Against Free Trade

Rather than Fight for Overseas Empire, Rebuild Manufacturing At Home

For most of my adult life, I was a doctrinaire free trader. As a youthful disciple of Austrian economics, free trade was more than just an economic belief; it was a principle. Like most supporters of free trade, I relied on the fundamentally Ricardian analysis of free trade, which holds that free trade creates positive gain by allowing nations to specialize in areas where they have comparative advantage.

The book "Free Trade Doesn't Work" by Ian Fletcher awakened me from my blind loyalty to free trade. Fletcher offers numerous theoretical and empirical rebuttals of free trade and explanations of why tariffs work. To understand Fletcher’s argument, you first have to understand Ricardo’s argument. Since I don’t want to assume everyone is familiar with that, I'll briefly summarize the Ricardian view, and then proceed into Fletcher’s arguments against it.

Ricardo’s Free Trade Theory

David Ricardo was a prominent British economist of the early 19th century. He developed the core arguments for free trade and his arguments continue to underpin the rationale for international trade and significantly influence modern economics and global trade policy even today.

Ricardo's argument for free trade is rooted in the following key concepts:

Comparative advantage: Ricardo posited that countries should specialize in the production of goods and services in which they have a comparative advantage. Comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than its trading partners. Opportunity cost refers to the cost of forgoing the production of one good in favor of another. In essence, countries should focus on producing goods that are relatively less costly for them to produce.

Specialization and trade: By specializing in goods with a comparative advantage, countries can efficiently allocate their resources, leading to increased productivity and higher overall output. Once countries specialize, they can engage in international trade to exchange their surplus production for the goods and services they are less efficient at producing. This trade allows each country to consume more goods and services than it could if it were self-sufficient.

Mutual gains from trade: According to Ricardo, the benefits of free trade are not one-sided. Both trading partners can benefit from increased consumption possibilities, economic growth, and improved living standards. When countries specialize and trade, they can exploit their comparative advantage and allocate resources more efficiently, resulting in a net gain for all parties involved.

Gains even with absolute advantage: Ricardo's theory of comparative advantage demonstrates that even if a country has an absolute advantage in producing all goods (i.e., it can produce every good more efficiently than its trading partners), it can still benefit from trade. By specializing in goods with the highest comparative advantage and trading with other countries, a nation with an absolute advantage can increase its consumption possibilities.

Absolute and comparative advantage require a bit of explanation. Imagine that Great Britain can produce 100 yards of wool per worker or 20 caskets of wine per worker annually. Imagine that Portugal can produce 50 yards of wool or 25 caskets of wine per worker annually. Great Britain has an absolute advantage in wool production, while Portugal has an absolute advantage in wine production - they simply produce more per worker.

Assume each nation has 1,000 workers, and each has enough factories to let 500 workers work in each industry. Before trade beings, Britain has 500 workers produce wool and 500 workers produce wine, it ends up with 500x100=50,000 yards of wool and 500x20=10,000 caskets of wine. Meanwhile, Portugal does the same, and it ends up with 500x50=25,000 yards of wool and 500x25=12,500 caskets of wine. The total production between the two countries is 75,000 yards of wool and 22,500 caskets of wine.

Now they begin trading and they each specialize in the area where they have absolute advantage, changing their factories to the new type they need. Britain now has 1000 workers in the wool trade producing 100,000 yards of wool and Portugal now has 1000 workers in the wine trade producing 25,000 caskets of wine. The total production is 100,000 yards of wool and 25,000 caskets of wine. That’s substantially more than they produced autarkically! The extra 25,000 yards of wool and extra 2,500 caskets of wine are surplus from trade.

Let’s complicate things. Let’s imagine Britain can produce 100 yards of wool per worker or 20 caskets of wine per worker, while Portugal can produce 65 yards of wool per worker or 18 caskets of wine per worker. Britain now has an absolute advantage in both wool and wine - 100:65 and 20:18.

But Ricardo says that they can still gain from trading because Portugal has a comparative advantage in wine. Is he right?

Well, if Britain doesn’t trade, it produces 500 x 100 = 50,000 yards of wool and 500 x 20 = 10,000 caskets of wine. If Portugal doesn’t trade it produces 500 x 65 = 32,500 yards of wool and 500 x 18 = 9,000 caskets of wine. The total is 82,500 yards of wool and 17,500 caskets of wine.

If Britain specializes in wool, it produces 1000 x 100 = 100,000 yards of wool. If Portugal specializes in wine, it produces 1,000 x 18 = 18,000 caskets of wine. We now see the total produced is 100,000 yards of wool and 18,000 caskets of wine. Amazingly, the two nations end up better off from trade even though Great Britain is better at everything.

