Challenging free trade theory

Inclusive Economy,Poverty & Inequality27 Feb 2013Andrew McKillop

Given the increase of income inequality over the past decades, legitimizing the global market on the basis of the proliferation of free trade is questionable. Reducing wage inequality would however challenge the very foundations of free trade theory.

Political economist David Ricardo claimed that free trade conditions would maximize production by comparative advantage most certainly to the benefit of capital. Given the increase of income inequality over the past decades, legitimizing the global market on the basis of the proliferation of free trade is questionable. Reducing wage inequality would however challenge the very foundations of free trade theory.

The Iron Law

Ricardo and the friend he often paid to write for him, Thomas Malthus, had a gloomy outlook on the world and its future. From their perspective, around 1810-1825, they predicted with alarm that world population would attain 1,000 million, or 1 billion, by about 1860. For them, this challenge was much more serious than general and massive poverty, and threatened human survival on the planet.

Ricardo is best known for his economic “laws” on wages, profits, rent, value, trade, and other issues. Concerning wages, his major work ‘On The Principles of Political Economy and Taxation’, 1817, said: “It is when the market price of labour exceeds its natural price, that the condition of the labourer is flourishing and happy, that he has it in his power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family”.

But Ricardo doubted this could last very long. He argued that high wages are an “encouragement to the increase of population”. Rising population causes more competition for limited places on farms and the factory floor, making wages fall back to what he called: “their natural price, and indeed….below it”. At this “natural price” for labour workers would be able to eat, but not much else.

This was Ricardo’s Iron Law of Wages.

Falling wages, rising profits

With Malthus, whose lifetime obsession with overpopulation was a major theme of his writings under his own name, Ricardo argued that his Iron Law means that “in the natural progression of society” wages will tend to fall even as profits rise, because the number of labourers seeking work will always grow faster than the demand for labour. Only high food prices, or crop failures causing famine, could change this by cutting food supply to what Malthus called (using euphemisms) the mindless masses, forcing them to limit their “propensity to procreate”. Only food shortage can stop them breeding. With fewer children being spawned, wages could gradually rise again.

Conversely, notably through free trade and the operation of Ricardo’s “theory of comparative advantage”, as well as low wages, capital would thrive.

Ricardo’s basic presentation of his comparative advantage theory was in his 1817 “Principles”, and compared wine and wool production in Portugal and Britain. Ricardo claimed that free trade conditions would maximize production by comparative advantage – wine in Portugal, wool in Britain – most certainly to the benefit of capital. He also argued that the combination of free trade and comparative advantage or specialization would also almost certainly resolve trade deficits, if or when they existed.

The reasoning he offered for this was as imaginative and flimsy as Keynes’ famous Multiplier, and many economists argue that Ricardo’s defence of free trade and specialization paid little attention to the probable, or highly possible growth of trade imbalances, which even in the early 19th century were a subject of growing preoccupation.

As noted above, both Malthus and Ricardo were frightened by human population growth, and this fear was joined by their alarm and fear about the French Revolution, only a decade back in time from when they were developing their theories. Many of the circle of London friends around Ricardo and Malthus were French exiles from the moneyed classes. The revolution had quickly degenerated into a terrorist regime, was anti-capitalist and was supposedly egalitarian; it was however neither communist nor socialist because, at the time, neither of these terms existed.

Tackling income inequality

The France of 2013 received a shock when Maurice Taylor, CEO of US tyremaker Titan International, rejected any possibility Titan taking over the failed Goodyear tyre plant in Amiens, and saving jobs at the plant. Taylor said in an interview with the French press on 19 February that the French Parti Socialiste government “should keep its so-called workers” who “only work three hours a day”.

Taylor, whose company specializes in agricultural vehicle tyres, went on to say in a “duel by public statements” with France’s minister of Industrial Recovery, Arnaud Montebourg, which was given high prominence by business media: “The French farmer wants cheap tyres. He doesn’t care if these tyres are from China or India and these governments are subsidising them. Titan is going to buy a Chinese tyre company or an Indian one, pay less than one euro per hour wages, and ship all the tyres Frances needs. You can keep (your) so-called workers”. (emphasis added)

For a 48-hour work week and 192-hour work month, this prices labour costs for Titan, outplaced to China and India, at around $250-per-month per worker before payroll taxes or charges. The “natural price of labour”, at least the Titan International version, is too low for today’s Europe.

Whether or not Maurice Taylor’s outplaced activity paying Iron Law wages will ship “all the tyres France needs” is however not 100% certain. As in previous crises of capitalism and economic power, import duties can be imposed to penalize unfair competition. Penalties exist for the sophisticated interests and concerns of elite trade regulators at the WTO, like environmental pollution, the protection of endangered species and intellectual property, which notably protects Microsoft’s monopoly on computer operating systems. The elite fear-theme of global warming may soon give rise to trade protection tariff measures to cover carbon emissions. Starvation wages can be penalized.

Under different political management, the WTO’s “organized trade system” could easily hit producers who pay their workers starvation wages and their CEOs like Maurice Taylor several hundred times what he considers “a fair wage”.

Free trade versus street politics

Reducing wage inequality would however challenge the very bases of Free Trade theory, as lengthily developed by David Ricardo. The lowest-cost producer always wins.

Plenty of economists, whether “Keynesian” or not will argue that maximizing comparative advantage needs a trade deficit. This is exactly the process which has created the yawning trade deficits of the OECD countries with China: the amount of goods produced has been maximized, producing a net transfer of wealth from the OECD countries to China.

The results include de-industrialization, unemployment, rising government deficits as tax revenues decline with industrial output, rising sovereign debt – and finally street protests. The alternative readout is that wages have not yet been pushed low enough in the former “rich nations” to make them “competitive” but the voting public, as Italy’s recent elections show, now clearly know what this elite slogan means: rising poverty and precarity.

To be sure, elites and their middle class allies in the formerly rich countries feel comfortable preying off workers paid 1 euro-per-hour in Chinese and Indian sweatshops. Well armed dictatorial elites in poor countries – as in the Arab world before Arab Spring – were always believed to “guarantee economic stability”. Any change in global trade regulation which penalizes cheap exports from countries paying Iron Law wages is automatically a “revolutionary socialist solution”.

Today’s parlous state of the global economy is easy to present as the result of a blind quest to maximize capital accumulation, and achieve the all-out maximum production of goods that can be put on sale – confused with the notion of “wealth”. This spurs outplacement and delocalization, reduces wages, and raises unemployment in the formerly rich nations, even if the process enriches poorer nations.

The rebuff from elite-friendly economists to proposals for trade barriers is this “will produce a 1930s-type great depression”. Ricardo’s comparative advantage is still the official “win-win solution”.

How long this stalemate continues is an open question. Its logic is unreal, like Ricardo-vintage notions of labourers needing only just enough to eat to prevent them procreating too fast – the only way to slow the “inevitable trend” for wages to fall below his Iron Law minimum.