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Unless we can create a perfect world, says managing editor David Donovan, truly free trade is an unattainable dream — and a dangerous and destructive ideology.

Why everything you thought you knew about economics is probably wrong (Part 2)

Read the other parts of this series:

Part 1: The art of economics

Part 3: Productivity and the myth of labour market flexibility

Part 4: Masters of the universe and the efficient markets myth

Part 5: Free market ideology

Absolute and comparative advantage — the faulty premise behind the ideology of free trade

IF THERE HAS BEEN one element of modern life that has been underpinned by classical economic concepts, it is the notion of “free trade”. Indeed, the world community spends a lot of time discussing removing tariffs, subsidies, trade barriers and other forms of protectionism. Under the auspices of the World Trade Organisation, the world community has been battling, unsuccessfully – since at least 2001, under the Doha round – to reach agreement on removing trade barriers. Indeed, Australia was established, largely, as a continental free trade zone.

And if there is a powerful economic ideology that has been taken up and championed by powerful nations, transnational corporations and neo-liberal right-wing think tanks everywhere, it is free trade — which should, of course, make everyone else highly suspicious.

The economic concept underlying free trade is the notion of absolute or comparative advantage, which is such a fundamental notion of modern economics it is taught in high school Economics syllabuses, straight after those obligatory supply and demand graphs. The concept is that a nation is better to produce those goods in which it has an absolute advantage – or in other words, can produce more cheaply than other nations – then devoting resources to producing things it makes less efficiently. The notion extends even where a nation cannot produce anything more cheaply other nations, in which case the law of comparative advantage states that it would be better to devote its resources to the production of whatever it produces more efficiently than anything else — or, in other words, the products in which it has a comparative advantage.

Taking this theory to its logically absurd conclusion, since all nations could presumably be found to be able to produce one product better than any other, they should therefore devote all their resources to producing that product or commodity, whatever it might be. In which case, the world would produce only as many products as there are nations — a couple of hundred. In Australia’s case, perhaps we would commit all our productive capacity to digging up coal (and indeed, building a quarry economy is something Australia has been committed to since at least 1996).

The basic underlying premise – that countries, companies and, indeed, individuals should devote themselves to doing what they do best and trade with others for what they do relatively poorly – is logical — within reason. However, anyone with a teaspoon-full of common-sense knows that the concept of absolute and comparative advantage has more holes in it than a colander. Indeed, since the concept arose a couple of hundred years ago, it has been picked apart and refined by economists more, perhaps, than any other.

Firstly, the concept is built on economic assumptions that do not, will not, and could not, possibly ever exist in the real world or, indeed, our universe. It is predicated on the notion of efficient markets with rational participants that, as explained in part 1, 'The Art of Economics', is a denial of our essential humanity. In particular, it assumes that all factors of production and resources are perfectly and equally mobile — which is blatantly idiotic. In Australia’s case, it would suggest that coal mines can be made to instantly appear with all the requisite infrastructure and that you could send everyone to work in them without them complaining, for instance, that dry weather is bad for their skin and, frankly, they don’t want to live in Moranbah. This assumption is important to notions of competitive advantage because, say, coal became fossil fuel non grata in the world community and wasn’t worth any money all of a sudden (as is likely) then you would need to be able to transfer all your productive capacity to something else pretty quickly or else your workers would earn no money and start dying of malnutrition, which is not an economic concept that resonates strongly in the wider community.

Secondly, as mentioned above, if each country specialised in whatever it was most efficient at, the world would need to get by with a maximum of around 200 products — an impossibility.

Thirdly, the theory ignores scale. To explain, say a small Caribbean nation has a competitive advantage in producing, say, bananas, and devotes a lot of its resources to producing bananas, which it can do cheaper than any other nation. Unfortunately, another vast and powerful nation, say the United States, also produces bananas and can produce them in such quantity that it can afford to sell them around the world for less than the Caribbean nation until the little nation’s producers all go broke and the industry dies. (Cue malnutrition.) And, of course, without any competitors, at that point, the bigger country will be able to charge what it wants and therefore make super profits, which kind of of defeats the whole purpose.

This is essentially what Woolworths and Coles do in the Australian market. The WTO spends much of its time trying to stop countries, like the EU and the U.S., dumping subsidised agricultural products on world markets and thereby killing off small nations’ export industries. They are invariably unsuccessful. Of course, poor nations wanting the U.S. and EU to remove agricultural subsidies is the prime sticking point in the Doha round of the WTO negotiations.

The underlying reason why these countries will never allow their agricultural industries to face true competition is due to entrenched vested interests and, more importantly, as insurance against war and serious international disputation — which is the other reason why truly free trade is an unattainable pipe dream.

he truth is that unless we can eradicate war and disputes between nations, all nations have a strategic interest in protecting vital industries, such as manufacturing, agriculture and the production of key resources. You never know when there will be a war, blockade or a disputation in which a nation may not be able to trade with the nations that produce, say, cars – or tanks – or iron ore or wheat most efficiently. Therefore, preserving the expert knowledge base and ability to expand production quickly – or in other words, retaining a generalised productive capacity in all essential areas – is vital to the national interest. Removing a nation’s ability in any strategic area is, ergo, a dangerous strategic liability, irrespective of any concerns about economic inefficiency.

Free trade is a popular ideology amongst the rich and powerful in our society, because it enables them to produce their products wherever they can do so most efficiently (usually meaning where they can pay their workers the least) and ensures they can ship the product without paying tariffs. For nations and individuals, however, it has vast dangers and its record is littered with examples of where attempts to reach the pot of gold at the end of the rainbow has proven to be a disastrous mistake. Australia’s 2004 “free trade” agreement with the United States – which removed very few barriers for Australian producers but worked largely to protect America’s economic interests in such areas a copyright law and intellectual property – is a solemn reminder of the dangers.

The truth is, free trade is highly desirable and would, of course, improve economic efficiency, but is also entirely impossible – and rather risky – in the real world.

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