Tag Archives: Comparative Advantage

By George P. Brockway, originally published November 2, 1992

1992-11-2 The Illogic of Leanness and Meanness Title

1992-11-2 JK Galbraith                EDITORIALWRITERS and speech makers are fond of the expression “lean and mean” (or, sometimes, “mean and lean”). I suspect it is the rhyme that appeals to them. They can’t possibly be allowing themselves to think about what happens to people who work (or used to work) for lean and mean corporations. They can’t possibly give a satisfactory answer to the question John Kenneth Galbraith asks in Affluent Society: “Why should life be intolerable to make things of little urgency?”

Nor can they possibly be wondering whether lean and mean corporations make this a better world to live in, even for their customers and their stockholders. St. Augustine wrote: “Every disorder of the soul is its own punishment,” and meanness is certainly a disorder of the soul.

Yes, I know: We are told we will have to be lean and mean to compete in the global economy of the 21st century. Some commentators say that the global economy and the competition are already here.  President Bush inclines to this view; President-elect Clinton inclines to this view; and I suspect that Citizen Perot had something similar in mind. At any rate, he had a lean and hungry look.

Fifty years ago another self-made man, Wendell L. Willkie, had a vision of One World in which we would all help each other. Willkie was a lawyer and CEO of a giant utility holding company before he became the 1940 Republican Presidential candidate (Harold Ickes, Franklin D. Roosevelt’s Secretary of Interior, called him the “barefoot boy from Wall Street”); he was no starry starry-eyed innocent. Yet his touchstone was cooperation, not competition. The world seems to be different now, and not as nice. What happened?

It is, I think, a case of Samuel Johnson being right again: “Hell is paved with good intentions.” The economic situation we find ourselves in is mean enough to have at least some of the attributes of hell, and it is paved in part with free trade, a theory whose intentions were the best in the world. I say “were” because I’m not so sure they’re all so good today.

Practically every economist is in favor of free trade, and the fraternity has been joined by a broad range of right-thinking, public-service citizens groups, from the Council on Foreign Relations to the League of Women Voters. The argument for free trade is simple and strong: All of us are consumers, and therefore benefit from cheap consumption goods. Tariffs, subsidies and the like increase the costs of consumption goods, and therefore are bad. A less materialistic reason for open international trade is that it is said to make for peace, although perhaps not in the Middle East.

The foregoing arguments, including Willkie’s, may be classified as general or ideological. There are also technical arguments in support of free trade – for example, the theory that cheap imports are both anti-inflationary in themselves and anti-inflationary in their competitive pressure on domestic prices. This notion was a favorite of former Federal Reserve Board Chairman Paul A. Volcker. The most famous technical argument is David Ricardo‘s so-called law of comparative advantage. Unhappily, there isn’t sufficient space here to discuss this “law,” except to say that it consists mostly of exceptions[1].

For the moment I merely want to register the point that each of the arguments, the ideological and the technical, depends – as does standard economics generally – on three assumptions: that full employment actually obtains here and now, that chronological time does not matter, and that all public questions are, au fond, economic questions (or, as Marx had it, that the state will wither away and need not be taken seriously).

Free trade as an ideal has had a long run on the American political stage, starting at least as early as the Boston Tea Party. What has happened recently is not inconsequential. Even as late as 1950, imports were less than 5 per cent of our GNP (exservices): currently they are running at about 16 per cent. Until 1977, American exports generally exceeded imports; I don’t have to tell you that the situation is different now. Nor do I have to read you a list of American industries that have been decimated by foreign competition. Those who say that the global economy is upon us are not far wrong. I am persuaded, however, that what they propose to do about it is indeed far wrong.

Essentially, they make two proposals. The first is the lean and mean thing, to which I will return. The second involves empanelling a committee of government officials, bankers, businessmen, economists, engineers, scientists, and the obligatory representatives of the general public (but not including Ralph Nader) to recommend research and development projects to the government, and then to pass judgment on the results of the research and propose ways of implementing the development of approved ideas. The government’s role would be crucial, because of the antitrust laws and because the research is thought likely to cost more than any corporation, regardless of its size, could afford. In addition, it is observed that the largest corporations tend to devote less and less money to research.

The scheme has both practical and theoretical flaws. The chief practical flaw is that whatever good ideas the committee might come up with would be immediately available worldwide. Just as the American television set industry quickly slipped into the Pacific sunset, so would the new wonder industries.

It is inconceivable, for instance, that giant American corporations would be excluded from the marvelous new industries thought up by the committee. Our giant corporations, however, are not really American; they are multinational. They are motivated by the self-interest of the stockholders (in the conventional theory) or of the managers (in Galbraith’s view); in either case, their devotion is neither to the nation nor to the nation’s workers.

Consequently, upon learning of the miraculous new product along with everybody else, if it is truly miraculous, the responsibility of these corporations to their stockholders or to themselves would require them to start producing it in the least expensive way. And where would they do that? Wherever in the world they found the most stimulating subsidies, the most alluring tax rates and the cheapest labor.

Wherever in the world that might be, it would not be in the United States of America, for the inescapable reason that, at least so far, the American standard of living is higher than that of any other first-rank country. The cheapest labor will not be found here unless we destroy ourselves. On the MacNeill Lehrer Newshour a few months ago, U.S. Trade Representative Carla Hills seemed to believe the Mexican poverty rate was only about 11 per cent (ours was 13.5 per cent two years ago and has undoubtedly risen since). She must have been thinking of some Mexico other than the one I’ve visited.

A MINOR practical flaw in the committee scheme is inherent in the very idea of creating such a group. Schumpeter counted the mature corporation’s addiction to committee decisions a prime reason for decline, and we all know the absurdity that would result if a committee tried to design an animal. Perhaps more important, we know from experience that a committee is quickly co-opted by those with the liveliest immediate interest in the outcome of its deliberations.

In the proposed body the industry and banking representatives may not be the smartest or the best informed, but they surely will have their minds concentrated on the fate of their sector of the economy, and they will certainly wield the direct and indirect power that comes with enormous wealth. In Japan, captains of industry respect the authority of even minor bureaucrats; in the United States, money talks.

Beyond this, the committee approach has a serious theoretical flaw in that it contradicts the very reasons for its formulation. These, it should be kept in mind, are (1) the decline of American industry because of foreign competition, and (2) the presumed impossibility or unacceptability of self-protection in any form.

The conventional charge against self protection is that it interferes with and distorts the natural course of trade, thus making for inefficient if not altogether wasteful use of resources. Publicists reinforce the charge with the cliché that a man knows better what to do with his money than does some bureaucrat in Washington. Yet if the charge and the cliché were valid, there would be nothing to be done about the decline of American industry. It would be natural and inexorable. Further, it would assure the “efficient” use of resources and be a necessary contribution to the wealth and happiness of mankind. Some people would no doubt be hurt by it, but you can’t make an omelet without breaking eggs.

On the premises, there is no more place for a reindustrializing committee than there is for self-protection. If the committee wouldn’t interfere with the natural marketplace, what would it do? Its whole purpose is to interfere in a large and comprehensive way. The logic of the scheme is absurd. Major premise: American industry is being ravaged by foreign competition. Minor premise: Self-protection is unacceptable because it interferes with the free market. Conclusion: A committee should be empaneled to interfere with the free market. What kind of logic is that?

The lean-and-mean logic is similar. Major premise: The American standard of living will be ravaged by foreign competition. Minor premise: Self-protection is unacceptable because it interferes with the free market. Conclusion: We should make corporations lean by firing people, make them mean by working the surviving employees harder for less pay, and thereby make ourselves miserable without help from anyone else.

I find it odd that standard economics, based as it is on self-interest, should find self-protection invariably reprehensible.

The New Leader

[1] This link includes references to the Law of Comparative Advantage in other Dismal Science articles

By George P. Brockway, originally published August 7, 1989

1989-8-7 Exxon And Squatter Economics Title

DEAN ACHESON once remarked wearily that if anyone, at any time, found him agreeing with any Indian on any subject whatever, that person should have him certified immediately. His judgment was no doubt colored by his experiences with V.K. Krishna Menon, who wanted all North Korean POWs shipped home whether they wished to go or not.

My feelings about standard economics are similar, perhaps because one summer, in a youthful fit of self-improvement, I spent many hours reading Frank Taussig’s introductory textbook when I could have been sleeping in the sun. My recollection is that Taussig, who was a big man in his day, started off by talking about Robinson Crusoe. I have since come to doubt that Robinson had anything to do with economics at all. So far as I know or Professor Taussig said, he never bought or sold anything, or used money.

One by one the classic laws have lost their savor for me. David Ricardo‘s Law of Comparative Advantage was an early loser, and I wrote three columns[1] about it six or so years ago. The notion that producers are profit maximizers and consumers are utility maximizers attracted my attention last year, and the Law of Diminishing Returns a couple of months ago. I’ve even dropped a hint or two concerning the Law of Supply and Demand, and might supply a column about it, if I detected any demand.

I’m ashamed to say that in one of my early columns I made a slip and endorsed the proposition that free competition in a free market makes for the most efficient allocation of scarce resources. As Abraham Lincoln[2] replied when requested to apologize for saying that Simon Cameron would not steal a red-hot stove, I now take that back.

