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Liberty: -- Analysis -- Free Trade and Factor Mobility

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    Check out our brand new rating system at: http://www.liberty-news.com/showNewsletter.php?id=200401171&src=emtxtyg Free Trade and Factor Mobility by Robert P.
    Message 1 of 1 , Jan 17, 2004
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      Free Trade and Factor Mobility
      by Robert P. Murphy

      In a recent New York Times op-ed piece, "Second Thoughts on Free Trade,"
      Senator Charles Schumer and economist Paul Craig Roberts argue that the
      typical arguments for free trade, while perhaps valid in the days of
      Ricardo, are no longer relevant in today's economy of multinational
      corporations and high-speed telecommunications. According to our

      Two recent examples illustrate this concern. Over the next three years,
      a major New York securities firm plans to replace its team of 800
      American software engineers, who each earns about $150,000 per year,
      with an equally competent team in India earning an average of only
      $20,000. Second, within five years the number of radiologists in this
      country is expected to decline significantly because M.R.I. data can be
      sent over the Internet to Asian radiologists capable of diagnosing the
      problem at a small fraction of the cost.

      Our authors acknowledge that most economists would interpret the above
      developments "through the classic prism of 'free trade,'" and that most
      economists would "label any challenge as protectionism." Nonetheless,
      our authors claim that "these new developments call into question some
      of the key assumptions supporting the doctrine of free trade."

      So what is wrong with David Ricardo's law of comparative advantage,
      which showed that per capita productivity is highest when each country
      specializes in those industries in which its workers are relatively
      superior? According to Schumer and PCR:

      [W]hen Ricardo said that free trade would produce shared gains for all
      nations, he assumed that the resources used to produce goods—what he
      called the "factors of production"—would not be easily moved over
      international borders. Comparative advantage is undermined if the
      factors of production can relocate to wherever they are most productive:
      in today's case, to a relatively few countries with abundant cheap
      labor. In this situation, there are no longer shared gains—some
      countries win and others lose.

      Schumer and Roberts are correct in their discussion of Ricardo's
      demonstration, which did indeed assume that factors of production were
      fixed and that only final goods could be shipped across international
      borders. However, Schumer and Roberts are wrong when they conclude that
      free trade is good only under these assumptions. (For an excellent
      discussion see Mises's treatment in Human Action.)

      The case for free trade is more general than Ricardo's narrow
      demonstration. The per capita consumption of a group of individuals will
      be lower if an external penalty (e.g. a tariff) is placed on their
      ability to trade with people outside of the group. This is true whether
      or not the tools with which these people work, or the people themselves,
      are allowed to leave an arbitrary geographical region.

      Tariffs are Taxes

      Before getting into the heart of the matter, let us remind ourselves of
      a basic but important fact: Tariffs are taxes. No matter how
      sophisticated the argument, when someone opposes free trade, what that
      really means is that he favors the placement of taxes (or similar
      restrictions) on consumers. In the present context, Schumer and Roberts
      are implicitly proposing to make Americans richer by raising taxes on
      some of the goods available for purchase.[i] They implicitly argue that
      trade barriers reduce consumption when capital is immobile (as Ricardo
      demonstrated), but all that changed with the invention of the Internet.
      Now, according to our authors, barriers to trade will raise living
      standards. Such an argument should puzzle any free market economist.

      "Two Recent Examples"

      Another preliminary observation is that the two "recent examples"
      (quoted in the first block paragraph above) really have nothing to do
      with factor mobility, and are no different from standard objections to
      classical free trade. Since the economist Paul Craig Roberts says that
      he agrees with free trade when Ricardo's assumptions hold, he should
      therefore understand that his two examples demonstrate the beneficial
      operation of the market.

      Recall that in the first case, our authors lament a New York firm that
      lays off 800 American software engineers and hires an "equally competent
      team in India." The firm does this because the wages of the American
      engineers are $150,000 while the Indians must be paid only $20,000.
      Apparently this is an example of the insidious influence of
      multinational corporations.

      But how does this example differ from the standard (naïve) objection to
      free trade? Suppose that an Indian securities firm hired Indian software
      engineers for $20,000 each, and drove the American firm out of business
      (when its American customers gave their business to the Indian firm),
      thus putting its 800 software engineers out of work? We can imagine the
      American firm running to Congress asking for a tariff. Its lobbyists
      would argue that because American engineers must be paid $150,000, they
      can't possibly compete with the Indian securities firm.

      There is really nothing different between this case and the one cited by
      our authors, except for the nationality of the individuals who own the
      company in question. Do our authors really want to argue that it is good
      (for Americans in general) when an Indian firm hires Indian engineers
      and puts American engineers out of work, but that it is bad when an
      American-owned multinational does the same thing?

      We can apply similar reasoning to our authors' second example, in which
      the speed of data transmission threatens the future of American
      radiologists. Remember, Schumer and Roberts argue that this case does
      not fall under the assumptions used by classical economists in support
      of free trade, because here the dreaded "Asian radiologists capable of
      diagnosing the [medical] problem at a small fraction of the cost" aren't
      simply using resources in Asia and then shipping over the final good to
      compete with the products of American radiologists. No, in this
      Information Age context, what is happening is that one of the "factors
      of production" involved in the service—i.e. the MRI data of the
      patients—can be transmitted to the Asian radiologists, who perform their
      analysis in Asia and then transmit their opinion back to the US.

      But does this difference really flip the conclusion reached by Ricardo,
      Bastiat, and other free traders? After all, with only a slight
      modification we can change the example to one clearly falling under the
      classical assumptions of immobile factors. Let us suppose that an Asian
      firm invents a disposable black box, programmed by Asian radiologists,
      which it sells to doctors all over the world. Into this imaginary
      device, a doctor feeds a patient's MRI data and then, after a few
      moments of whirring and buzzing, out pops an expert diagnosis.

