What you See is, What you Get: On UFOs, Unicorns, Bigfoot, and Comparative Advantage
Sometimes I think it’s a sin, when I fell like I winnin’, but I’m losin’ again.
- Gordon Lightfoot, Sundown
As a lecturer and a PhD student, I’ve taught David Ricardo’s theory of Comparative Advantage to hundreds of MBA students. This is the brilliant little economic model that demonstrates how when each nation focuses their resources on the work they are best at – even if they are not better than all others – production will be maximized and consumers will benefit. In its pure, abstract form, Comparative Advantage represents an unarguable truth. There is a beautiful, transcendental moment when a business student suddenly “gets” the simple mathematical model and sees the nearly magical benefits Ricardo’s model offers to “all trading nations.” It’s comparable to the experience of an undergrad sociology student encountering Karl Marx for the first time. Suddenly the world is brilliantly clear and the solutions are so simple, if only everyone could be compelled to embrace them.
As different as Riardianism is from Marxism, the two economic theories share a common theme – they sound swell, but fail completely when faced with the reality of human behavior. The problem is that both of these grand ideas require that individuals or nations, respectively, repress their natural inclination to act in a self-interested manner, for the promise of a mutual beneficial outcome.
In the real world, we know this promise never works. Letting individuals pursue their own, inefficient, unplanned, selfish economic courses actually works out better than getting smart folks to organize them for the greater good – the free market has trumped socialism in every sad empirical test of Marx’s dream.
The ideology derived from Comparative Advantage that has erroneously been labeled “Free Trade” actually involves the same logic as socialism – that free nations subsume their national desires for control of their jobs and strategic resources to a greater global interest, which promises to benefit their consumers as well. Even more curiously, the strongest supporters of individual freedom are the first to villainize anyone who suggest “protecting” a domestic market for the benefit of their nation. They then invariably drag out the ghost of David Ricardo to explain to us simpletons that becoming the world’s trade bitch will be good for us. China’s 25% tariff on U.S. cars vs. our 2.5% tariff on their imports is no problem because American consumers benefit from low prices when American producers shut down!
However, the empirical evidence is again, perfectly clear: nations that pursue the acquisition of technology and capital, fight for high-value manufacturing jobs, and seek smart trade advantages increase their national wealth and individual prosperity. Naïve countries that actually practice, “free trade” spiral into decline and unemployment. There is no better example of this than 19th century Britain, the first nation to embrace Ricardo’s crazy idea.
After the brilliant theoretician sold Parliament on his simplistic theory, the UK went on a free trade frenzy. During the next century the United States, operated on Hamilton’s “American System” featuring very high tariffs, and an active industrial policy geared toward rewarding production, building infrastructure and developing markets. America gutted England’s manufacturing base. Despite controlling a third of the world’s resources Britain entered a slow decline. Only those Brits involved in investing capital elsewhere gained real wealth. Building a welfare state became unavoidable to avoid revolt. Meanwhile, the U.S. developed a vibrant middle class and rose to global prominence.
However, in the last century smart leaders in Japan, Korea, Taiwan and others have followed the American System to perfection, while giving “free trade” the appropriate lip service for a senile America. The results were absolutely predictable to anyone with common sense.
In most ways, China’s rise has been no exception. It isn’t that the Communist Party has been run by brilliant new thinkers (the last really new thing out of China was probably gunpowder), it is simply that they steal good ideas and have belatedly copied a proven economic formula. China’s leaders have followed a policy of pure self-interest while mumbling all the right words in public as they dance their way through the free trade tango with skill. If they’d actually had good sense they would have done this fifty years earlier and spared the Chinese people decades of misery.
The exception with China is, of course, that the Communists never have any concern for personal misery. Their goal is nothing but building greater power for those at the top of the Communist Party dog pile and economic planning is just a tool to achieve that. That’s why handing over the torch of global leadership this time is a very different thing than it was with the UK-U.S. transition last century. Supporting the U.S. to Communist China power transfer is tantamount to endorsing a new Dark Ages for humanity.
In my next posting, I’ll address the theoretical weaknesses that cause comparative advantage to backfire in the real world. In the meantime, understand that counter-intuitive economic theories are always the rage with academics and pundits that need to sound cleverer than the average citizen. Remember, these are the folks that sold us the “we can borrow and spend our way to prosperity” theory under the label of Keynesianism. When something looks like economic slight of hand to you it probably is; and whenever you encounter an ideology-driven economic theory fiercely supported by a cadre of closed-minded, true believers run!
Empirical evidence should trump theory. When medical researchers see that an experimental treatment appears to be actually killing their patients they halt the research and re-evaluate, regardless of how good the thing looked on paper. This common sense protocol should apply to U.S. economic policy – where we only have one patient. If the theory is obviously not delivering economic benefits STOP! Instead, while we congratulate our self on the victory of free trade our trade deficit soars, unemployment skyrockets, GDP plummets, and a staggering debt accumulate. The true believers tell us to close our eyes and stay on course, because the enormous Chinese market is just about / very soon / any day now going to usher in a new generation of prosperity. Sure, right.
In my next post, I’ll address the theoretical problems with Comparative Advantage.
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