The issue is in the news because of the great Valdez oil spill. Some excitable people want to punish Exxon, but they have been patiently told it would be inefficient to do so. Encouraged by the sound of their own voices, the naysayers add that it would be inefficient to impose further restrictions on the exploitation of Alaskan oil, and also that an increase in the gasoline tax would distort the allocation of resources. They urge, too, a relaxation of the already relaxed standards of gasoline efficiency (that word again) for new automobiles. Red-blooded Americans, if given their druthers, would prefer very big cars that can go very fast; therefore they should be allowed to put their money where their preference is, and the speed laws should be lifted while we’re at it.

The more beguiling advocates of free market theory admit that sooner or later oil will run out. They are confident, however, that the spur of possible profits will drive some mad scientist to invent a way of using crab grass or zucchini for fuel (as some tried to use dandelions for rubber in World War II), thus rehabilitating suburban agriculture and saving the automobile. In the meantime, they argue, as oil gets scarcer and the price rises higher, those willing to give up coarser pleasures are entitled to enjoy the daintier pleasure of burning gasoline in fast cars, fast boats and fast snowmobiles. Their willingness shows that is the efficient thing to do.

Let’s examine the proposition, not from the point of view of ecology or even of national security (where it’s a clear loser), but from the point of view of logic. Is economics really about the allocation of resources at all? To answer that question, we have to be able to say what a resource is. How about this: A resource is something that is useful or necessary to make something else, a component of an economic commodity.

(At this point there is a side issue we ought to deal with. The Education President tells us that a trained labor force is an essential resource in our struggle with Japan and Germany for the hearts and moneys of the world. But a labor force is not a thing; it is human beings, and human beings are ends in themselves. Trade is for human beings; human beings are not for trade. They are not a resource or a means to anything else. To treat human beings as means is the ultimate sin. I know that George Bush is a kind and gentle man who does not always mean exactly what he says. But if we are to read his lips, he should watch his tongue.)

So resources are things, objects. Natural resources are things untouched by human hands, lying around ready to be picked up or dug up or fished up, and used. Economic resources are also scarce. There is no point in talking about them if they are not scarce. Taussig (if my memory serves after all these years) gave air as an example of a noneconomic resource, the reasons being that there was a lot of it, and that no one could figure out how to bottle it and sell it. We’ve made progress, however. If you’re in the hospital and they decide to pep you up with oxygen, you’ll find $100 a day added to your bill. And Los Angeles knows that breatheable air would be impossibly expensive.

But of course not all scarce natural objects, even those that could be readily packaged, such as bluebird nests, are natural resources. Leon Walras, the patron saint of marginal utility analysis, credits his father Auguste with the notion that an economic good has to be useful as well as scarce. This does not seem a remarkably difficult advance in thought. It does not really advance us very far, either.

Maybe you are not clever enough to think up uses for bluebird nests, and maybe no one is; that does not mean a use will never be discovered or invented. Think of petroleum. If you had asked Adam Smith about it, he would have shrugged his Scotch shoulders. It was a sticky, stinky substance where it appeared, as in the notorious fields near Cumae, rendering useless the land that harbored it. Or you might have asked Karl Marx about uranium. He would never have heard of it, for one thing. What kind of resource is something you never heard of.  On the other hand, ancient man mined and traded obsidian, which, apart from the art and tools the ancients made of it, is now of no interest to a Harvard Business School graduate.

From these random samples we can infer that the usefulness of objects is not something inherent in them. As it happens, there is no dispute on this point. W. Stanley Jevons, who shares with Walras the distinction of having invented marginal utility, put it this way: “The price of a commodity is the only test we have of the utility of the commodity to the purchaser.” A half century earlier Jean- Baptiste Say had characteristically introduced an intermediate and indeterminable abstraction: “Price is the measure of the value of things, and their value is the measure of their utility.”

In our day, Gerard Debreu, a Nobelist and probably the world’s foremost mathematical economist, is in agreement with Jevons and Say. “The fact that the price of a commodity is positive, null, or negative,” he writes, “is not an intrinsic property of that commodity; it depends on the technology, the tastes, the resources … of the economy.”

(Please forgive another side issue. Noting the word “resources” before Debreu’s ellipses, I confess myself puzzled, since in a subsequent passage he says, “The total resources of an economy are the a priori given quantities of commodities that are made available to (or by) its agents.” It would appear that the price of a commodity depends, at least in part, on resources, and that resources are commodities-a line of argument that looks suspiciously circular to me.)

ONE WAY or another, then, we come to the conclusion that it is not so easy to say what economic resources are. They are useful, yes, but neither petroleum nor uranium nor a bluebird nest is, in and of itself, useful. Indeed, if you don’t know how to use them petroleum is nasty and uranium is dangerous. But our economy does know how to use them, up to a point. So they are resources for us. They are resources for us because of the way our economy is organized.

The organization of our economy is, as the marginal analysts say, a price system. (Like Oscar Wilde’s cynic, we economists know the price of everything and the value of nothing.) Every price is dependent on every other price in a delicately beautiful equilibrium. It is this balanced price system that allocates resources. If tomorrow morning some bright fellow comes up with a use for bluebird nests, the supply of and demand for them (the story goes) will set the price for them. Not only that, but as the demand for bluebird nests develops, the demand for some other things must decline. But other resources (including, sad to say, human resources) are shifted into the bluebird nest industry, restoring the equilibrium. Everything is properly allocated again.

Bluebird nests are now a resource, not simply because they are rare and a use has been found for them, but because they fit into the price system. That is crucial. The market does not so much allocate resources as tell us what resources are.

What, then, becomes of efficiency? It disappears. It is not separately discoverable, for resources are resources because the market says so, and their allocation is efficient only because the market says so. The market is not a better way of allocating resources; it is the only way. This is what the theory says.

Having said this much, it has uttered nonsense. If you really want to learn about resources and their allocation, you should go, not to Wall Street, but to someplace like World Watch Institute, which publishes an annual report called State of the World that explains the consequences of what we are doing and tells how we could do better.

Nonsense is always dangerous. The horror story that “The Market Knows” damages the ecosystem.  It also destroys economics itself, reducing the whole exercise to a defense of the status quo. True believers in the market apparently do not understand this, for they are very liberal (if you know what I mean) with advice about the sorts of issues we mentioned earlier – finding a way to make Exxon pay, restricting further exploitation of Alaskan oil, and so on. Yet these matters, as they now stand, are part of the present system. Changes in favor of the oil industry are no less an interference with the market than are changes in favor of the world and them that dwell therein.

Once any sort of change is admissible, every sort can be argued up or down. In the 1850s, Stephen A. Douglas proposed squatter sovereignty (allowing the territories to vote on slavery), which appeared to be impartial but actually favored the South. In their renowned debates, Lincoln forced Douglas to admit that slavery could be voted down as well as up. That won Douglas the Senate seat, but cost him the Presidency two years later. It would be lovely if we could come to understand the vacuity of squatter economics.

The New Leader

[2] Readers should see the upcoming link about “stealing a red-hot stove.”  The author attributes the quote to Lincoln but it was, according to Wikipedia, Thaddeus Stevens talking TO Lincoln.

Originally published May 6, 1985

TO WRITE THIS I had to turn off a television show featuring a rock star, eyes closed in rapture or agony or something, moaning an expression of his solidarity with the people starving to death in Africa. I should-and shall-leave the task of commenting on TV performances to Marvin Kitman. I  will even resist the temptation of recalling the Stan Freberg skit of a few years ago in which he asks everyone to stop at a certain hour of a certain day and tap dance for peace.

There is no question that our fellow citizens’ capacity for pity and terror has been stirred by the pictures they have seen of the starvation in sub-Saharan Africa. There is no question that they want to help in some way. It would be pretty to think of them beginning by wondering how the tragedy came about. For anyone ready to take that necessary initial step there is a new book available called Debt Trap: Rethinking the Logic of Development. Yes, I am afraid that to understand starvation in Africa you must start with money and banking, because they are the roots of the problem.

The author of Debt Trap is Richard Lombardi, a former vice president of the First National Bank of Chicago. His office was in Paris, a nice place to have an office, but he was in charge of lending in both French-speaking and English speaking Africa, and he traveled widely and steadily in those countries. What he saw troubled him deeply, for he is an intelligent and compassionate man. To think about the situation in greater depth he took a leave of absence and became a research associate and Thursday Fellow in Georgetown University’s School of Foreign Service. The result is his important and enlightening work.

Lombardi lays out the connection of starvation with banking roughly as follows: People starve because they cannot get food. They cannot get food because they either do not grow it or have no means of securing it from those who do grow it. In Africa they do not grow so much food as they used to, since many farmers have moved to the city and many more have switched to crops for export, like sugar and coffee and cola nuts. Their governments have induced them to switch to export crops to earn foreign exchange. The governments need foreign exchange to try (unsuccessfully) to meet the interest payments on their foreign loans.

