After Free Trade

Eamonn Fingleton writes:

“I don’t care who writes a nation’s laws, or crafts its advanced treatises, if I can write its economics textbooks.” So said one of the greatest textbook writers of them all, Paul Samuelson. But even Samuelson didn’t live forever—he died in 2009 aged 94—and now others decide what the rising generation is reading. It is a fair bet that, on one of the most critical issues of modern economic policy, his successors’ books would not meet with the master’s approval. That issue is trade.

Although Samuelson spent most of his life promoting unqualified free trade, he came close in his declining years to admitting he was wrong. In a paper in 2004, he suggested that there might be some circumstances in which a nation did not benefit from free trade. His analysis was carefully hedged; but, given his unique status not only as a textbook writer but as the first American economist to win a Nobel Prize, the effect on the faithful was as if the pope had conceded there might not be a God after all.

The interesting thing is that Samuelson’s doubts have not merited so much as a footnote in most of today’s top selling textbooks. This is not an isolated oversight. The textbooks have overlooked many other key developments, not least the work of Ralph Gomory and William Baumol, who have posited a much more widely applicable, if equally mathematically watertight, challenge to conventional trade theory. These omissions are all the more surprising for the fact that economics textbooks are constantly revised and updated, the better no doubt to keep sales ticking.

Robert Prasch, an economic historian at Middlebury College and a prominent critic of the free-trade consensus, puts it succinctly: “The economics profession generally is probably 15 years behind reality, and the textbook writers are a further 15 years behind the profession.” When will the dismal science catch up with reality? Judging by my inquiries, probably not anytime soon—and maybe not before its adepts have vaporized what little is left of American economic prowess.

In the reality-based community, the attitude towards the economics profession could hardly be more sullen. Thom Hartmann, a talk-show host and author who ranks as one of the American media’s most impassioned critics of globalism, points out that, in marked contrast to economic theoreticians, ordinary Americans have long sensed there is something wrong with trade policy. “To the extent there is a trend, it is at the grassroots,” he says. “People have seen the factories go, and now many of the jobs that cannot be exported are being filled by illegals. Ordinary Americans don’t understand the theoretical issues but they are gravitating to a very simplistic nationalism reminiscent of Europe in the 1930s.”

Many of America’s thinking classes are no longer willing to drink the Kool-Aid. As the most recent presidential administrations have staggered from one economic debacle to another, economists have found themselves pilloried not only for failing to offer timely warnings of the dangers ahead but, in far too many cases, for the erstwhile rapture with which they endorsed the policies that resulted in the Wall Street train wreck. The result, as the Washington-based commentator James Fallows has pointed out, is that there is increasing doubt these days about almost every aspect of established economic wisdom. Fallows, an author on East Asian trade who learned his economics as a Rhodes scholar at Oxford, adds: “I don’t think that anything as coherent as a new view, or systematic critique, has emerged. It’s more an inchoate sense that the established ‘laws’ and principles are increasingly mismatched to the observed realities.”

Although the number of economists prepared to question conventional trade theory openly has steadily risen in recent years, they remain a small minority—and a marginalized one. Even as evidence mounts that the profession is presiding over one of the most remarkable fiascos in intellectual history, many factors discourage waverers from breaking ranks. Most obviously, the textbook industry’s self-censorship makes it difficult for even skeptical teachers to provide a balanced, nuanced account. Young teachers aspiring to tenure are well advised to keep their more heterodox opinions to themselves. “Change does not come easily in academic life,” says Prasch. “For the most part we will have to await the gravedigger’s shovel. Guys in their fifties rarely admit that what they have been teaching all their lives is balderdash.”

Darker forces may also be at work. Paul Craig Roberts, a principal architect of Reaganomics who in recent years has become one of the right’s most penetrating critics of globalism, has suggested that many globalist-leaning economists are “bought and paid for.” What is clear is that academics who aspire to moonlight as corporate consultants have little choice but to endorse orthodox views on things like offshoring. And, of course, no analyst flourishes in Wall Street’s gravitational field without toeing the line. Nonetheless, turmoil is evident just below the surface. The metaphor of a volcano about to blow is overworked but it well describes the intellectual pressures that have been building for several decades.

The earliest rumblings came from economists on the left, some of whom began focusing on trade’s impact on jobs as far back as the 1970s. Most such skeptics—they included Jeff Madrick, Jeff Faux, Barry Bluestone, Bennett Harrison, and Robert Reich, and they were soon joined by younger colleagues such as Dean Baker, Laura Tyson, and Ira Magaziner—were advocates of industrial policy. That stance almost by definition implied a wary view of free trade. It also made them easy to marginalize. Such is the esteem with which free trade theory is viewed by almost the entire economics profession, in the early days proponents of industrial policy shrank from an all-guns-blazing assault on the consensus.

