Thursday, February 24, 2011

The Two Worlds of Trade

There are two longstanding narratives in economics about trade.

1. Trade is about comparative advantage. Two people or communities that specialize in what they can do best (relative to what they would be doing otherwise) and trade with each other are better off (enjoy higher levels of consumption) than they would be without trade. The story becomes more dramatic when you bring in specializations within communities: those who specialize in goods that have a comparative disadvantage (e.g. electronics assembly in the US) lose out when trade is opened up, although their losses are not as great as the gains experienced by the rest of the community. The lesson is clear: there are special interests who will try to impede trade liberalization, but they should be resisted (or bought off) by the rest of us. Economists, who know the score, have a particular obligation to expose and combat protectionism.

2. Trade, while essential for growth and development, is a potentially destabilizing aspect of national and global macroeconomics. The gold standard was doomed to fail, for instance, because the specie flow mechanism (outflows of gold resulting in reduced money supply and lower prices) did not, in practice, cause trade deficits to diminish over time. In the absence of other adjustment mechanisms, countries with persistent deficits were forced to adopt punishing austerity measures, and this imparted a contractionary bias to the global macroeconomy. In the current period of flexible exchange rates, it is still the case that unbalanced trade is not only the norm, but has even increased in scale and destabilizing potential. Deficit countries are particularly subject to financial crises, due to the accumulation of private and public debt. (This is the message of the fundamental macroeconomic identity.) On the national level, persistent trade deficits result either in chronic employment problems or addiction to Keynesian demand stimulus that should, in principle, be only temporary medicine. In a world of sovereign states, we are still far from establishing a financial architecture that can contain the destabilizing effects of capital mobility and unbalanced trade.

What is interesting is that there is almost no communication at all between these two narratives. In particular, the second invalidates the first: if trade does not balance at the margin (changes in imports exactly offset changes in exports), the microeconomic case for trade liberalization collapses.

4 comments:

kaleberg7 said...

There is a inherent tension between taking advantage of free trade and taking advantage of development by means of import replacement. Every developed nation went through a period with high tariff walls and active government subsidization of import replacing industries, but now every developed nation seems to have scorned the baser rungs by which they ascended and supports free trade. Economists, of course, seem totally unaware of the how development works, or at least unable to discuss it realistically.

You seem to be having some second thoughts about free trade. Perhaps it is time to consider its impact on development and living standards.

Sandwichman said...

It seems like there are ALWAYS two narratives that don't communicate.

Brenda Rosser said...

Regarding the 'second world of trade':

"In the current period of flexible exchange rates, it is still the case that unbalanced trade is not only the norm, but has even increased in scale and destabilizing potential. Deficit countries are particularly subject to financial crises, due to the accumulation of private and public debt. (This is the message of the fundamental macroeconomic identity.) "

The USA appears to be the notable exception to this scenario over the latter decades of the twentieth century (and most of the past one). Capital flowed into this debtor nation from 'surplus' nations such as China and Japan.

David McClain, in his 1988 book 'Apocalypse on Wall Street' maked an interesting observation. "International buying and selling of financial assets, not trade in goods and services, dominates foreign exchange-market transactions. . . transactions in financial assets [were then] 30 times greater..than..trade flows .
Page 167.

Re: "In a world of sovereign states, we are still far from establishing a financial architecture that can contain the destabilizing effects of capital mobility and unbalanced trade. "

Are states still 'sovereign'? I tend to side with the retired economic hitman.

"The guiding philosophy for this particular form of capitalism is an uncompromising belief in the privatisation of resources, the granting of unfettered powers to corporate executives, and the encouragement of debts so extreme that it results in contemporary modes of enslavement - for countries and individuals alike. Based on the assumption that the CEOs running our most powerful corporations consitute a special class of royalty who, unlike normal people, do not need to be governed by regulations, it totally altered geopolitics. Now we have entered a time not unlike that when city-states were replaced by nations - excpet that today the nations have been usurped by the giant corporations."

Hoodwinked: An Economic Hit Man Reveals Why ...
by John Perkins

Septeus7 said...

The second narrative has always been the protectionist argument even before concepts of Keynes stimulus where brought into the equation. Friedrich List's entire argument is that the levels of developments need to be equal (arguably a physical impossibility) before free trade can be considered.

I believe it was President Grant that said America might be able be able to Free Trade in a minimum 200 years and last time I check we still have a number of years before the 2070s.

The Free Trader's have never even attempted to deal historical argument nor it's conceptual foundation of protectionism because they don't deal with real world economics which takes place in space-time and thus cannot be separated from the historical context of the situation unlike the mathematical models which only exist the minds these anti-reality economists.