Why do they have foreign loans? It comes down to Gertrude Stein‘s answer when she was asked why she had written Tender Buttons: “Why not?” As Lombardi tells it, the world’s big bankers bought the oil sheiks’ OPEC winnings on the Eurodollar market and then jet-setted around the Third World peddling the money. The bankers called this recycling; actually, it was salesmanship.

The bankers happened to launch their maneuver at about the time that the Third World nations, almost without exception, were in trouble with the World Bank and the International Monetary Fund (IMF). The bankers could offer assistance because they had money and also because they had a new vision-not of banking, but of what they came to describe as “world financial enterprise.” Lombardi credits (if that is the right word) this vision to Walter Wriston, who transmogrified the First National City Bank of New York into Citicorp in 1967. At any rate, the “Citicorp Concept” was reverently discussed in the business press and widely emulated by David Rockefeller‘s Chase Manhattan and the rest. The hairy details I’ll leave you to read in Lombardi’s book, only noting Wriston’s fatuous dictum, “But a country does not go bankrupt.”

The stage was now set. The Third World needed (or wanted) money; the bankers had it (or knew where they could get it). And the bankers had convinced themselves that all Third World loans were risk free. What happened? In 1960, Lombardi tells us, Third World debt totaled $7.6 billion. Today, a quarter of a century later, it is nearly $1 ,000 billion that is, $1 trillion, or an increase of roughly 12,000 per cent. The sum is not owed to the banks alone. UN agencies are heavily committed, as are our Export-Import Bank and its counterparts in other First World nations.

All of this occurred because those who count in both the First World and the Third World have been acting out what Lombardi (using an unlovely but fashionable word) terms a “paradigm.” Two components of the paradigm we have discussed here before: Ricardo’s Law of Comparative Advantage (How Our Sun May Rise Again,” NL, July 12-26, 1982), and the notion that a growing GNP cures all ills (“Sinking By the Numbers,” NL, May 2, 1983). A third principal component, perhaps not now so prominent as the others, is the theory of Walt Rostow (Lombardi erroneously calls him Walter) that developing societies invariably pass through five stages: “the traditional society, the preconditions for takeoff, the takeoff, the drive to maturity, and the age of high mass consumption.” A dream world.

In the grip of this paradigm, everyone began pushing the Third World to modernize and industrialize. The Export – Import Bank and its ilk underwrote sales of steel mills and sugar refineries and atomic energy plants. The national airlines of countries of fewer than a half million souls, most of them tribesmen with neither the need nor the possibility of flying anywhere, bought fleets of Boeing 747 jumbo jets. The World Bank lent money at low rates for roads and airports and dams and other infrastructure. The UN Development Decades favored an urban focus, precipitating a population shift from farm to city. The demand for agricultural exports accelerated the shift, because export crops tend to be more efficiently handled by agribusiness than by customary methods.

Under such prodding the Third World’s GNP rose even faster than the Development Decades had hoped. But Third World debt rose faster yet. This outcome, which should be a puzzle to true believers in the GNP, threatened to swamp the UN agencies. The IMF (then as now) counseled austerity, meaning cut imports (or, more frankly, reduce your standard of living) and expand exports (done by lowering wages and, again, your standard of living).

At that point in time (as Watergate taught us to say) the Citicorp Concept flashed across the horizon. Gone was the old-fashioned bankerly attempt to evaluate the business prospects of each enterprise applying for a loan. In its place was the actuarial notion that lots of risks are safer than a few. Risk itself disappeared because countries did not go bankrupt. Recycling could go on merrily as long as Third World countries could be induced to borrow money at a point or two over what the bankers had to pay for it on the Eurodollar market.

It turned out not to be difficult to induce Third World countries to borrow, what with everyone advising them to do so and especially with fewer and fewer questions asked. Lombardi has some horror stories to relate. A billion dollar steel mill in Nigeria is too sophisticated to use the low-grade ore it was originally intended for. Zaire has the longest transmission line in the world, and no particular need for it at either end. A loan to Costa Rica was underwritten by a banking syndicate on the basis of a news article in Time.

At least some of the borrowers were foolish like fox terriers. They didn’t bother to buy so much as a new presidential palace with the money, instead sending it straight to numbered bank accounts in friendly Switzerland. Periodically, statesmen who had that kind of foresight were overthrown, and their successors opened up their own numbered accounts. No one knows how many billions thus disappeared. The critical fact, however, is that the bankers lending the money didn’t care; they lent the money to countries, not to individuals, and countries don’t go bankrupt, even when they are stolen blind.

Of course, countries whose debts have increased 12,000 per cent in 25 years do usually have trouble meeting even the interest payments. So the IMP urges austerity; food is in short supply; starvation looms-chronic starvation, not the sort that results from a natural disaster.

LOMBARDI paints the unhappy picture with great fervor. He emphasizes that the Third World’s troubles are not merely those of an exploding population. The population problem certainly plays a role, but in the improbable event of zero population growth troubles would remain. The key is breaking that paradigm.

Lombardi suggests ways this can be done. He also shows the trouble the paradigm has caused and will cause in the First World-that is, to you and me. For when bankers lend money to Brazil to buy a steel mill or to Tunisia to manufacture blue jeans or to Taiwan to keypunch data into American computers via satellite, Americans lose their jobs.

The apostles of the Law of Comparative Advantage (a.k.a. “free trade”) counter that building the Brazilian steel mill and the Tunisian garment factory and the Taiwanese data-processing equipment makes jobs for Americans, and to a degree they are right. An hour or two at, say, John F. Kennedy Airport in New York will convince you that Boeing has sold (with Export-Import Bank help) an awful lot of747s to foreign airlines you never dreamed existed. Still, unless we are prepared to give our airplanes and steel mills and wheat and corn away, someone has to pay for them-that is, the loans the bankers have made for us have to be paid off. If they can’t be paid off, our friendly bankers will surely find ways to transfer the bad debts to us taxpayers. And if they are paid off, Third World austerity programs will throw Americans out of work. “When bank credit to Mexico stopped in 1982,” Lombardi observes tellingly, “more jobs were lost in the following six months in the United States than in the three previous years of a depressed U.S. auto industry.”

Banking, in short, is not an innocent enterprise. It can cause starvation in the Sudan and unemployment in Cincinnati. Faulty practice flows from faulty theory. Faulty banking theory flows from faulty reading of history. Lombardi devotes several chapters to this question, and though I don’t always agree with him (in particular, I think he misunderstands evolution), I certainly applaud his effort. I therefore earnestly commend his book to your attention.

A useful supplement to the foregoing is The Dangers of “Free Trade, a new booklet by Professor John M. Culbertson of the University of Wisconsin-Madison. Culbertson details the mischief caused in both the Third and First Worlds by the Law of Comparative Advantage, then suggests new trade policies suited to the actual situation of the actual world we live in. He makes a strong argument for conducting international trade between nations (rather than between private citizens or firms), and he makes a persuasive case for bilateralism (showing that he’s not afraid of unconventional thoughts).

The New Leader

Originally published December 26, 1983

A DELUSION appears from time to time in philosophy whereby appearance and reality are so separated that, as Charles Peirce observed, their connection is like that of a freight train held together only by a feeling of good will between the engineer and the brakeman in the caboose. A corresponding delusion suffered by many economists is that there is a real economic world underlying the actual one in which we live and have our being.

Classical economists are especially prone to talking about the real world rather than the actual one. They investigate the “real” GNP, not the “nominal” GNP (the quoted terms aren’t the same as those of medieval philosophy, but they give rise to similar difficulties); real interest rates, not nominal ones; real wages, not money wages: These investigations seem sensible and down to earth. Money, after all, is only good for what it can buy.

It was one of the marks of John Maynard Keynes‘ genius that he saw through at least some of the confusion this causes. At the very start of The General Theory, he showed why labor is concerned with money wages, not with real wages, to the bewilderment of classical economists. “Since there is imperfect mobility of labor,” he explained, “and wages do not tend to an exact equality of net advantage in different occupations, any individual or group of individuals who consent to a reduction of money wages relatively to others will suffer a relative reduction in real wages, which is sufficient justification for them to resist it.” He noted further that no specific wage negotiation can have a great enough effect on the general price level to make the latter worth considering by either party. High wages in Detroit have a slight and remote effect on the prices of the food and clothing automobile workers (and automobile magnates) buy.

Conservative businessmen nevertheless argue for “reality,” and not only in labor negotiations. Thus we hear much talk about the real interest rate, and how – regardless of what you thought when you talked with your friendly banker about a loan – until recently it was very low, or even negative. The nominal interest rate is what the banker was going to charge you; the real rate is generally determined by subtracting the rate of inflation from it (Keynes reasonably thought the deduction should be for future inflation, but that is obviously a guessing game and so not properly scientific).

If in 1980 you screamed when your banker reluctantly offered you a 16.5 per cent mortgage, he could sweetly point out to you that, what with inflation then running at 13.5 per cent, he was really asking you for only 3 per cent (plus, naturally, several mysterious fees and “points”). Moreover, if your tax bracket was, say, 30 per cent, he probably noted that your tax deduction for interest paid would amount to almost 5 per cent, putting you ahead of the game. You may have wondered who was keeping score.