      Now according to our authors, if American radiologists were put out of
      business because doctors could obtain MRI analysis more cheaply by using
      the imported Asian black boxes, then no tariff protection would be
      warranted. This would be a classic example of comparative advantage, in
      which the Asian product could provide the service more efficiently than
      its American counterparts. Although the American radiologists might be
      worse off because of the Asian innovation, Americans in general would be
      richer, because of the lower price of MRI analysis made possible by the
      cheap imports. Some poorer Americans might actually owe their very lives
      to the low-cost analysis made possible by the imported boxes.

      So again I ask: Do our authors really want to argue that this second,
      imaginary case would not warrant tariff protection for the American
      radiologists, while the first case would? Do they really think there is
      a significant difference between Asian radiologists programming their
      knowledge into a black box and shipping it overseas, versus Asian
      radiologists (after receiving MRI data) typing their diagnosis into a
      computer and emailing it overseas? If the Asian innovation represents a
      boon to the average American in the hypothetical example, why shouldn't
      we likewise applaud the real-world ability of Asian radiologists to
      diagnose "the problem at a small fraction of the cost"?

      A Sympathetic Treatment

      Although we have seen that the "two recent examples" cited by our
      authors do not importantly differ from standard mercantilist (and
      long-since refuted) arguments against free trade, we should still take a
      moment to understand what has led our authors—in particular, a generally
      free market economist like Paul Craig Roberts—astray. I think Roberts
      may have had something like the following in mind:

      First let's imagine a scenario with immobile factors of production (and
      which thus falls under Ricardo's classical assumptions). Suppose that a
      US capitalist owns a tractor, and that there is a US farmer who is an
      expert at growing coffee. For a while the capitalist hires the farmer to
      use his tractor and grow coffee, which is sold to US consumers.

      But then this happy arrangement is interrupted when a Brazilian farmer,
      without using any tractors, grows coffee and ships it to the United
      States. Because the Brazilian farmer is willing to work for only the
      equivalent of 25 cents per day, his coffee is much cheaper than the US
      brand. In the face of this merciless competition, the US capitalist
      fires the farmer and hires a different farmer to grow tomatoes with his

      Now we can imagine the displaced US coffee farmer running to Congress
      and demanding a tariff on Brazilian coffee in order to "protect jobs."
      But economists like Paul Craig Roberts could inform the coffee farmer
      that, as Ricardo showed way back in the 19th century, Brazil has the
      comparative advantage in coffee production. It is more efficient to use
      US labor and capital goods in the production of crops like tomatoes. The
      reason US workers don't accept wages of 25 cents per day is that their
      labor is far more productive in other lines.

      So much for the first scenario, with immobile factors of production. But
      now let's relax this classical assumption. Assume that the US
      capitalist, facing competition from the Brazilian coffee growers, still
      fires the US coffee grower. But now, instead of using his tractor in a
      different industry in the United States, our capitalist ships his
      tractor to Brazil where he hires a Brazilian coffee grower. (We assumed
      that this option was not profitable in our discussion above, perhaps
      because shipping costs were too high.)

      Again, we can imagine the displaced US coffee grower running to
      Congress, demanding tariffs on Brazilian coffee. He could correctly
      point out that a high enough tariff would render US coffee production
      profitable once again, and thus prevent the US capitalist from shipping
      his tractor to Brazil. Surely not only the wages of US coffee growers,
      but average US wages, would be higher if Congress enacted policies to
      keep capital goods within the United States!

      At first, this type of reasoning contains a superficial plausibility.
      After all, how can the free trader possibly argue that US citizens will
      have a higher standard of living if US workers have fewer capital goods
      with which to augment their labor? After the tractor is shipped to
      Brazil, won't fewer physical things be produced in a given time period
      within US borders?

      Yes, other things equal, fewer physical goods will be produced within US
      borders when capital goods are shipped to other countries. But so what?
      What matters is not how many physical items are assembled in the US, but
      rather how much enjoyment US citizens get from the goods that they end
      up consuming. And even in the case of the tractor being shipped to
      Brazil, US consumers benefit from the Brazilian imports.

      What happens is this: The Brazilian coffee growers are (by stipulation)
      willing to work for 25 cents per day, and now on top of this they are
      aided by a US tractor. Thus their productivity will increase, meaning
      the price charged to US consumers for Brazilian coffee will fall even
      lower. Although it is true that fewer physical things will be produced
      in the US, nonetheless these items will still fetch more consumption
      goods through international trade.

      Whatever it is that Brazilians are importing from the US in exchange for
      their coffee, will now see an increase in demand because of the higher
      productivity (and hence real purchasing power) of the Brazilian coffee
      growers, due to their use of the new tractor. (This is simply the
      operation of Say's Law.) In short, just as lower coffee prices made US
      consumers better off in our first scenario when the tractor was merely
      shifted to another US industry, so too do much lower coffee prices make
      US consumers better off when the tractor is shifted to Brazil.


      The case for free trade remains solid. The citizens of the US are not
      made richer by raising taxes or other barriers to foreign consumption
      goods, and this is true whether factors of production are immobile (as
      Ricardo assumed) or mobile. We should not fear the cost-cutting
      advancements in data transmission, or the improved skills and education
      of foreign workers. On the contrary, we should welcome these
      developments because they mean lower prices for imported goods and
      services, and hence a higher standard of living for Americans.

      Source: http://www.mises.org/fullarticle.asp?control=1416

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