As the years have gone by, however, they have not only become more emboldened but have been joined by some on the right. Hence the sight today of President Reagan’s assistant Treasury secretary Paul Craig Roberts making common cause with liberal peers such as James K. Galbraith, Herman Daly, and Ronald Baiman, not to mention journalist Alexander Cockburn. (It should be noted, however, that Roberts draws a sharp distinction between traditional free trade and the recent phenomenon of offshoring. Roberts argues that offshoring is not true free trade as understood by classical economists. So while he opposes offshoring, he upholds the classical version of free trade, which assumed among other things that all a nation’s capital would be invested at home.)

Among the earliest challengers, two names particularly stand out—Robert Kuttner and John M. Culbertson. They both threw down the gauntlet in 1984. Kuttner came from the industrial-policy school and was then just starting to make a name for himself as an economic journalist. Culbertson was a more startling case. Having worked as a young economist for the Federal Reserve System, he later taught at the University of Wisconsin-Madison. Previously known for rather staid work on monetary policy, he crossed a professional Rubicon with the publication of International Trade and the Future of the West. The profession’s response can be aptly summed up in the Japanese term mokusatsu—“killing with silence.” A search of LexisNexis reveals just two reviews, in National Journal and Foreign Affairs, and in the latter case his apostasy was dismissed in just five sentences.

Indeed, so out of step was he with all respectable opinion that he had to resort to publishing the book himself—a gambit that all but guaranteed his slightly amateurish-looking effort would be consigned unopened to literary editors’ garbage cans. Such editors are of course busy people and in reflexively ignoring self-published authors their instinct is almost always right. But Culbertson has proved a spectacular exception. With each passing year his challenge to the consensus is looking more inspired. He predicted that low-wage foreign competition would precipitate the collapse of the American middle class—the so-called race to the bottom that has recently been the subject of an eponymous book by Alan Tonelson.

In a field known for obscure language and ample resort to subordinate clauses, Culbertson’s writing style left nothing to the imagination. Here is a sample: “In economic affairs, the decades ahead must be a time of change and challenge, indeed a time of ‘sink or swim.’… Unless economic change is shifted to a new pattern, brought under intelligent control, the years ahead could bring cumulative deterioration and demoralization to the United States, the West, and to much of the world.” He added: “Many economists wear blinders that will induce them to continue their crusade against ‘protectionism’ all the way to the sinking of the West. … Will the United States and the West … come to interpret international trade realistically, and respond intelligently to the situation that actually exists? This question is decisive for the future of the West.”

Like Culbertson, Kuttner issued his challenge via a book. In The Economic Illusion, he presented an analysis that went far further than that of other liberal economic commentators in targeting the core of the free-trade consensus. That core is, of course, the venerable theory of comparative advantage formulated by the British banker David Ricardo as far back as 1817. Kuttner argued that the world had changed since Ricardo. While Ricardian theory assumed a static world in which the structure of trade reflected mainly each nation’s natural endowments—Ricardo famously cited Britain’s advantage in making woolen cloth versus Portugal’s in wine—Kuttner pointed out that, in modern manufacturing, nations can judiciously rig their markets to conjure up productivity advantages where none existed before. This is particularly likely—and is particularly consequential—in high-tech goods. With the help of an elaborate array of industrial policies, Japan, for instance, has come from nowhere in the 1950s to achieve dominance almost right across the board in advanced manufacturing, particularly in capital goods, which though invisible to consumers are essential for finished-goods producers such as those in China and other low-wage nations.

Kuttner also pointed out that Ricardo’s theory depends on other hidden assumptions that have become increasingly unrealistic over the years. The theory works as advertised only if there is no significant unemployment or unused production capacity, for instance. It is a long time since those conditions existed in America. By the latter half of the 1980s, support for trade dogma began cracking even among the American right. One of the first prominent conservatives to break with the consensus was Patrick Buchanan. Another notably early challenge came in 1986 from Pat Choate, an economist who advised TRW, then a major player in several high-tech industries.

Choate, who had already identified himself as an advocate of industrial policy as far back as 1980, focused on the practical politics of trade, particularly East Asian mercantilism, which in its Japanese manifestation was already a red-hot issue. Japan’s variously preposterous excuses for shutting out American goods had long become notorious. Most memorably, in comments that were clearly intended to drive a wedge between Republicans and Democrats, Tokyo blamed trade imbalances sometimes on incompetent American managers, who allegedly did not try hard enough to understand the Japanese market, and sometimes on American workers, who allegedly were lazy or uneducated.