The competing architects of the mishmash that is Reaganomics are agreed that your banker was correct in his reasoning. Messrs. Martin Feldstein and Donald Regan, Paul Volcker and Jack Kemp, all chant in unison that the economy suffers because rich people don’t have enough incentive to save. In particular, they don’t make long-term investments because they fear that when they get their money back it won’t buy as much as it does today. (The few I know seem to fancy buying extra condos here and there, and that seems like a long-term investment to me, but let that pass.) At this writing, when the real interest rate as calculated by your banker is at an all-time high, those with money to lend are (they would be shocked to learn) following Keynes in allowing not for present, but for future, inflation, which they evidently guess will increase.

Here Reaganomics has a stock answer: Make the rich richer. Considering what has been done so far, it’s hard to imagine what remains to be done, yet we need not doubt that pressure will be steady to reduce taxes in the higher brackets and to reduce income in the lower.

The anonymous White House and the palpable Representative Kemp (R-N.Y.) say in addition that the Federal Reserve Board should reduce the interest rate. Chairman Volcker replies that he could do so for a short while by increasing the money supply, but that resulting fears of inflation would send the long-term rate through the roof and would soon drag along the short-term rate, too. In brief, it is argued that the lenders’ search for real interest would make the nominal interest rate too high for anyone to borrow. Even though we may not like what is being done to us, it is for our own good.

T O CHECK on this argument, we must look a little more closely at the meaning of “realism” in economics. Does it in fact make sense to disregard money values and concentrate on real values? I will say that it does not.

In the actual world, where we do our actual buying and selling, it is money values that we do – and should – pay attention to. Keynes satisfied his tastes for old books and new paintings by speculating, mainly in commodities and currencies. He used his winnings for (among other purposes) buying paintings at the Degas auction in 1918. The real value of the paintings he bought for himself and urged others to buy was not about to change and, by definition, could not change. But the money value, as he anticipated, changed dramatically. He needed money to pay the money price for the paintings before it went up; the real values of either commodities or paintings had nothing to do with the case.

And of course it is impossible to say what the real value of those paintings was or is. Some of them I’d not give house room to, except for their sentimental association with the great man who once owned them. As far as the Consumer Price Index (CPI) or the GNP Deflator is concerned, the value of the paintings is nil. They don’t count; and to value them in terms of Smith’s or Ricardo’s or Marx’s labor theory would be ridiculous, as it would be ridiculous to attempt to apply Keynes’ wage unit to them. Since there is no way of saying what their real value is, it seems quixotic to insist that they have any in economic terms.

Nor are the paintings unique. The market basket of the CPI includes many items I would not give house room to and many others – entertainment, for example – that can be connected with a labor theory of value, or with any other “reality,” only by dint of the most laborious of gyrations. A theater ticket can be counted in the CPI because it is bought, that is, because it has money value. What its real value may be is beyond calculation.

The mere fact that the CPI is not the all-purpose market basket for all seasons, and that other indices (including many of the same items) have to be devised, indicates that the alleged reality shifts as the sands. In any event, like Keynes with his paintings, I need money to buy the things I want out of the baskets; and the more money I have, the more things I can buy. Regardless of the rise or fall of real values (whatever they might be thought to be, and however they might be determined), I’ll be able to buy more if I have more money. Why then should I not join other workers in resisting a reduction in my money wage?

In this I am no different from the investor (or speculator) who resists a reduction in money interest. Regardless of the so-called real rate, his choice is between the money rate and nothing at all. Like the unfaithful servant in the parable, he can bury his money, but that won’t help him. Or he can spend it, and that will help the economy. But if he wants to invest, he’ll have to follow the money rate of interest. In the end, he will compare the results of various investment strategies in accordance with the amounts of money they earn. Realism has nothing to do with it.

The New Leader

Originally published November 14, 1983







A FRIEND has taken exception to my proposal to limit or forbid the importation of foreign manufactures that threaten to destroy important domestic industries because of low prices based on the exploitation of local labor (“The Way to Protect,”November 14, 1983 NL, September 19). He says his freedom would be unacceptably abridged if he couldn’t buy a Japanese automobile, because he thinks they are better made than ours. He doesn’t deny that Americans are thrown out of work when our industries are shipped abroad, but he is confident that their distress is only temporary and perhaps not altogether undeserved. Besides, he objects to the word “exploitation” as old-fashioned rabble-rousing.

Two questions are mixed together here. The first I find difficult to take seriously. It is nowhere writ – not in the Bill of Rights, not in the Magna Carta, not in the Sermon on the Mount, not in the Code of Hammurabi – that my friend has a right to buy a Subaru, no matter how well it may be made. For various pragmatic or prudential reasons, the government will not interfere with his use of money except reluctantly and after due reflection; yet many uses are now routinely denied him, and there is no use that cannot, in principle, be denied. Money is, after all, a social, not an individual, creation. The issue is not whether denial is legitimate, but whether denial in this particular case is reasonable.

The other question is one of fact. In setting forth my proposal, I specified two steps that would have to be taken before barring a given import: “First, we decide that certain of our important industries are threatened in our home market by severe competition from foreign industries. Second, we determine whether that threat is made possible by wages or conditions that we would consider “exploitative.”

Now, whether these conditions apply to Subaru or not can readily be determined. I repeat: It is a question of fact, not of theory. For the purposes of our argument, my friend conceded that the conditions do apply, and that thousands of Americans in Detroit are thrown out of work because of Japanese labor policies. He nevertheless maintained that in the long run not too much suffering would be caused by the collapse of the American automobile industry; and that if suffering is caused the way to alleviate it is directly through the dole, not by forbidding the importation of Subarus.

I’m afraid that no doubt exists about the suffering, and it is by no means confined to the automobile industry. As I have previously said, as long as the American standard of living is higher than the Oriental standard of living, there is nothing whatsoever that cannot be manufactured more cheaply there than here. This goes for high-tech industries even more than for smokestack industries, because the technology of the former is in fact simpler and the capital requirements less extensive.

Nor is there any doubt that very little of the suffering we have so far seen will be alleviated by the so-called recovery. What’s going on now does not fit into the late Joseph A. Schumpeter‘s theory of new industries – ” railroad construction in its earlier stages, electrical power production before the First World War, steam and steel, the motor car, colonial ventures” – Ieading the upswing of fresh business cycles. The only new industry now on the horizon is high-tech, which, as noted, is high-tailing it for the Orient, and is not a big employer anyhow. For this reason, all the vague talk of retraining the millions of our unemployed fellow citizens is cruel nonsense. Retraining for what?

My friend is a compassionate man and is willing to consider the problem. Like Mr. Micawber, he expects something to turn up, but in the meantime he is willing to institute the dole (he is not a Reaganite) and to pay for it with a progressive income tax.

I am not one to say that it could not be done. Indeed, I say that it should be done. It is little enough. A dole at the poverty level might seem a bonanza for a part-time textile worker; it is a disaster for a veteran automobile worker who has saved a little money, started a family, bought a house, and nurtured the American dream. If, as some tell us, he was overpaid, then the dream was a fraud.

That is one side of the problem: the unconscionable cost to American workers of my friend’s assumed right to buy a Subaru or a Hong Kong sports shirt. The other side is the cost to my friend in taxes. Being in thrall to classical economics, he wants to balance the budget. At present rates, the Federal income tax raises about $285 billion, leaving a deficit of about $200 billion. A poverty-level dole would cost another $100 billion; a halfway decent dole would be double that. Thus to do what my friend wants to do would require income taxes one and a half times (if he doesn’t balance the budget) to two and a half times (if he does balance) those now in force. A flat tax at that rate of increase, let alone a truly progressive tax, would be a lot to pay for a Subaru. And millions of our fellow citizens would be condemned to aimless, hopeless lives.

Against this dreary scenario, my friend raises the specter of the Smoot-Hawley Tariff, sponsored by reactionary Republicans in 1930 and ever after blamed by junior high school civics texts for the Great Depression, the rise of fascism, World War II, the Cold War, and innumerable minor irritations. The analysis doesn’t rise even to the level of post hoc ergo propter hoc[1], for the Great Depression was already well under way when Smoot-Hawley was passed, while fascism had been in power in Italy for eight years, and was rapidly growing in Germany.

An interesting thing about Smoot-Hawley is that its original impetus came from distress on the farms. Although by the time the bill was passed, duties were raised on almost everything under the sun, the presenting complaint in President Hoovers call for a special session of Congress was largely agricultural. Today there is again distress on the farms, but its cause is different. This time no one is underselling us in our domestic market, or in our international market. The trouble, instead, is that the Poles and others who want our wheat haven’t anything to pay us with. (Except, my friend says, golf carts: Would you have believed that almost all carts on American golf courses were made in Poland?) The Poles have coal for sale, but so have we-and so do the Germans, the French, the Belgians, the British; (One of the “reindustrializing” schemes that has been advocated and, for all I know, implemented involves rebuilding the port of Norfolk to facilitate the export of coal to God knows whom.)