That is essentially Ricardian free trade theory.

Fletcher’s Anti-Free Trade Theory

Ian Fletcher is neither as famous nor respected as David Ricardo. What little I have gleaned about him on the Internet is that he was once a Research Fellow at the U.S. Business and Industry Council and then served as Senior Economist for the Coalition for a Prosperous America (CPA) from 2010-2012. His magnum opus, "Free Trade Doesn't Work," only has 125 reviews on Amazon (less than half of the 389 reviews my book Arbiter of Worlds has amassed from its prestigious #150,030rd place ranking.) To date, no one has won a Nobel Prize in Economics for their work on Fletcherian trade theory.

Nevertheless, he is right and David Ricardo is wrong.

Fletcher’s assault on Fortress Free Trade

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consists of five interlocking theoretical arguments and one empirical argument. He begins by undermining the assumptions at the foundation of Ricardian free trade theory.

Labor and Capital are Mobile. Go back and re-read the examples above. Did you notice what was excluded from the hypothetical? The movement of capital and labor. That’s because Ricardian free trade theory simply assumes as given that labor and capital are immobile. All competition is via industry or product.

But this is not the case nowadays. Nowadays both labor and capital can move. The result of that is that investment capital and labor pursue absolute, rather than comparative, advantage. And with capital and labor mobility, absolute advantage trumps and gains from trade evaporate.

Let’s imagine that the advantage that accrues to British labor is due to better capital investment: each man-hour of labor is more productive in Britain because it has better factories. Let’s also imagine that Britain and Portugal have foolishly agreed to enter some sort of “union” which allowed their workers to work and live in either country. Labor is now mobile so each worker can move where the best jobs are available. Since labor wages tend to increase when productivity increases, the Portuguese workers will realize they can earn more and tend to move to Britain. The outcome is not happy Portuguese vineyard workers, but Portuguese immigrants trying to get jobs in British wool and wine factories.

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Now let’s imagine that the advantage that accrues to British labor is due to the fact that hourly wages are lower and working hours longer than in Portugal. The factories are equally the same, but you can get 60 hours of British labor for the cost of 35 hours of Portuguese labor. Let’s also imagine that Britain and Portugal have deepened their union such that financial investments can flow freely between the countries. Obviously, what happens is that the Portuguese investors invest their capital in Great Britain, where they can take advantage of the cheap labor. Many high-paying Portuguese jobs vanish as the capital flight causes the factories to shutter. This is, of course, exactly what has happened between the US and China.

Capital is Not Fungible. Go back and re-read the examples again. Did you notice that I said “each has enough factories to let 500 workers work in each industry” initially, but that when they began trading, “each specialize in the area where they have absolute advantage, changing their factories to the new type they need.” I didn’t allocate any cost to this switch — there was no depreciation of the old factories, no loss of investment, no scrap metal yards filled with wool-spinning machines the Portuguese no longer need, etc. Ricardian free trade theory just assumes that capital is fungible - an investment into wool factories is convertible into an investment into wine factories.

In the real world, we know this is not true. If it were true, the entire globe wouldn’t be fixated on Taiwan’s chip manufacturing factories. Capital is very much not fungible. To the extent that capital is not fungible, it means there are deadweight costs to free trade, in the form of shuttered factories, depreciated machines, and so on, that Ricardian theory does not take into account.

An orthodox Ricardian will reply to this criticism by asserting that in the long run capital is fungible and that the long term gains from trade will more than make up for the short-run costs. This argument will be accompanied by a complex econometric paper that uses 10 pages of math written in Greek symbols that says exactly the same thing as I just said in one sentence.

Not so fast, mathemagicians. Fletcher has another howitzer to fire at Fortress Free Trade, and it demonstrates why the infungibility of capital is a much bigger deal than the orthodoxy wants to admit.

Capital Investment Experiences Path Dependencies. Ricardian free trade assumes that there are no path dependencies from capital investment. It assumes a static level of technology. But in fact, capitalist technology exists in trees, like in a game of CIV IV.

If you were Great Britain in 1600 and you had comparative advantage in wool, then that lead you to wool factories. Wool factories lead you to other types of factories, and voila! You were on your way to an industrial revolution that opened up other types of productivity enhancement.

If you were Portugal in 1600 and you had comparative advantage in wine, then that lead to… making more wine. Wine making has barely changed in 500 years. It’s an economic dead end.