Although the instinct in Washington, particularly among mainstream economists and other proponents of Ricardian doctrine, was to challenge every jot and tittle of Japanese rhetoric, Choate argued that the United States should simply accept that Japan did not believe in free trade and never would. Further efforts to remake Japanese society along American lines would be a fool’s errand and would only foster resentment and circumvention in Japan. Meanwhile the attempt would delay disastrously any effective remedy for American manufacturers, many of whom were already then on their last legs. Thus, in a recommendation that scandalized orthodox American economists, Choate, who went on to achieve prominence as Ross Perot’s running mate in the 1996 presidential election, became one of the first proponents of “managed trade”: Washington should, he said, simply set targets for Japan’s imports and ask Tokyo to use its various industrial-policy levers to meet them.

But of all the challenges to the consensus, none has created more intellectual shockwaves than the Gomory-Baumol analysis. Although when it was first unveiled in 2000 it received far less publicity than Paul Samuelson’s similar later contribution would, within the economics profession many recognized it as having holed the orthodoxy below the waterline. Indeed, in the view of Paul Craig Roberts, Gomory-Baumol is probably the most important development in trade economics since Ricardo’s own theory. The authors’ credentials are hard to shrug off. Gomory is a world-class mathematician who in a former life as director of research for IBM saw first-hand how sharply global competition in high-tech industries diverges from traditional theory. Baumol is a New York University economics professor who served as president of the American Economics Association in the 1980s.

The Gomory-Baumol analysis goes further than any other in examining the assumptions underpinning free-trade orthodoxy. In focusing on the role of assumptions, Gomory draws an analogy with how objects in the physical world behave under the influence of gravity. As he points out, in predicting the trajectory of falling objects, sometimes you have to take the effect of air into account—in addition to the force of gravity—and sometimes you don’t. But if you insist on ignoring air all the time you will end up predicting that airplanes won’t fly—that they will just fall to the ground.

Similarly with economic models, your assumptions have to be chosen with care. “The Ricardo model describes pure market forces acting in a world where production capabilities don’t change,” Gomory points out. “But today production capabilities do change. China is a great example.” Gomory and Baumol used the Ricardo model; but they were able to consider not just one set of productivities but all possible productivities in different circumstances and at different times. Using the Ricardo model that way they could investigate, for example, how your trading partner’s economic development affects you as his productivities change. They got a very non-obvious answer: your trading partner’s economic development is at first good for you, and then, as your trading partner becomes more and more developed, bad for you. And of course, as Gomory points out, market forces are not the only forces at work. Governments help their industries in many ways, from tax breaks to making technology transfer a prerequisite for market entry. These non-market forces are strong incentives affecting what companies do.

“The market forces are still there,” says Gomory “and we have to take account of them through models such as the Ricardo one, but if we don’t also take seriously the non-market forces, we may reach conclusions that may be as wrong as predicting that airplanes can’t fly.” Airplanes do fly, of course. And mercantilism can work. Certainly the East Asian variety does. As someone who has lived in Tokyo since 1985, I have long enjoyed a special vantage point from which to watch the trade debate. I am struck by how parochial are most Anglophone discussions and how little they take account of easily documented reality in other parts of the planet.

Certainly the world looks very different from Tokyo, not least because East Asian leaders are convinced that, in its ever more heedless commitment to laissez faire, the United States is digging its own grave. But of course, East Asians are discreet people and, short of being waterboarded, they are unlikely to ever offer a frank opinion on an American mindset that happens to have done so much to transfer industrial leadership to East Asia.

It has long been obvious to Tokyo-based observers that, where trade is concerned, the world is divided into two economic camps—on the one hand, nations that generally run a trade surplus and on the other those that run chronic deficits. The United States, of course, now ranks as the all-time champion in the latter camp, but it shares its heedlessness with most of the English-speaking world, including the United Kingdom, Ireland, Australia, New Zealand, India, and Pakistan. By contrast, nations that generally run surpluses include not only virtually all of the East Asians, but Germany, Sweden, Austria, Switzerland, the Netherlands, and other rich European nations.

Largely overlooked in the Anglophone media, the two camps are polar opposites in several policy matters, most obviously their approach to exchange rates. Anglophone nations have generally taken pride in strong—i.e., overvalued—currencies and have rushed to the barricades when threatened with depreciation. (This mindset was epitomized most absurdly by the “defend the pound” antics of a sickly post-imperial Britain in the 1960s and 1970s.) In contrast, the surplus nations have rejoiced in low exchange rates. To be sure, the United States recently has undergone a partial change of heart with respect to the Chinese yuan. But U.S. policymakers still show little interest in securing competitive exchange rates for their exporters against the Germans, the Japanese, and the Koreans.

The dichotomy in mindset between surplus and deficit nations raises many questions. Why, for instance, do Anglophone economists win so many Nobel Prizes and their peers in such robust surplus nations as Japan, China, Korea, and Germany so few? And, conversely, why are Japanese, Chinese, Korean, and German exporters so much more effective than their American and British counterparts in world markets? The answers will wait for another time, but it is a fair bet that there are more things in heaven and earth than are dreamt of in American economics textbooks.