Since the Poles can’t pay us for our wheat, we had to fall back on our ingenuity. The solution was simplicity itself: We lent them the money. Partly we lent it as a nation through the Export-Import Bank, and partly we had it lent for us by our friendly bankers. Of course,

Chase and Citibank and the rest didn’t exactly use our money; they used the Arabs’ money, deposited with them because of the high interest rates the Federal Reserve Board encouraged, allegedly to fight inflation. Just as bankers become unwitting partners of debtors to whom they lend too much money, however, we as a nation have become the unwitting partners of the banks that now have shaky foreign loans far in excess of their assets[2].

THE UPSHOT of all this is that we the people of the United States will in effect pay our farmers for the wheat that is in effect given to the Poles. I have nothing against the Poles, but it occurs to me to wonder why it is better to give our wheat to them than to poor fellow citizens, whom we expect to feed themselves on a supplement of less than a dollar a day. Charity should no doubt be world-wide, yet it should certainly begin at home.

The result of the banks’ loans to Brazil et al. in many ways is worse. The Brazilians invested the money (which, you will remember, couldn’t be lent to New York City because it was a “bad risk”) in building up their industry, particularly steel. Thanks to their low wages, they are now driving American steel out of the world market and to a considerable extent out of the domestic American market. To repay the loans, though, Brazil has to export still more steel and import less of whatever it imports. It must adopt what the bankers and the International Monetary Fund (IMF) aseptically refer to as austerity measures. This means reducing Brazil’s standard of living, and consequently paying its steel workers even less than at present.

If the bankers’ scheme succeeds, by no means a certainty, additional American steel workers will lose their jobs. Should the scheme fail, the banks will come crying to Uncle Sam to bail them out (they’re already lobbying for an increase in our contribution to the IMF), and we will in reality have given Brazil the steel mills that are destroying our industry and putting our fellow citizens out of work.

A very high percentage of foreign trade follows the patterns I have outlined, distorting economies everywhere to the principal benefit of bankers. There are, naturally, many things we want or need to import; oil (because we are too witless to cope with our energy requirements), tungsten, chrome, bauxite, coffee, and there are many things we can, without special government assistance, export to pay for them. But the necessity, or even the desirability, of foreign trade has been grossly oversold.

Trade is one of the modes of civilization (that is what makes economics a humanistic-and ethical-discipline). Trade also adds to wealth – the wealth of individuals, of nations, of the world. It does this by increasing and rationalizing employment, for wealth is the product of work. When trade expands employment for both partners, the prosperity of both is advanced, and David Ricardo’s Law of Comparative Advantage (see “How Our Sun May Rise Again,” NL, July 12-26, 1982) can be said to apply. Conversely, when trade brings about unemployment for one of the partners, its advantage disappears. Trade will always result in some unemployment in a competitive situation, and the unemployment will be compounded where the competition is based on gross wage differentials. If Japanese citizens were to buy up the output of Korea’s nascent automobile industry in preference to Subarus and Toyotas, Japanese wealth would be decreased, and you may be sure that the Japanese government has imposed effective restrictions.

Microeconomically – that is, company by company-foreign trade can be very attractive. Once a company is successful in its home market – factories built and paid for, experience gained – it takes little extra effort to open an export business, and economies of scale will make that business extraordinarily profitable at the margin, especially when stimulated by tax incentives. The profitability of multinational conglomerates is enhanced by their ability to manufacture where wage scales are the lowest (and declare their profits where taxes are the lowest).

When we shift from microeconomics to macroeconomics – from firm to nation – we find (as we frequently do in such shifts) that we have committed the fallacy of composition. What is good for each firm individually is not necessarily good for the nation. In the circumstances we have been discussing, some (not all) American exports are being paid for by us in the shape of high interest rates that inordinately benefit a few, and we will doubtless bear the further cost of rescuing banks in danger of failing. On the other side, some (not all) American imports are being paid for by individual citizens in the shape of shattered prospects and grinding poverty.

These outcomes are not divinely ordained. They are the result of policies deliberately, albeit perhaps blindly, adopted. If this be rabble-rousing, as I told my friend, make the most of it.

[1] A logical mistake which assumes that when things happen in a sequence that means that the second event was dependent on or caused by the first.

[2] Reading this in 2012, post the late 2000’s mortgage fiasco, I can change this sentence by replacing “shaky foreign loans” to “shaky mortgages” and not have missed a beat.

Originally published February 7, 1983

A CURIOSITY of economic thought is its frequent dependence on what economists call psychology. My choice of words is deliberate, for what economists call psychology has only the most casual relation to what psychologists call psychology.

Examples appear on almost every page, certainly in every chapter, of all the great practitioners, from Adam Smith to the present. The latest economics fad (“Rational Expectations“) is based on concepts that pretend to be psychological. My favorite example – favorite because it comes from the work of the greatest economist of this century – will be found on page 96 of The General Theory of Employment, Interest, and Money by John Maynard Keynes.

“The fundamental psychological law,” Keynes writes, “upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.”

Of a lesser man than Keynes one might be tempted to say that he wrote so emphatically because he was aware his evidence was so slim. In any case, one may scour all the psychology textbooks in the land and read with close attention the 24 volumes of the Complete Psychological Works of Sigmund Freud, not to mention the writings of everyone from Erik Erikson to B.F. Skinner and even as far out as Noam Chomsky, and one will never find the faintest adumbration of this allegedly dependable psychological law.

The most familiar example of economists’ use of a purported psychological law is of course the profit motive. Psychologists talk of motives from time to time, but never of this one, while economists – especially conservative and radical economists – sometimes seem to talk of little else. One wonders, therefore, what it is that economists are trying to say, and why they should be trying to say it in this particular way.

The profit motive turns out, on examination, to be truly protean. I obviously am not interested in money this minute, so I must be scheming to get it eventually. Or I find prestige profitable. Or I get my kicks from being praised for doing good, or even from actually doing good. Or I yield a little to the proletariat today to forestall the revolution tomorrow. Or I mistakenly think I’m turning a profit when I’m barely keeping up with inflation. Or I believe I’ll be richly rewarded in heaven.

The only way the profit motive can be maintained at all is by pretending that everything is in some way profitable. What explains everything, however, explains nothing in particular. And if there is no way I can avoid being motivated by profit, then it follows that there is no way you can motivate me: I’m already motivated. You may try to disillusion me about my chances of heaven, but only by convincing me of the relevance of some other version of the motive. You can’t free me from, or stimulate me by, the profit motive itself.

Economists nevertheless stay the course, so to say, with motives because this procedure has a certain advantage. Writing nine years before The Wealth of Nations, Sir James Steuart observed that the “principle of self-interest” is the “only motive which a statesman should make use of, to engage a free people to concur in the plans which he lays down for their government.” Otherwise, he explained, “the statesman would be bewildered,” for “Everyone might consider the interest of his country in a different light.” Restricting one’s inquiries to matters that aren’t bewildering is a little like the vaudeville wheeze about the drunk looking for his lost wallet at the street corner because the light was better there. But it is more than that: It is an effort to establish an impersonal foundation for economics.

Establishment of this impersonality was the great achievement of Adam Smith, whose work swept Steuart’s into near-oblivion. Smith’s “invisible hand” was a truly world-historical idea: It changed the world. Its first appearance is worth quoting in extenso:”

“By preferring the support of domestic products to that of foreign industry, [every individual] intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. By pursuing his own interest he frequently promotes that of society more effectually than he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants,” Smith adds drily, “and very few words need be employed in dissuading them from it.”

There are several aspects of this passage that may be astonishing. First, it comes not at the beginning of the book (where Smith put his famous analysis of the division of labor) but halfway through it, an incidental point in an argument against import restrictions. Second, it is not stated as an immutable rule (Nor is it always the worse …” frequently” “I have never  known much good … “). Third, it is based on merchants’ preferences (which no longer exist, if they ever did) for domestic over foreign products. Fourth, it is connected with the rest of economics only as an afterthought (“as in many other cases”). Yet the invisible hand shook the world.

Smith’s less metaphorical, and perhaps as often quoted, statement of the idea comes some 225 pages further on: “… the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest in his own way, and to bring both his industry and capital into competition with those of any other men or order of men.” That appears at the end of an attack on the physiocrats. But this time Smith goes on to state explicitly the factor of the idea that gave it its historical power: “The sovereign is completely discharged from a duty … for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of society.”

Thus the regularity of the profit motive became a lever to pry from the backs of mankind the age-old oppressions of sovereign lords. It was as liberating an idea as Copernican heliocentrism or the Newtonian laws of motion, which, by making the natural universe regular, freed mankind from intimidation by priestly revelations.

For two centuries economists have searched for and disputed over impersonal economic laws: from Say’s Law that “the creation of one product immediately opens a vent [demand] for other products” and Ricardo’s Law of Comparative Advantage (see “How Our Sun May Rise Again,” NL, July 12-26, 1982) to the Phillips and Laffer Curves (both now discredited) and other contemporary marriages of active imaginations with analytic geometry. Marx joined in the search: “It is not,” he writes in The Holy Family, “a matter of what this or that proletarian or even the proletariat as a whole pictures at present as its goal. It is a matter of what the proletariat is in actuality and what, in accordance with this being, it will historically be compelled to do.”

What was launched in search of freedom from arbitrary domination has paradoxically come aground on sociohistorical compulsion.

