Anderson Misses the Point

I appreciate the attention William L. Anderson has given my recent syndicated column, Jobless in the USA. In his analysis he does not present the gist of my argument or concern, perhaps because my argument is new and he mistakes it as an argument for protectionism against free trade.

As free traders we are all predisposed to dismiss any argument that might be interpreted as protectionist or anti-free market. On occasion our knees jerk too quickly and we misinterpret what is being said.

Free trade is based on Ricardo’s law of comparative advantage. As Ricardo recognized, for comparative advantage to hold, factors of production must not be internationally mobile. Otherwise, they would flow to countries with the greatest absolute advantages. Those countries would gain and all others would lose.

In Ricardo’s day, agricultural output was a significant component of GDP. A counry’s advantages resided in climate and geography, clearly immobile factors.

One question that I raise is whether the mobility of factors of production today (capital, technology, business know-how and labor) is such as to undermine comparative advantage. I ask: Is what we perceive to be free trade in fact what we think it is.

People will reply that capital and technology have always been mobile, which is true. But this objection misses a difference that might be fundamental. Flows of capital and technology from England to the U.S. in the 19th century and from the U.S. to Europe after WW II were invested in producing products for markets in the recipient countries. GM and Ford made cars in Europe to sell to Europeans, not to export to the U.S.

Today a significant proportion of U.S. outflows of capital and technology are to Asian countries, such as China and India for the purpose of employing Asian labor to produce for U.S. markets. The outflows result in a direct substitution of foreign labor for U.S. labor. This is a new development.

Manufacturing jobs were the first to be lost to offshore production. Now it is IT and knowledge jobs, the jobs of the New Economy that were supposed to take the place of the lost manufacturing jobs. The Internet makes it possible for firms in the U.S. to replace a wide range of employees--bookeepers, accountants, engineers, designers, researchers, radiologists, literally any occupation that does not require a face-to-face or hands-on presence--with Indian and Chinese employees who are able through the Internet to supply labor to U.S. offices.

Free traders can pretend that no such thing is happening, but corporate executives know it is happening, as do the displaced employees and high school students searching for careers that cannot be shipped abroad.

This is a second new development. Modern technology and offshore production have created a new form of labor mobility. Labor does not have to physically move in order to be mobile.

Previously, American labor faced competition from foreign labor indirectly in the markets for traded goods and services. Today American labor faces direct labor market competition from Asian labor that directly enters the U.S. job market through the Internet and offshore production.

Asian labor working with U.S. capital, technology and business know-how is just as productive as U.S. labor. However, it does not have to be paid the same wage.

The vast excess supply of labor in India and China and the much lower standards of living mean that U.S. employers do not have to pay Asian employees the value of their marginal product. The excess supply of labor allows labor to be “exploited.” It is the attraction of wages and salaries that are far below U.S. levels that causes U.S. firms to replace U.S. employees with Asian employees.

The second question is: Have offshore production and the Internet made Asian labor mobile to the U.S. to the extent that U.S. employees face in their home labor market direct competition from foreign labor?

If so, then for the U.S. the main factors of production are mobile. Where resides comparative advantage for the U.S.?

In today’s world, does absolute advantage reside in countries with the lowest labor cost? Are we witnessing the phenomenon of factors of production flowing to countries with the greatest absolute advantage? If so, it is not Ricardo’s case for free trade.

These are the issues that I raised. Before we spout mantras and mount our high horse to defend free trade, let’s be sure that what we are defending is, in fact, free trade. As Ricardo recognized, the free flow of factors of production can be something different. Nothing will more certainly destroy the case for free trade than to defend an imposter in its name.