Against the Tide

Against the Tide

An Intellectual History of Free Trade

by Douglas A. Irwin

Princeton University Press, Princeton, New Jersey, 1996

ISBN 0-691-05896

Review Copyright © 1998 Garret Wilson

November 1, 1998, 10:20am; November 2, 1998, 3:15pm

In the theoretical realm of economics, the superiority of free trade is accepted, if not as a given, then at least as probable by a majority of modern economists. Expounded by those such as Smith and Ricardo, it has been firmly established that, in the very least, some free trade is more advantageous than no free trade at all. This is not to say that there have been no dissenting voices throughout the centuries since free trade first became a popular idea; indeed, there have been many. Douglas Irwin discusses the formation of free trade theory and the attacks made on it through the years, and evaluates the extent to which free trade has remained a viable concept "Against the Tide" of protectionist arguments.

The ancient writers saw the seas as being purposed for the transfer of goods to areas that need them the most. Some early Christian writers claimed that each region should make use of the goods they had, but many others saw the design of Providence in the seas as vehicles, not only of trade, but of bringing humanity together.

The 16th century saw the rise of what has become known as "mercantilist" ideas. Mercantilists were not against trade itself, but rather felt that a countries economic prosperity (which was vaguely defined, if defined at all) was brought about by exporting manufactured materials and importing raw materials. After all, the argument went, if raw materials are exported, so is a potential for improvement on those materials – the other country could than use those materials for manufacturing, employing its citizens, and then selling the products to the first, which supposedly would result in lower wealth of the first country.

In the 17th and 18th centuries, some writers began to question the concept of having any stipulations on free trade. In particular, Henry Martyn had ideas that are very close to what would later become classic free-trade arguments: "If nine cannot produce above three bushels of wheat in England, if by equal labour they might procure nine bushels from another country, to employ these in agriculture at home, is to employ nine to do more work than might be done by three," and, "It is to oblige the things to be provided by the labour of many, which might as well be done by few; tis to oblige many to labor to no purpose, to no profit of the kingdom, nay, to throw away their labour, which otherwise might be profitable" (58). Surprisingly however, even though such writers as David Hume were evaluating trade practices along with formulating frameworks for morality, Irwin believes that, in considering "how the economic implications of the late eighteenth-century debate over self-interest affected conventional views on commercial policy... the answer is very little" (72).

Adam Smith changed ideas about the expediency of free trade with the publication of Wealth of Nations in 1776. His revolutionary work, which was unique in content except maybe from writings of Martyn, immediately brought about a change in ideas of free trade. The "classical economists" after this time understood free trade to be desirable because countries could acquire products from abroad cheaper than they could be made at home, allowing that labor to be used for other purposes, in effect getting more products for the same amount of labor. Several good arguments were put forth to explain the benefits of free trade, such as one explanation by Nassau Senior in 1928:

If we should think it madness to prohibit, or to tax, the use of an improved steam-engine, because it must be injurious to those employed in raising coal, what pretence is there fore prohibiting or taxing foreign ribands or velvets because their importation would be injurious to the English silk-weaver? [T]o prohibit every change which is accompanied by individual injury would be to prohibit every improvement whatever (93).

Since the rise of the classical economists, there have been various arguments set forth that bring into question the benefits of free trade. The first listed by Irwin is the "Terms of Trade" argument brought about by Robert Torrens in the 1800's. Dealing with the ratio of a countries exports to imports, Torrens stated that a country could create tariffs which would result in more exports than imports, eventually raising the price of the imports and benefitting the country (104). John Stuart Mill elaborated on this idea, but acknowledged that this would lower the economic conditions of the world as a whole and doubted that any country could properly set tariffs for its benefit (109). Mill and later authors brought the Terms of Trade argument to what Irwin feels to be "the most robust and least subject to qualification or exception" to this day (115).

John Stuart Mill brought forth another idea that has been popular in modern times. The "Infant Industry" argument claims that the presence of some industries could benefit a countries economy, but these industries could never get started because of high initial costs and early losses which are inevitable. Therefore, import restrictions should be made on these products to enable the industry to establish itself. It is questionable how well later gains could cover the early losses, however, and import restrictions do nothing a capital loan couldn’t do. Furthermore, the concept of what actually constitutes an "infant industry" has never been clearly defined.

In the 1920's, Frank Graham advanced the "Increasing Returns" argument, which says that manufacturing brings about increasing returns to scale, while agriculture does the opposite. In other words, more people working in a factory should bring about more returns per person by an increased output, but more people working on a plot of land will bring about less returns per person because the land has a set limit of food it can produce. In real life, however, there are limits on the increasing returns sectors, and unlimited increasing returns would monopolize an entire industry – such unlimited increasing returns do not exist. That is my partial understanding of the criticism that "increasing returns that are internal to a firm are incompatible with market competition" (138).

Mihaïl Manoïlescu in the 1800's advanced the "Wage Differential" argument that attempts to promote protection for an industry that has a higher wage for workers than larger industries in the country. In 1931, Bertil Ohlin (of the Bertil Ohlin Lectures of Jagdish Bagwati’s Protectionism) asked the "obvious question" of why workers would not migrate to the jobs with higher pay automatically, without protection (165). In 1963 the aforementioned Jagdish Bagwati and V. K. Ramaswami recognized the existence of wage differentials brought about through a market failure (some area in which the market wasn’t entirely "free" in theoretical terms), but brought about a ranking system of fixes for these "distortions" (169). I can attest that these rankings of first-best, second-best, etc. policies for fixing market distortions are prevalent in International Economics courses and textbooks. In short, there is almost always a better way to fix a distortion than to throw a tariff at it. Thus, Bagwati and Ramaswami unlinked the ideas of free trade and laissez faire; just because a market may require some intervention does not necessitate protectionism.

Similar to the Increasing Returns argument against free trade, the "Australian Case" was made in the 1920's. The case was that, if a country were to become an exporter of a sector with diminishing returns, such as agriculture, many citizens would choose to emigrate to countries that specialized in industries with increasing returns, such as industry. This would result in a decrease of the country’s population. A closer analysis reveals that this is a non-economic complaint; the argument is not that the country’s economic condition would be worse off, but that the results of free trade did not coincide with the value judgements of policy makers.

The Australian Case coincided with a closer examination of free trade outside the realm of strict economics, concentrating on the distribution of wealth and the meaning of welfare. Instead of looking solely at whether free trade resulted in a theoretical gain or loss of wealth for the entire country, normative examinations were made concerning who actually received the wealth brought about by trade liberalization. These "welfare economics" made a distinction between "wealth" (the "overall quantity of goods... available to a society") and "welfare" (concerning an individual’s happiness or satisfaction) (181). (In fact, I should look further into the discussion of "marginal utility" (183), which may better illuminate the argument I was making against an "efficient free market" in Friedeman’s Hidden Order.)

The rest of the discussion on welfare-related issues refers to a Pareto-improvement (a situation where at least someone benefits and no one loses anything) (184) and a Kaldor improvement (a "potential" Pareto-improvement) (186), harking back to the excellent discussion of both of these in Hidden Order. In the end, Irwin considers welfare economics to have been a failure because it is so difficult for one to modify a free market system to redistribute wealth and be sure of enhancing welfare (188). Pareto-improvements are very difficult to create manually.

The last objection to free trade discussed is that of the icon of 20th century economics, John Maynard Keynes. Keynes originally was completely for free trade in all circumstances, remarking that, "We should hold to Free Trade as a principle of international morals, and not merely as a doctrine of economic advantage" (189). After World War I, however, Britain returned to the gold standard at pre-WWI levels, leaving a currency that was overvalued. If no additional steps were taken, this would result in more foreign investments and imports with less exports, since goods from other countries would suddenly become cheaper and British goods would become more expensive.

In a perfect free market system, wages would fall, lowering the price of British goods, and bringing about a deflation which would result in an equilibrium. Keynes feared that modern trade unions would force wages to remain high, resulting in unemployment (191). He therefore advocated a tariff on imports and a subsidy for exports, which would counteract the issue of an overvalued currency (194). This became a moot suggestion in 1931 when Britain abandoned the gold standard, so Keynes’ suggestions were never put to the test (198).

These last cases make several points clear, which could be considered the main points of Irwin’s work. The first is that most of the objections to free trade have been on theoretical grounds; actual testing of any of these policies have been "almost completely absent, and what empirical evidence there is has been unhelpful in making arguments against free trade more compelling" (221). The world economy is so complex and policy making so difficult to be analyzed regarding a single variable that validating specific assertions are virtually impossible.

Secondly, the most of the arguments against free trade are not on the theory of free trade in a perfect world, but examinations of the implications of the world economy as it exists today. There are numerous aspects of free trade that are not as "free" as it would appear to be on paper. In practice, there are many so-called distortions such as labor-immobility – in theory, countries benefit from importing because labor previously employed in that sector will simply move to the exporting sector; in reality, not everyone has the skills needed to change jobs or the means to move across or out of the country.

Thirdly, while even completely free trade will bring about overall economic gains, the actual distribution of the gains may not be desirable on normative grounds. However, whether or not "real-life" free trade meets it theoretical predictions or meets our expectations of welfare advancement, Irwin claims that free trade is still the best overall policy. Due to the inherent limited knowledge and abilities of individuals within the system, government intervention would usually result in a worse economic conditions than none. In the words of Krugman, the modern argument" is a sadder but wiser argument for free trade as a rule of thumb in a world whose politics are as imperfect as its markets" (227).