IN THE MEANTIME there are other consequences of the reliance on universal motivation, particularly profit motivation. Though this motive must become, as we have seen, protean in definition, it is construed narrowly in application. The argument goes that since men do things only for profit, the way to get them to do things is to make the doing profitable – to quickly and lavishly reward with money. This has always been the rationale of conservative economics and is by no means the invention of George Gilder or of Reagan, Regan or Kemp. What follows, of course, is that greed becomes a virtue.

That is a terrible notion. It is also a terrible choice as the ground of public policy; if you encourage greed, you will surely discover a great deal of it hitherto hiding under stones. Greed is, moreover, in the end an ineffectual basis for public policy. That is to say, it is ineffectual if your ultimate aim is something other than more greed. It is simply not true that most men and women are mostly motivated by greed. So when you try to run your economy on greed, you are running on a very few cylinders. We’re now experiencing how badly this works.

Similar inefficiency will plague you no matter what motive you select to base your economics on. A universal instinct of workmanship is as formless as universal greed. Motives are as individual as the individuals alleged to be motivated. A person’s motives are what he says they are. Gandhi was not out to make a buck; and if you charge him with hypocrisy because your theory says that everyone is out to make a buck, you lay yourself open to the same charge. And if disinterested discourse is thereby foreclosed, it becomes impossible to claim valid impartiality for any statement, including the original proposal of universal motivation. The rest is silence.

Motivation is the wrong idea, anyhow. It suggests what people do automatically, what they are programmed to do, what they “really” do. ‘Insofar as psychology inquires into such doings, it is no longer a suitable foundation for political economy. It played a necessary role in freeing us from the divine right of kings. The issue now, though, is not freedom from but freedom for. Our problem is not psychological but moral. It is not a question of determinism but of determination. As one of the prolegomena to any future economics, one can say that its task will be the discovery of conditions for free and responsible action[1].

The New Leader

[1] In this article, and especially the closing paragraphs, one can see the precursor to the arguments made in The End of Economic Man

Originally published September 20, 1982

Dear Editor

Oriental Labor|

The apparent clincher in George P. Brockway’s “How Our Sun May Rise Again” (NL, July 12-26) is his rhetorical question about explaining “the steadily increasing prices of electric irons and TV sets and cameras and automobiles, despite their being produced in the allegedly more efficient and assuredly lower wage Orient.” Steadily increasing compared to what? All the items he mentions have had small increases in price over the years relative to either the overall price level or disposable income.

Consider the following data on average annual increases from the end of 1970 to the end of 1971: Disposable income climbed 10.2per cent and the consumer price index for all items rose 8.1 per cent. Meanwhile, the prices of new automobiles and footwear went up only 5.1 per cent; household appliances, 4.8 per cent; apparel, 3.8 per cent; and television sets, a scant 0.3 per cent. All these are consumer goods that were heavily affected by imports from East Asia, especially the last two items. The answer to Brockway’s question is that his factual premise is all wet, not for the first time.

Brockway is also careless in describing the theory he sets out to overturn (by assertion). Like other valuable insights, the principle of comparative advantage was elucidated somewhat imprecisely by its formulator, David Ricardo, and has been refined in the 165 years since 1817. The principle does not depend on the trans-national immobility of capital. It is valid as long as some factors of production are geographically immobile to some extent: physical capital, mineral resources, skilled labor, entrepreneurial talents, whatever. Clearly, such immobilities are ubiquitous, otherwise there would be no differences in wages and other returns to factors of production among nations or among the regions of one nation. (The principle, pace Ricardo, does apply within a single country.)

Ricardo would not have discarded his law, nor would he have been as pessimistic as Brockway is about the American capacity to come up with “sunrise” industries. More likely, he would have remarked upon our repeated success over the years in replacing “sunset” with “sunrise” industries. To be sure, the international transmission of industrial knowledge and skills, as well as capital, is swifter than it was in the past. But that swiftness tends to raise, not lower absolute standards of living here “and elsewhere, although it reduces the disparity among industrialized countries’ standards of living, which is a good thing, not a bad one.
New York City

Urban Research Center
New York University

 George P. Brockway replies:

 Dick Netzer is agile at the old debater’s trick of answering resoundingly a question different from the one asked. When I said that various items produced in the Orient are steadily increasing in price, I meant precisely that. Netzer says that their prices haven’t gone up so much as disposable income, which is another question. Since his statistics, if they prove anything, prove my point, I’ll refrain from questioning his choice  of dates or inquiring into the effect of shifting exchange rates or comparing the behavior of the prices of American-made versions of these products  with those of the same products produced in the Orient.

As to the history of the Law of Comparative Advantage, I certainly do not question that refinements have been made in it since David Ricardo formulated it 165 years ago. As a practical matter, however, these are beside the point: The present putative Oriental advantage is the result of cheap labor and often unsafe working conditions. (Chinese doctors are good at reattaching chopped-off fingers and arms, because they have so much practice at it.) It would be dishonorable to treat American workers as Oriental workers are treated, and it is dishonorable to throw our citizens out of a job in furtherance of Oriental exploitation.

The Ricardian argument, moreover, implicitly requires that workers displaced by the transfer of their industries abroad will immediately find comparable positions in industries that (for some reason the theory cannot explain) stay home. My factual premise, which Netzer  unaccountably thinks is “all wet,” is that millions of Americans are out of work because we have exported their jobs, and that billions of ‘dollars’ worth of American plants are standing idle because we have exported their industries.

It may be that, as Netzer says, I am too pessimistic about the prospect of coming up with sunrise industries to replace sunset industries. If the real world were as optimistically fast-paced as he pretends, I should think he would at least have suggested a few sunrise industries to relieve my gloom. And I’d dearly love to have him explain why certain industries are sunset here but sunrise in the Orient, unless the difference lies largely in wage scales and working conditions.

Finally, I must diffidently point out that the rhetorical question Netzer has tried unsuccessfully to answer is only one of three that I asked, and the least important at that. And I really must object that I did not and would not rely on a rhetorical question in the middle of my essay as a “clincher.” I have more respect for my readers than Netzer allows.

Originally published July 12, 1982

A NOTE IN Thomas Balogh‘s stimulating new book, The Irrelevance of Conventional Economics, tells the following story: When Professor Paul Samuelson was asked by a Harvard mathematician to name “one proposition in all of the social sciences which is both true and non-trivial,” he confessed that this was a test he always failed. “But now,” Samuelson wrote, “some 30 years later … an appropriate answer occurs to me: the Ricardian theory of comparative advantage; the demonstration that trade is mutually profitable even when one country is absolutely more or less productive in terms of every commodity.”

The anecdote is worth attending to because the so-called Law of Comparative Advantage is the foundation of most arguments for free international trade, and the dogma has been sanctified by practically all economists, liberal or conservative. The law thus provides at least part of the justification for deeds such as GE’s closing an electric iron factory in California and replacing it with one in Singapore (see “America’s Setting Sun,” NL, June 14).

As expounded by David Ricardo in The Principles of Political Economy and Taxationone of the half dozen most influential books in the history of economics-the law develops like this: Suppose (there goes an economist imagining things again!) that a certain amount of wine exchanges for a certain amount of cloth. Suppose that in England it would take a year’s labor of 100 men to make the cloth, and of 120 men to make the wine, while in Portugal the man-years required are 90 and 80, respectively. In these circumstances, it would be to Portugal’s advantage to make only wine and England’s to make only cloth, with the countries then exchanging the surpluses: Portugal would multiply its wine output 2.125 times ([90 + 80] ÷ 80), and England its cloth production 2.2 times-and since the cloth and the wine are equal in value, both countries would come out ahead.

I say that the law is false in the modern world, however, and I say that Ricardo knew why [editor’s emphasis]. “Such an exchange,” he observed, “could not take place between individuals of the same country. The labor of 100 Englishmen cannot be given for that of 80 Englishmen, but the labor of 100 Englishmen may be given for the produce of the labor of 80 Portuguese, 60 Russians, or 120 East Indians. The difference, in this respect, between a single country and many, is easily accounted for, by considering the difficulty with which capital moves from one country to another, to seek a more profitable employment, and the activity with which it invariably passes from one province to another in the same country.”

Ricardo went on to declare that “feelings, which I should be sorry to see weakened, induce most men to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign countries.”

What Ricardo could not foresee, and what his modern followers have overlooked, is that the new multinational corporations fail to share the feelings of patriotism or indeed of prudence that he ascribed (somewhat naively even in the 19th century) to the capitalists of his time. Today capital flits freely from here to there, moving as indifferently from the United States to Singapore as it did in Ricardo’s day from London to Yorkshire.

The results of this movement are neocolonial exploitation in the Third World and spreading unemployment in the industrial West, leading in turn to Reaganomic doctrines of lower wages, less concern for worker safety, disregard for the environment, and abandonment of consumer protection. Teenage girls now making electric irons in Singapore, though exploited by our standards, may be better off for the moment than they were before GE hired them. But the mature American men and women who lost their jobs when GE abandoned its plant in California are irremediably worse off. Many-perhaps most-of them, having worked with reasonable faithfulness (at least matching that of GE toward them) for 15-20 years, may never find a comparable job as long as they live.

