448 views

No wonder free trade is under threat: We are only just remembering its downsides

Paul Ormerod
Follow Paul
Donald Trump
Donald Trump has called for higher tariffs on imports from China and Mexico (Source: Getty)

It had been an article of faith among economists and policy-makers that free trade is a Good Thing. Trade liberalisation was a key feature of the world economic order enforced by the United States after the Second World War. For decades, the trend of removing trade barriers led to world trade growing around twice as rapidly as world GDP.

All this now seems under threat. Calls for greater protectionism have been a feature of the US presidential race, emanating from both Donald Trump and the Democrat hopeful, ultimately defeated by Hillary Clinton, Bernie Sanders. In Britain, the Brexit vote puts the spotlight on trade policy for the first time for many years. Even the International Monetary Fund (IMF), the high priest of economic orthodoxy, has joined in the debate, with a warning at the end of September that free trade is increasingly seen as benefiting only the well off.

The economic principles which support free trade go back over 200 years, almost to the beginning of economic theory itself. Adam Smith, in his great book the Wealth of Nations, set out the basic arguments in the late eighteenth century. Trade enabled countries to take advantage of specialisation. If Portugal produced, say, wine more efficiently than Britain, and we made cloth better, by concentrating resources on what each were good at and trading the outputs, both benefited. Production of both commodities would be concentrated in the country which was most efficient at each.

Read more: Forget trade deals: Unilateral free trade can be our Berlin Wall moment

David Ricardo, writing in the early nineteenth century, was not just an economist but a self-made multi-millionaire – at a time when a million pounds was a million pounds – and a Member of Parliament. He took Smith’s arguments further, and showed that trade was beneficial even if one country could literally make everything more efficiently than everyone else. Countries should specialise in what they were comparatively best at.

This, the so-called principle of comparative advantage, remains at the heart of the economic theory of trade to this day. Ricardo’s theory was tremendously influential. It was used by the Lancashire politicians John Bright and Richard Cobden to secure the repeal of the Corn Laws. These put high tariffs on the import of corn into the UK. Their abolition meant cheap food for the industrial working class, and was the most important social reform of the entire nineteenth century.

Read more: Britain has a moral duty to lead the world on free trade

But all theories make assumptions. Ricardo made it clear that he was assuming that capital did not move across borders. It stayed put in its country of origin. In the early nineteenth century, this was a reasonable assumption to make: international capital flows did exist, but not on a massive scale.

If capital can flow freely, Ricardo’s theory needs to be heavily qualified. So, when the Berlin Wall fell, German companies built factories in Poland and the Czech Republic, destroying German jobs. In the long run, trade may still be beneficial, but there will be many losers along the way. Next year sees the two hundredth anniversary of Ricardo’s great book. The IMF has just rediscovered something which good economists knew all along.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Related articles