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Genre = Economics
Intriguing Connections = Globalization and International Trade: A Known Problem?
The irreconcilable nature of the real world and current standard trade theory models is the focus of The Global Free Trade Error by Ron Baiman. Starting with Ricardo’s overly emphasized comparative advantage model, and then seeing how the Neoclassical Hechsher-Ohlin represented trade. Baiman then show some models with different assumptions that predict trade better. Ending with the current state of the economy, a rentier economy, Baiman shows the problems with the current approach to trade. With direct representation from the trade models, Baiman uses mathematical proofs to express their underlying flaws. This book is determined to prove that the standard theories cannot be reliable given the assumptions and their mathematical rendering.
To express the poor quality of the models, their own words are used. The major paragraphs in Ricardo’s Principles of Political Economy and Taxation that relate to trade are provided and clarified helping to understand the theories underlying assumptions. Comparative advantage obtains the results everyone wants under a variety of assumptions. The major four assumptions are complete specialization, full employment, balanced trade, and balanced aggregate supply and demand. Given that each country stops production of the disadvantages product, it will completely specialize in the advantages products. With specialized production, there will be more quantity of both products. To satisfy the increased supply would mean a need not only for the increased production to be bought, but more labor to produce it. Should trade be unbalanced, it will lead to one of the trading partners to accumulate more gold. Accumulation of gold alters the relative prices of the products resulting in unfavorable exchange rates thereby making comparative advantage trade unprofitable.
Some of the assumptions, such as complete specialization and full employment, are not directly stated within the Ricardian formwork. Baiman explains that the model requires them and the model itself would not work appropriately without them. The assumptions are provided with mathematical representation. The result show that Ricardo’s comparative advantage is overdetermined and not generally solvable. Comparative advantage requires five independed equation, while only three unknowns, creating a mathematical oddity.
The neoclassical version, the Hechsher-Ohlin, corrects for a demand problem, but is still overdetermined. To obtain factor price equalization (one of the results of this model), the model requires the restrictiveness of the perfectly competitive marginal product returns. Any deviation away from perfect competition renders the Hechsher-Ohlin model irrelevant. Within this framework, wages should equalize under this model, but the model itself does not provide any mechanism to equalize nominal wages. The good news about this model, is that a solution can exist, the problem is that the solution will be mathematically unstable due to constant readjustments and will not be economically meaningfulness.
For both, comparative advantage and the Hechsher-Ohlin model, to fulfil their results requires many conditions. Those conditions do not support free trade, but in fact support managed trade. Baiman points out that trade should not be an exclusive market activity, but should be managed. Normal market operations would create unstable and unsustainable trade, only via managed can trade become mutually beneficially stabilized and the gains from trade sustainable. A bit ironic that the models which want free trade depend on the trade being managed.
The models that perform better are those that assume unequal exchange. Unequal exchange due to different bargaining power reflects the ownership structure of the resources, per Baiman’s explanation. Exchange that appears to be voluntary, but is actually coercive. Benefits of trade, rather than be dispersed, is more concentrated in country which has more bargaining power. Wealth is transferred to the more dominant trading partner. That leads to two policy option which can rectify the situation, with the two options being fair trade and a global Marshall Plan.
Fair trade would allow the less productive country to purchase the more productive country’s machines at low prices. The price need to be managed, and would need to be high enough to make the trade profitable. The pricing of the products reinforces a hierarchical division of labor, making it more difficult for the less productive country to develop. The global Marshall Plan would have the unused or surplus products distributed to trading partner under long-term credit. This policy would make trading partners comparable as it would balance endowments of each partner.
Without the policies, the current trading mechanism is producing what Baiman calls the rentier economy. Exchange occurs without producing any advance in productive capacity. Services like finance, are not investing in social wealth. These services are transferring more income to the few who already hold the wealth. This type of system produces rent seeking behavior, to maintain the status quo in wealth accumulation for the few.
The reason why current dominant trade policy theories are not theoretically possible and the practical hardships they cause was the point of The Global Free Trade Error. There needs to be a lot more research regarding trade, for even this exposition was not enough. This book would benefit from clarifying the trade assumptions further, going deeper into alternative trade policies, and defining contested issues.
Some assumption that Baiman imposes on Ricardo’s comparative advantage which were not part of the original assumptions change the very model under study. Complete specialization would not be prescribed under comparative advantage as that would be too costly. Comparative advantage alters the amounts of production in favor of the advantaged product, but it does not require nor does the model want complete specialization. Baiman does state that compete specialization is a special case, but still uses the assumption for the mathematical rendering. Another assumption is that of full employment. The claim is that with comparative advantage, both countries must produce more to fulfil the higher demand. The problem with this the total production does not need to change, which means that there would be more non-working hours while producing the same amount of goods. There would be more employment in the advantaged product, but there is no need for full employment. The full employment assumption is necessary for the Neoclassical model, but not so for the standard comparative advantage. The mathematical rendering is useful, but it technically expresses a very different model at the same time.
Baiman makes it very clear that the actual requirement for free trade, to achieve the same results, would mean managed trade. Managed trade is not proclaimed to be a panacea, for it will not be able to continuously adjust to a multitude of different factors. What is missing from the story is a theory of government, those that would manage the trade. Free mobility of capital may not create good policies, but that does not mean that managed trade is the way to go. States have been controlling their various markets for millenniums before capital was able to move freely, and history shows that governments do have a better track record. The case for managed trade needs to elucidated.
With the growing dominance of the rentier economy and various impacts on production and trade, the situation needs to be further developed. Rentier economy is represented as increased in financial service (non-production) and decline in the production activities such as manufacturing. The issue is that many services are under the heading of a non-production activity, along with finance. Many non-production activities are needed such as government administration and social infrastructure, and finance has a role to play in the development of the economy. Altering the mechanism which produces the rent seeking behavior is a high aim, and the rentiers of finance are the current expression of the problem. Developing a deeper understanding of what is a rentier economy and how to prevent its wasteful distribution of wealth is needed.
In summary, comparative advantage and other free trade models are too restrictive to be economically feasible. It would require a plethora of resources just to have the results which these models predict. Using resources to maintain trade mean that trade needs to be managed, but even managed trade has a host of problems. Baiman’s book shows what kind of trade cannot happen utilizing both theory and models. The kind of trade models that are needed are those of unequal exchange, which need to be analyzed. Trade is historically, culturally, and economically important, which means we need to find some type of trade which celebrates diversity and promotes exchange.
Pages to read: 158
1st Edition: 2017
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