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david_ricardoProlonged, widespread joblessness, collapsing real estate markets, and lower economic growth are a few of the many headline issues about the economy. Recommendations range from more stimulus to denying unemployment benefits but there is little in these discussions that convinces us policymakers know what they are talking about and there is much that is misleading, relying on slogans instead of sound thinking. In this latter group can be found the use of the expression “free trade” as opposed to “protectionism” especially in talks about the problem of outsourcing. But ideologically-driven discussions misunderstand–or deliberately misrepresent–economic theory on this matter and result in bad public policy.

It is one of the signal contributions of German economist Wilhelm Roepke that he distinguished in his work between the principle of a free market and the various historical forms it has taken. This distinction allowed him to reform market policy without maintaining the abuses of capitalism on the one hand or falling into the pit of socialism on the other. This sensitivity to distinctions serves us well in the case of the free trade argument. Roepke himself would have been among the first to insist on a correct understanding of the meaning of the principle involved.

Mainstream economic theory has traditionally relied on the principle first articulated by David Ricardo in the early 19th century England. Ricardo’s famous example to illustrate this was trade between two countries: Portugal producing wine and England producing linen. The free trade argument concludes that nations jointly maximize their levels of consumption to their mutual benefit when firms within the nations are allowed to engage in trade unhindered by arbitrary interventions by government especially those intended to shield some industries from foreign competition. Hindering such trade through the imposition of tariffs or quotas is called protectionism. His principle and approach have been the basis for subsequent expansion and development of the free trade idea, and are still taught in principles textbooks.

However, in the hands of politicians or economists with a certain axe to grind the discussion loses sight of the major prerequisite for the benefits of free trade to hold: it is assumed that capital and labor stay within each country. They are reallocated within a country, but not between them. That means that outsourcing of, say labor, is not an example illustrating free trade nor are those who object to outsourcing promoting protectionism. In short, maintaining the Ricardian prerequisite is not anti- free trade.

The key concept which drives this conclusion is the distinction between comparative and absolute cost advantages. A country may be able in absolute cost terms to produce something more cheaply than its trading partner (using fewer workers, for example). However, it still may find it advantageous to let its trading partner produce this good, if its own alternative uses of (labor) resources allows it to be still more productive. Subsequent trade between the two countries will be to their mutual benefit. The essence of the free trade principle then is comparative not absolute advantage. Yet when corporations scan the globe for the cheapest labor to move their factories to or hire their services from, they are looking for absolute not comparative advantage–a situation that goes beyond the bounds of the free trade principle. It is not a tenet of free market economics that losing one’s productive assets is beneficial for the nation, however much it may benefit a particular corporation. Current US experience makes the point very clear: the middle class continues to shrink while paupers and billionaires continue to grow. This is not the hallmark of a healthy economy.

Armed with this distinction we are liberated to adjust policy (within limits) without losing our economic integrity to free markets. We can, for instance, admit that there are situations where a complete free trade or laissez-faire approach is unwise. These are situations not considered in the Ricardian analysis but which subsequent work has shown complicate the picture of benefits and costs arising from international trade and which do call for prudent policy interventions. (The work by Baumol and Gomory on the problem of economies of scale is one example.)

Such problems do not vitiate the value of the comparative advantage doctrine, but indicate only that one needs to balance that principle with other concerns much like a nutritionist in prescribing a healthy diet needs to balance all the factors affecting the patient. We recognize, for example, the importance of fruits, vegetables, grains and meat. Yet some people may have food allergies that prevent them from eating wheat or strawberries. This does not mean we throw out the concept of a balanced diet but we work around the problems to come as close as possible to a realistic balance. Nations also face different circumstances that must be met by balancing various principles. Writers from Edmund Burke to Russell Kirk have repeatedly reminded us it is the hallmark of the mature policymaker to take all factors and principles into account to produce a wise policy for a nation as a whole. It is the hallmark of the immature and doctrinaire to select one principle for fanatical devotion at the expense of everything else. (We do not praise the anorexic for the fierce devotion to her diet.) That is why Roepke, operating in this same tradition, advocated “liberal”–not libertarian–trade policy which still allowed for moderate tariffs. This is not compromise in the unwholesome sense of violating basic principles but in the sense of mutual adjustment to produce the best overall outcome.

As a matter of concrete historical example, we may refer to Roepke’s own instance of 19th century Denmark to show how an active agricultural policy increased that country’s ability to engage in free trade. Denmark was able to expand its arable land, increased the number of heads of cattle, and enlarged the agricultural population and became more competitive in the international agricultural trade with no subsidies or tariffs. The principle of free trade combined with an intelligently crafted public policy rooted in a common vision of economic, political and cultural health brought about very satisfying results. It illustrates the marriage of principle and prudence at its best. As a contrary example, bald economic principle without prudence, can be seen in the more recent experience of Latin American countries. Here the benefits of free international trade and globalization were oversold based on narrowly considered economic arguments; and the results proved very unsatisfactory. In the name of so-called “free trade” countries reduced their tariffs but the promise of intense, beneficent economic growth was not realized. Whatever benefits obtained were unevenly distributed and the policy was positively hurtful to poor farmers.

In our present circumstances, with so many jobs and manufacturing enterprises having been outsourced over the past few decades, policies for more stimulus to spur output are at best incomplete. It is like trying to jump start a car when the engine is missing. While there are many aspects a prudent economic policy must deal with, one of most important is rebutting the myth that outsourcing of jobs is an essential and positive part of free trade doctrine. It is not…and it must be stopped before its economic devastation is complete.

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