This sort of thing is happening every day in what Lester C. Thurow calls “sunset” industries, and if you believe in the Law of Comparative Advantage, you see nothing wrong with it. Singapore produced irons will be (possibly) less expensive than California-produced irons, and American capitalists and consumers may benefit even though American workers will certainly suffer. We now have a good many” sunset” industries: textiles, steel, shipbuilding, electronics, optics, and of course automobiles. We also have 10 million unemployed.

Professor Thurow fears that our whole economy, except for service industries and agriculture, will be shipped abroad. He proposes a massive national R&D effort to identify “sunrise” industries and to channel investment into them. It would, he says, be better to underwrite the development costs of such hopeful undertakings than to shore up doomed firms like Lockheed and Chrysler. The professor points, too, at the Japanese experience, claiming that Japanese prosperity results from just such cooperation among big government, big finance and big business (in Japan there is no such thing as big labor).

The Japanese model gives me pause. I wonder what is to prevent the Japanese from moving into our new “sunrise” industries. The challenge comes not just from the Japanese, I hasten to add: GE and dozens of other multinationals are as American as apple pie; yet the effect on American workers of their operations in Singapore and Taiwan and Mexico is in no way different from that of Toyota and Panasonic. It was not so many years ago that we had a “sunrise” industry making TV sets and today that sun is slipping into the western ocean. I can’t see why the yet-to-be-invented “sunrise” industries won’t suffer the same fate in due course. As Ecclesiastes had it: The sun also goeth down.”

So what is to be done? Well, nothing, according to the Law of Comparative Advantage. Its adherents may drop a tear for GE’s former workers in California and sigh at the wasteful abandonment of the Ford plant in Mahwah. But they steadfastly accept these disappointments, secure in the stern faith that the long-run result will be lower prices and hence a higher standard of living for American consumers.

Three questions occur to me. First, how long will the run be? Second, how will unemployed American consumers get the money to pay the promised lower prices? Third, how do you explain the steadily increasing prices of electric irons and TV sets and cameras and automobiles, despite their being produced in the allegedly more efficient and assuredly lower-wage Orient? I leave the questions rhetorical.

Discard Ricardo’s law, as he surely would have done, and you may find it is precisely at this point that the Japanese have something to teach us. A much complained-of fact is that it is exceedingly tough for American firms to establish branches in Japan or even to obtain Japanese import licenses. This is partly bureaucratic bungling, partly preserving foreign exchange for essential imports, and partly requiring foreigners to produce goods in the Japanese way if they want to sell them in Japan.

These matters, it is important to notice, have little to do with tariffs in the usual sense. What is being protected is less Japanese fledgling industry than customs, and the Japanese don’t propose to allow them to be corrupted for any number of pieces of silver. As has long been noted, tariffs inefficiently shield new or weak industries. Import regulation, on the other hand, does help preserve a national way of life.

THIS IS a very sound approach, and one that we have taken as well, albeit not always for the right reasons. President Eisenhower, for example, restricted the importation of oil in the mistaken belief (yes, I credit him with having been merely naive) that he was protecting a war industry (our war-making ability would rather have been enhanced by keeping our oil in the ground and using foreign oil in peacetime). An accepted provision of Cordell Hull‘s Reciprocal Trade Agreements bans products that are “dumped” -that is, sold at a loss. And we quite reasonably refuse entry to automobiles that do not meet our safety standards, to drugs we judge to be harmful, to beef from cattle we believe to have been infected with hoof-and-mouth disease.

In short, we have long acted to protect Americans as consumers and Americans as entrepreneurs. If we protected Americans as workers in the same way, we’d have less trouble with “sunset” industries.

It is easy to foretell that multinational corporations will fiercely resist giving up the American market for products manufactured cheaply abroad. Moreover, they will succeed in mobilizing some consumer organizations and doctrinaire free-traders in their behalf.

There will also be those who worry, quite properly, about employment in the Third World. The reply here is that to break out of their underdevelopment, the nations of the Third World will have to encourage trade among themselves. If goods manufactured in the Third World had to be sold there, the multinationals would be constrained to produce what the Third World needs (maybe neither irons nor calculators) at prices it can afford. That way lies increasing prosperity, instead of neocolonialism and permanent poverty.

From our point of view (which is the only basis for our legislation), it is futile to try to prevent the flight of American capital abroad even if we wanted to. It would be easy to avoid the concomitant harm done to American workers, though, and to stop encouraging the flight of capital. Such protection would be no harder to handle than present regulations about drugs and diseases.

Unless we come to understand that the Law of Comparative Advantage no longer holds, and unless we therefore do something to protect American working men and women-in other words, us-we can expect industry after industry, no matter how thoroughly researched and comprehensively planned, to vanish with the setting sun. And as we continue to force additional millions of our fellow citizens onto the relief rolls, we can expect our standard of living to fall steadily lower among the industrial nations of the world.

The New Leader

Presented at Brigham Young University by George P. Brockway
March 3, 1988

Let’s start with a story. Professor Paul Samuelson tells us that several years ago, when he was asked by a Harvard mathematician to name “one proposition in all the social sciences which is both true and nontrivial,” he confessed that this was a test at which he always failed. “But now, some thirty years later, he says, “on the staircase, so to speak, an appropriate answer occurs to me: the Ricardian theory of comparative advantage; the demonstration that trade is  mutually profitable even when one country is absolutely more or less productive in terms of every commodity.

If Professor Samuelson is right, there is no point to this conference. Foreign trade goes on the way it does because of the law discovered by David Ricardo less than two centuries ago. While subject to refinement and correction, as is any scientific law, it is nevertheless immutable in the sense that we poor mortals cannot repeal it.

Most economists consider their discipline a science on the model of physics. There is nothing good or bad about “S = ½ gt²”; that’s the way the natural world works regardless of our feelings on the ethics of falling bodies. Even when Aristotle, two millennia before Galileo, had an entirely different theory, no one thought ethics had anything to do with it. And most economists hold that there’s nothing good or bad about the law of comparative advantage, which, they say, is the way the economic world works, regardless of our feelings and intentions.

Let us consider this remarkable law in three ways: historically, empirically, and morally.

First, what is the law? Ricardo explained it this way: Suppose that a certain amount of wine exchanges for a certain amount of cloth. Suppose that in England it would take a year’s labor of 100 men to make the cloth, and of 120 men to make the wine, while in Portugal the man-years required are 90 and 80 respectively. In these circumstances, it would be to Portugal’s advantage to make only wine and England’s to make only cloth, with the countries exchanging the surpluses. Portugal would multiply its wine output 2.125 times, and England its cloth production 2.2 times; and since the cloth and the wine are equal in value, both countries would come out ahead, as follows:

Table I

Men per Cloth


Product per Man

Total Men







2.2 units






2.125 units

[editor’s note: The Khan Academy has a 9 minute video that explains in more detail]

You can see why economists are fascinated by the law. In the case before us, Portugal is more productive than England in both wool and wine; yet specialization is advantageous for both countries, and particularly advantageous for England, the less productive of the two. And note this: Ricardo does not even mention the economies of scale that might well result from the specialization.

The law of comparative advantage is the bedrock of the standard theory of international trade, taught with remarkable unanimity in almost all economics departments throughout the land. On this foundation arguments for free trade–for GATT and against Gephardt–are erected. There have of course been many more or less technical corrections. For example, when Ricardo compares industries on the basis of the labor involved, he is using his special brand of the generally discredited labor theory of value. Today the notion of productivity is usually used. (For my part, I should question that notion, too, but that’s another matter.)

The principal modification of Ricardo was advanced by the Swedish economist Eli Filip Heckscher in 1919 and developed by his student B. Ohlin in 1933. They argued that it would always be advantageous for countries to specialize in those industries where they were capital intensive and to import those goods where they were labor intensive.

So much for the history of the law. Now we come to what I find one of the most astonishing facts about it. Ricardo published it in 1817, but it was not until 1951–one hundred thirty-four years later that a serious attempt was made to find empirical confirmation of the law. The attempt was made by one G. D. A. MacDougal, and in the thirty-odd years since his paper appeared in Economic Journal, a debate has smoldered as to whether his results actually do support Ricardo. Of two widely used textbooks on international trade that I consulted at random, one says flatly that MacDougal did confirm Ricardo, and the other says just as flatly that he did not.

I think you will agree that this is an extraordinary state of affairs for a discipline that claims to be a science. Can you imagine a proposition in physics being taught as gospel for one hundred thirty-four years before anyone bothered to test it? And can you imagine it still taught as gospel when the test proved equivocal? And finally, in your wildest nightmare, can you imagine such an equivocally tested theory used to design a structure on which the livelihoods of literally billions of people may depend? An engineer who proposed to build on such a basis would be treated as a madman and locked up as a threat to civilized society.

But wait, as the television commercials say, there’s more. Professor Ohlin published his elaboration of Professor Heckscher’ s theory in 1933. It had to wait only twenty years–still an unconscionably long time for an alleged science to act–before its first full-dress test, which was conducted by Professor Wassily Leontief. And what was the outcome? The sad fact is that the empirical findings were the diametric opposite of the predictions of the Heckscher-Ohlin theory. Leontief didn’t merely fail to confirm Heckscher-Ohlin; he refuted it.

