing industries have higher costs until they gain “economies of scale” and thus, need protection. Indeed from 1816 to 1945 the tariffs protecting US industry were some of the highest in the world – and then the US saw the light. (Chang, 2002)

The argument was picked up by others including a German born economist who migrated to America, Frederich List. For List, the calls for free trade from Britain were insincere, as indeed they were, and as US and European trade policy are today:

Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth. Quoted in (Wikipedia, Frederich List, 2013)

The Ricardian Vice – constructing arguments with required conclusions already buried in the premises

The method used by Ricardo is also interesting, for it is used repeatedly in a particular style of economics and was termed, by another economist, Joseph Schumpeter, as “the Ricardian vice”. A set of isolated assumptions is made that give the required deduced results. The conclusions are already contained in the assumptions. More on this practice is discussed in chapter eight. For now, let me quote two ecological economists, Daly and Farley who write that “Within the world of its assumptions the logic of comparative advantage is unassailable.” (Daly & Farley, 2004, p. 312)

However, let us now follow Daly and Farley in examining those assumptions to see what is left out of the picture – and add a few more points into the bargain.

Firstly, as already pointed out, it is an exercise in comparative statics. The infant industry argument is a dynamic one in which industries develop the capacity to look after themselves later in their development, rather as children do.

Secondly, Ricardo only mentions labour costs. The theory can be adapted to capital and labour costs but very typically “natural capital costs” are not taken into account. All production involves an energy input and, since the industrial revolution, has typically involved a fossil fuel input, with increasing greenhouse gas emissions. Where are the depletion costs for fuel or the cost of climate change in the model?

Thirdly, there are transport costs. To be fair to Ricardo, he did acknowledge these but in the case of heavy and bulk goods they could be considerable. To this, from a modern perspective we must add the emissions and the environmental costs from increasing transport.

Fourthly, in order for Portugal to specialise in wine and England in cloth, it not only meant an international “division of labour” it meant an international “division of land” – specialised land use. But specialised land use involves total transformation of eco-systems, radical reduction of bio-diversity and the destruction of natural processes. This is obvious when it comes to the creation of urban industrial landscapes that displace the countryside, for example, centres for cloth production. But wine making and viniculture is a monoculture too. Left to itself, nature evolves into diverse plant and animal communities, guilds of species appropriate to places. Nature is multi-functional and diverse when it is healthy. In and of itself the loss of the experience of living in conditions of biodiversity represents a reduction in the quality of life and experience. That’s why towns have parks, gardens and other green spaces. It is why rental values are higher when there are trees in a street and why property values are higher in New York around Central Park. Above and beyond the welfare dimensions of biophilia, there are more fundamental issues of specialised land use (Monocultures). There are limits for the pushing of the international division of labour because, beyond a certain point, the generalised reduction in biodiversity threatens to destabilise the entire planet. No doubt Ricardo could not have foreseen so far into the future but at the beginning of the 21st century the issues look different. Scientists are warning that, on a global scale, there is a danger of an ecological tipping point when biodiversity loss goes so far as to produce a change of phase state.

Fifthly, Ricardo ignored the costs of transition to the more specialised economy. Economists typically celebrate specialisation by comparative static models but ignore the costs, inconveniences and disruptions to the lives of people as they adjust – in this case, from being cloth makers to wine makers or vice versa. What is missing here is the idea that, even if the more specialised state with trade is superior in some way to the less specialised state, the costs of the transition from one state to the other might exceed the gains once in that new state.

Sixthly, once an economy has developed a specialisation, it is costly and difficult to reverse this situation. Specialisation renders some countries vulnerable if the terms under which they export their specialised products in exchange for their imports moves against them. Further, as Daly and Farley point out, countries are likely to be especially vulnerable if they import essentials in exchange for exporting less essential goods. Their bargaining power will be less, particularly if they only export one or just a few products. The more that they are specialised the less bargaining power they have. It should also be pointed out that Ricardo wrote in a period of expanding colonialism which was hardly conducive to favourable terms of trade for the subordinated countries.

Seventhly, Ricardo explicitly assumed that, while goods are mobile and can be traded between countries, capital and labour does not move between countries. This is what Ricardo said:
Experience, however, shews, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has
to quit the country of his birth and connexions, and intrust himself with all his habits fixed, to a strange government and new laws, check the emigration of capital. These feelings, which I should be sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign nations.

Writing at the end of the Napoleonic Wars towards the beginning of the 19th century, this made sense as a description of the state of affairs given the relations between many countries -although the capital and labour flight from Ireland to England when tariffs were brought down in Ireland in the early 19th century was a very real phenomenon.

Times change – capital immobility is a ridiculous assumption in the modern world

Nowadays however, a capital immobility assumption does not make any sense since capital can move around the world at the speed of light. The implications are considerable. In the cloth and wine example, if capital can move then, if there are conditions where costs are lower (and profits higher) for both products in one country, capital will move to that country and invest in both sectors. It will abandon the country with the higher costs as a production location altogether. (Daly & Farley, 2004, p. 316)

To sum up, Ricardo was claiming that free trade linked to “the principle of comparative advantage” was another example where the “pursuit of individual advantage is admirably connected with the universal good of the whole”. It was put forward as a universal truth of trade theory – another example of what specialisation could achieve.

Yet the argument was deployed in a highly particular set of circumstances and served the interests of the emerging industrial employing class. It was aimed at opening up markets for them and aimed to facilitate cheaper wages (because of cheaper food costs for their workers if food was imported from cheaper sources abroad). Behind the discussion about cloth and wine, or shoes and hats, the real idea was that Britain should produce and export manufactures from their factories to countries who were supposed to specialise in producing and returning cheaper foodstuffs and raw materials in a system of “imperial preference”.

To pursue that agenda, the protection of agriculture by import tariffs, the so-called Corn Laws, had to go. Less than 20 years after the publication of Ricardo’s book the industrial employers had won their argument and the Corn Laws were repealed. Food prices fell and so did land rents. The industrial employers were able to develop industry under cheaper conditions at the expense of owners of rural land.

Different theories for different times and different places

In other countries, in other conditions, the issues looked different. The argument for tariffs prevailed in the USA. The argument for tariffs was also won in European countries like newly united Germany, as well as in Japan. In these places economic theories guided an elite who were configured differently. For example, in Germany and Japan there were different kinds of relationship between the landowning and military elite and the state. The elite sponsored top-down industrialisation processes, hastened on in order to ensure that their countries kept their independence in the face of what was perceived as the threat of the newly industrialising power of Britain and its empire. In these countries political economy looked different.

For example, Frederich List insisted on the special requirements of each nation according to its circumstances and what he took to be its degree of development. He counterposed a “national system of political economy” to the individualistic notions of Adam Smith. Whereas Smith saw the market bringing about best outcomes from individual actors pursuing their individual interests while the state stayed out of things as far as possible, List saw the role of the state as promoting the welfare of its citizens. To be sure, over-regulation would harm, but there were occasions where pursuing the interests of the individual did not correspond to general well-being and the state had a duty to step in.

As the state played such a crucial role for List, it is not surprising that he thought that statesmen should take a long term view. Statesmen had two responsibilities – one to current generations and the other to future generations. Towards the end of the 20th century, there was an idea that politicians should formulate policies that take into account the needs of future generations. This is described with the word “sustainability” and it has become, in the PR spin at least, a theme of policy. It was already there in Frederich List over a hundred years earlier. That being said, the sustainability idea has been around for a long time. Even List did not invent it. Many indigenous peoples all over the world have a view for land care that takes into account effects up to 7 generations ahead.

The writings of List were eventually published in English translation but the theory went in a more individualistic direction. The rational individual pursuing self-love and self-interest was used to explain how people made their choices in the market and life in general. The explanatory framework that evolved was partly derived from the utilitarian philosophy espoused by Jeremy Bentham.

 

Teaser photo credit: By Billy Hathorn – Own work, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=34037637