If hired to work for a nation-state that wants to grow its economy, and has a comparative advantage in a particular industry, a Ricardian will advise the nation-state to specialize in that industry. A Fletcherian will advise the nation-state not to specialize in the industry if it’s a technological dead-end, even if they have a comparative advantage that will create gains from trade. Instead he will advise them to pursue investment in areas that can move them up the value chain.

What’s interesting about the Fletcherian advice here is that it is absolutely accepted by everyone when it comes to individuals, yet roundly rejected by orthodox economists when applied to economies.

Consider the case of a lawyer and secretary. Let's assume that the lawyer can type 80 words per minute or he can talk to clients with those minutes. The lawyer’s secretary can type 40 words per minute and can’t talk to clients at all. The lawyer has an absolute advantage in both typing and talking, while the secretary has a comparative advantage in typing. Therefore, it makes sense for the lawyer to hire the secretary because his time is better spent talking to clients. That's what is meant by comparative advantage.

Ricardian free trade theory would say that the way for the secretary to get ahead in the world is… to learn to type faster. But hat's nonsense. There's nowhere to go from typing faster - 40 words a minute, 60 words a minute, 80 words a minute, it’s a dead end. For the secretary to advance, she needs to invest in higher education and new skills that will enable her to improve her position in the economic value chain. In other words, she needs to not specialize in her area of comparative advantage if she wants to get ahead.

The same is true of markets and nations. Comparative advantage locks a nation-state into doing what it’s already good at, but to grow its economy the nation-state needs to pursue excellence in areas where it doesn’t currently have advantage.

Think about what China has been doing as it moved from “low-cost labor for cheap consumer goods” to “world leading manufacturer of everything.”

Resources Get Depleted: In our hypotheticals above, we assumed that the trade was in wool and wine. But what if the trade was in lithium and petroleum? Ricardian analysis would be the same! Ricardian free trade theory simply assumes that there is no resource depletion.

If a country has a comparative advantage in a depletable resources, such as oil or arable land, Ricardian theory advises the country to specialize in it. Yes, if it does so, it will earn gains from trade for a while… but when the resource is depleted, its economy will collapse. Since capital is not fungible (as discussed above), all of the investment is then lost - the oil rigs can't just be turned into bunny farms.

In 1968, the year it became independent, the island-nation of Nauru (population 11,505) had the richest phosphate deposits in the world. As good Ricardians, the leaders of Nauru specialized in phosphate export. For a few decades, the people of Nauru possessed the highest GDP per capita in the world - they were #1. Today the government is bankrupt and the country is 119th in GDP per capita, below economic powerhouses such as Namibia and Eswatini. Had the leaders of Nauru been Fletcherians, this tragedy wouldn’t have happened.

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Not Every Industry is Equally Good for the Population. Economists generally agree that the average wage level in a country is driven by the average productivity of its industries. But not every industry is equally productive, even in the same economy. Labor productivity is vastly higher in fields where goods can be manufactured at scale using capital, and vastly lower in fields where individualized service must be offered without economies of scale. Fletcher asserts (with strong evidence) that every nation with a high per-capita GDP owes its wealth to some sort of highly scalable industry which raises the wage rates for all worker.

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But Ricardian free trade entirely ignores the impact of various industries on wages. If a country has a comparative advantage in an industry which is labor-intensive but does not benefit from economies of scale in capital, it will never, ever see wage growth.

In the United States, when we deindustrialized and shifted our labor force into industries such as food service, health care, social work, education, and other fields that haven’t been able to benefit from capital, we saw wages fall flat. That wasn’t the only reason, of course (as my regular readers know); but it contributed.

Fletcher’s Anti-Free Trade Facts

Fletcher’s last argument is empirical, rather than theoretical.. It’s based on a close study of economic growth cross-indexed with economic policy. Using economic historical records, he makes a list of the nations in the world that have had the most remarkable economic growth, including the UK, US, Germany, Japan, South Korea, and China. He then divides them into two groups: the group that experienced hyper-growth from protectionist policies and the group that experienced hyper-growth from free trade policies. Here’s the list split into the two groups:

• Protectionist Success Stories: UK, US, Germany, Japan, South Korea, China

• Free Trade Success Stories: N/A

Fletcher goes on to explain that the gospel of free trade was developed by the British after they had industrialized, and it was, Fletcher argues, a strategy specifically designed to prevent other countries from industrializing. "We've specialized in industrial production as our area of comparative advantage, so you should specialize in your area of comparative advantage by sending us wheat and raw materials." Any and all of the countries that agreed to free trade with Britain had stillborn industrial revolutions.

Meanwhile, in the United States, our political leadership flatly rejected free trade. In fact, so profound was the difference in opinion in the US that free trade became known as “the British system” while protectionism became known as “the American system.” To the Framers and their successors, free trade was un-American! Wells King, in his article “Rediscovering a Genuine American System” at American Compass, explains:

The American System’s development was supported by political economists whose thinking came to be known as the American School. Like Clay, the thinkers behind the American School were engaged not only in a battle of ideas, but a contest between nations. They were contemporaries of the great British classical economists like David Ricardo and John Stuart Mill and took part in a transatlantic debate over the laws of economics and the role of government. They rebutted the arguments of these “British School” advocates for free trade and laissez-faire and outlined policies to protect America’s interests from what they deemed to be hostile British policy.

Daniel Raymond (1786-1849), for example, established his reputation after publishing criticism of Adam Smith’s Wealth of Nations. Raymond objected to Smith’s very definition of national wealth as the sum of all private wealth, arguing that its distribution mattered and that national wealth ought to reflect “the condition of the whole nation” such that “general prosperity and happiness” would be maximized.

Another leading light of the American School was Friedrich List (1789-1846), a German émigré who developed and systematized a “national system” of economics that stressed the importance of industrialization in the emerging global economy. “To attain the highest degree of independence, culture and material prosperity,” List argued, a country “should adopt every measure within its power to defend its economic security.” For the still-developing United States, this meant tariff-based protection and import substitution for the nation’s infant industries…

These were common themes of the American School: treating the nation—rather than the individual—as the principal unit of economic analysis and incorporating social and geo-political factors that today might seem beyond the scope of economics. The British “dismal science” could not satisfy the optimism and liberality of the still young American republic.

The American School struck its mid-century crescendo in the work of Henry Charles Carey (1793-1879). He warned that the purpose of British free trade policy was to “secur[e for] the people of England the … monopoly of machinery” and argued for an aggressive policy of support for infant industries to “break down this monopoly” and “restore the natural tendency” of balancing manufacturing with agriculture to support “stabler self-sufficient communities.” “The Americans, and few more so than Henry Carey,” writes historian Gabor S. Boritt, “made political economy the beautiful science.”

I have, perhaps, quoted too much on the American School, but the length reflects the degree of surprise I had when I encountered it. When I read Free Trade Doesn’t Work, I was utterly unaware of the existence of an American School of economics. In school I had been taught Neoclassical economics, Keynesianism, and Monetarism; on my own I had taught myself Austrian and Georgist economics and I thought myself a mighty heterodox iconoclast for rejecting the contemporary Neoclassical-Keynesian synthesis. Yet I was oblivious to a truly heterodox school that had been the leading light in my country for a hundred years, during the period of its greatest economic growth!

My ignorance is, perhaps, excusable as the American School was not even mentioned, let alone taught, at any of the egregiously elite universities I attended. Somehow, despite its success, the American School’s lessons were tossed aside by US policymakers. Other nations have continued to heed the American School, with leading Chinese and South Korean economists and policymakers highlighting Friedrich List as one of their key influences. But in America, List, Carey, and their colleagues are virtually forgotten.

And that’s a shame, because Fletcher ends his book with exactly the sort of practical policy-making advice that Carey once gave to US presidents. Fletcher explains that that the best way for an economy to bring wealth to its people is by having an extensive manufacturing base that it protects against international competition with robust tariffs. He recommends every country focus on developing its capabilities in one or a few strategic manufacturing industries in which it aims to be world-class and capable of competing internationally. It seems to me the sort of audience that one might follow if one wanted to Make America Great Again.

Contemplate this on the Tree of Woe.

1. I know, I know, I really like military metaphors, ok?

2. Vox Day has written extensively on free trade with his harshest criticism being that it causes too much immigration for any nation-state to be able to handle without losing its national character. I won’t delve into those arguments here as they didn’t appear in Fletcher’s book, but Day has already covered the ground so thoroughly it’s unnecessary.

3. The situation is even more tragic than I described above. The leaders of Nauru were wise enough to know that one day the phosphate would run out, so they collected the surplus in trust funds. However, they then invested the trust funds in foreign countries! A better example of “capital is mobile” is hard to find. As a result the domestic economy of Nauru was deprived of the investment that might have put it on a sustainable footing.

4. The infamous Baumol’s Cost Disease, about which I will have much to say in a future essay, is driven by the difference in productivity gains in capital-intensive versus labor-intensive industries. Bluntly, the reason you can’t have new cathedrals built by master masons using traditional methods is because you can have iPads and automobiles.