What do you think the economics profession, that stern band  this of scientists, did when faced by this contretemps? I could give you a million guesses, and you’d never hit it. Psychologists tell us that the first step in mastering a fear is to name it; so the economists gave the results a name in capital letters–Leontief’s Paradox. Then they said Leontief had chosen a bad year for the test. (So Leontief took another year, and Heckscher-Ohlin still failed, though not quite so badly.) Then an entire new industry grew like a fungus within the economics profession. If you needed a subject for your dissertation, or if (after getting your Ph. D.) you needed a subject for a journal article to ensure your promotion, all you had to do was to come up with a new explanation of Leontief’s Paradox. The field was, and is, wide open. The only comparable situation I can think of is the Modern Language Association’s fascination with William Faulkner. Since it was not clear, perhaps not even to Faulkner, what he had on his mind, there are no limits to what one can write about him. It’s hard to say something new about Shakespeare, but anyone can be an innovative critic about Faulkner. It’s an academic goldmine. Likewise Heckscher-Ohlin and Leontief’s Paradox.

There is, however, a difference. Much ink and paper and brain power are no doubt wasted on Faulkner, but the damage is pretty well controlled within the profession. A few susceptible students may suffer temporary disorientation, but no one is much hurt. The case is otherwise with Heckscher-Ohlin, where it’s not much too much to say that the fate of nations–particularly this nation–hangs in the balance.

Now, I think you’ll agree that it would be legitimate to argue that the economics profession has, by and large, been morally irresponsible in its unequivocal advocacy of equivocal doctrines. This is not, however, the ethical issue that concerns me here. I wish to call into question, not the morals of economists (who as individuals are probably no better and no worse than ordinary people), but their view of their discipline as an amoral science– not an immoral science, whatever that might be, but an amoral science, like physics, where the behavior of electrons is neither right nor wrong.

Let’s begin at the beginning–at least at the beginning of international trade. The first requirement of international trade is that there be nations. If there are no nations, there can scarcely be trade among them. This point may be stupifyingly obvious, but its consequences are far from trivial.

We haven’t time to examine in detail the meaning of nationhood, but we can make a few observations. A nation will have citizens, and it will have boundaries, and within those boundaries it will be sovereign–a law unto itself. An aspect of that law will be that its citizens have, in the grand old phrase, certain rights, privileges and immunities that are denied to those who are not citizens. If we who are citizens are not, in this way, distinguished from those who are not citizens, of what meaning is citizenship to us?  And if national citizenship is without meaning, of what meaning is the nation?

I leave the questions open. Maybe we don’t want a nation; and immunities that are denied to those who are not citizens. If we who are citizens are not, in this way, distinguished from those citizens, who are not” of what meaning is citizenship to us? And if national citizenship is without meaning, of what meaning is the nation?

I leave these questions open.  Maybe we shouldn’t have one. Perhaps we reserve our loyalty for those who are very near and very dear to us. Perhaps, as D. H. Lawrence put it, we “love-whoosh for humanity.” I’m prepared to argue those questions, but my point here and now is merely this: If we have international trade, we have a nation; and if we have a nation, then the well being of our fellow citizens is vital to us. We can’t demand respect for our own well being unless we, at the same time, to the same extent, and for the same reasons, respect theirs.

David Ricardo was open to such considerations. He wrote that patriotic sentiments, “which I should be very sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign nations.”

What Ricardo could not foresee, and what his modern followers have overlooked, is the fundamental irresponsibility of the modern multinational corporation, which knows no boundaries other than the bottom line. Today capital flits from Schenectady to Singapore more speedily and safely than it moved in Ricardo’s time from London to York. Aside from a few temporarily secret processes, technology anywhere is quickly available to literate people everywhere. Domestic availability of raw materials has not dictated a country’s industry since the Industrial Revolution and certainly does not do so now. Today the costs of all but one of the factors of production are nearly homogeneous throughout the world.

But the cost of labor is not internationally homogeneous. And since labor is usually the single most costly factor, as well as always the original and necessary factor, the heterogeneity of wage scales and working conditions overrides all other considerations.

Returning to our parable, we find that what happens is not that England specializes in wool and Portugal in wine, but that England abandons the production of both wool and wine and imports both from Portugal.

The question becomes, how will England pay for the imported wool and wine? By exporting something else, most economists will answer; but they tend to be coy when asked what that something else might be. If because of its wage scales (or for any other reason), Portugal can underprice England in the production of every product you can name (many of which Portugal does not consume herself), why should she buy anything at England’s higher prices?

Well, it may be urged, England, limping into the post-industrial world, can concentrate on service industries; and while some services, like dishwashing and motorcycle maintenance, can’t be exported, financial services can be. Economists make much of the importance to the British Empire of “invisible imports”–interest, insurance premiums, royalties, profits, and employment for younger sons. Keynes once amused himself by calculating that the entire overseas wealth of the Empire at its height could be accounted for by 350 years of Queen Elizabeth’s share of only 3 ¼ percent on the loot Sir Francis Drake plundered from Spain in 1580. Yet during all those years Britain compound interest also made pots of money in the usual visible ways of manufacturing and exporting textiles and steel rails and steam engines and anything else anyone could think of.

In any case, invisible imports can only help pay for visible imports; they can’t carry the whole load or even a major share of it. All financial services together, including exploitative profits, account for certainly less that 35 percent of the cost of a commodity and often less than 20 percent. Thus 65 to 80 percent of the cost of imports remains uncovered even when the importing nation contributes the entire cost of financial services. And it’s not clear why the exporting nation should not itself contribute part and, eventually, all of these services, as exporters are largely doing today. We call the consequence a trade deficit.

The ultimate consequence of abandoning productive industry is national stagnation and decline, not merely of power but also of standard of living. It has happened before. In 1675 a Spanish nobleman, one Alfonso Nuñez de Castro wrote, “Let London manufacture those fabrics of hers to her heart’s content; Holland her chambrays; the Indies their beaver and vicuña; Milan her brocades; Italy and France their linens, so long as our capital can enjoy them; the only thing it proves is that all countries train journeymen for Madrid and that Madrid is the queen of parliaments, for all the world serves her and she serves nobody.”

Don Alfonso understated Spain’s contribution to the wealth and happiness of mankind. She produced no cloth, but she provided services–military services, administrative services, ecclesiastical services–to the New World, and also to the Two Sicilies, to the Low Countries, to Burgundy, and even to the Holy Roman Empire. These services, valuable though they might have been (there has been doubt on this point), were not enough to support the imperial style in Madrid. When the silver from the Indies ran out, Spain slipped into a slough of despond from which today, three centuries after Don Alfonso, she has yet to escape.

Immeasurably more important than the loss of imperial glory, the consequence of service orientation is unemployment. The owners of financial services (including the previous owners of those sold to cash-rich exporting nations) are as happy as clams, but the disemployed workers in the abandoned industries are not. People say that what matters is that those who still have jobs or money in the bank can buy cheaper sports shirts and classier sports cars. Nothing, they say, should interfere with the automatic working of the free market.

It is barely conceivable, as an imaginative exercise, that the market could be allowed much greater sway if we had a world state. Then it might be possible to say that the efficient accumulation and distribution of goods was the most important function of the state, and that the free market was the most efficient way of performing that function. But as it is–a world of nations and of international as well as intra national trade—we do not and cannot allow the market to define our national purposes or the method of their fulfillment. We will not buy our battle tanks from the Russians no matter how cost-effective they are. We may buy golf carts from Poland, but we will not contract with China to supply us with ground-to-air missiles, although we could thereby save half or more of the cost.

Since we make such exceptions to alleged economic laws in order to protect ourselves militarily, it is logically perverse to refuse at least to consider other exceptions in order to protect also the morale and well being of our fellow citizens and of ourselves. Indeed, that is why we have a nation–and why international trade is something to have a conference about.

We started with a story told by Professor Samuelson; let’s conclude with a quotation from his famous textbook: “Thus [he writes] if exchange-rate parities and money wage rates are rigid in both countries or if fiscal and monetary policies are poorly run in both countries, then the blessing of cheap imports that international specialization gives might be turned into the curse of unemployment.”

There is no doubt that the curse of unemployment is with us, with all of us all over the world. Can we conclude that our fiscal and monetary policies are poorly run? Who will claim they are not? How else could we Americans have doubled our national debt and turned ourselves from the world’s leading creditor nation into the world’s leading debtor?

Another fact beyond doubt is that “protectionism” in any form has not been part of the fiscal and monetary policies that have done so poorly for us. So “free trade” is not a plausible panacea for any ailment from which we now suffer. We have pretty close to free trade now, and we are very ill.

Proper fiscal and monetary policies are no doubt beyond the scope of this conference, but moral questions are inescapable. It is morally wrong for me as an individual or for the citizens of this nation or any nation to pursue our private pleasures at the expense of our fellow citizens. I have no moral need for a state-of the- art sports car or a state-of-the-style sports shirt, but I do

…. [copy ends – Editor would appreciate readers who may have the last page to send it on]

%d bloggers like this: