FALLACIES OF FREE TRADE GLOBALIZATION
Globalization Doctrine Rested on False Assumptions and Fallacies
Until recently, it has been an article of faith among the free world elite, especially that sub-species known as Davos Man, that free trade and globalization would inevitably lead to world peace and and if not to complete global democratization certainly to global liberalization and peace.
It was this consensus that convinced President William Clinton to shift from a policy of “no dictators from Baghdad to Beijing to one of bringing China into the World Trade Organization (WTO) and that vigorously backed President George W. Bush when he insisted that “free trade inevitably plants the seeds of democracy wherever it proceeds.” Of course, the elite also cheered when President Barack Obama signed new free trade agreements with South Korea, Panama, and Colombia early in his administration.
Yet, events since China’s entry into the WTO and a closer look at the assumptions and realities of free trade in practice as opposed to in theory suggest that far from extending the peace, free trade may be a major source of conflict and war.
A long time problem with the win-win doctrine of free trade is the fact of economies of scale. Most economic thinking, theorizing, and policy making has been done on the basis of an assumption of non-existence of economies of scale (the more you make of an item the less each item costs - think semiconductors, autos, most manufactured goods) or of the assumption that economies of scale can be drivers of trade between countries with similar resources and of similar size and demands. But Japan, the Asian Tigers, and now China have also demonstrated that economies of scale can be created by use of protectionist trade and investment policies and used as a kind of weapon to acquire dominance of national production in key product markets.
Until the late 1970s-early 1980s, the economic theories of David Ricardo and Hecksher/Ohlin assumed the non-existence of economies of scale. Even today, many standard trade models do not make allowance for the phenomenon of economies of scale. Finally, Paul Krugman, Joseph Stiglitz and others insisted that economies of scale could not be excluded as potential drivers of trade. This was a revolutionary breakthrough in economic theory, but also a problematic one. Heretofore, the theories and equations unquestionably revealed free trade to be the optimal solution to all international trade possibilities. Protectionism always proved less profitable to all players. But, now, if protectionism could yield sufficient economies of scale, in theory at least, a country could profit by switching from a policy of free trade to one of protectionism.
At the time (early 1980s), Japan was doing something like this with its “catch-up” industrial policy and was decimating the U.S. steel, auto, consumer electronics, and semiconductor industries to name only a few. I spoke to Krugman about his “discovery” of economies of scale and about Japan’s apparent success in using industrial policy to protect the domestic market while also subsidizing targeted export industries to enable them to gain enormous economies of scale and thereby not only to dominate the Japanese market, but also to gain commanding power in other world markets. Krugman said “it could work in theory” but that in practice, at least in the United States, it would not work because the policy would be captured by the targeted industries which would just continue drinking at the public trough without becoming competitive. Later, he changed his mind and admitted that he and other well known economists had been mistaken about how globalization would work in practice.
The facts are that governments of countries with large domestic markets can use protection of those markets and subsidies to domestic producers for those markets to speed up the growth of their production and the inevitable slide down the per item produced cost scale to achieve low cost production status. Further export subsidy and promotion policies will enable further domestic production and cost reduction as foreign markets are captured and foreign producers put out of business.
A good recent example is solar panels. First developed in the U.S., the big market for and producer of the panels became Germany between 2000 and 2013 when the German Renewable Energy Act provided some subsidies and a bigger market for solar power. During this time, the Germans were the low cost producers and major exporters of panels. But by 2005, China had identified solar panels as a key product for the future of China and had introduced large production subsidies along with guidance to domestic buyers to “buy Chinese.” With the Chinese market being larger than that of Germany and even than that of the EU, and with China’s government subsidies being much larger than anything the German government would do, along with the fact that in China “buy China” is a policy that has teeth while Germans are much more independent and free to buy as they like, the result has been that the Chinese industry has essentially eaten the German industry for breakfast as it eyed the newly hopeful U.S. industry for a tasty lunch. Thus, the world solar panel market today is almost completely supplied from China.
Interestingly, this does not necessarily mean that China is the low cost producer or that it has what economists call a “comparative advantage” in the production and sale of solar panels.
The reason for this uncertainty is that many costs are not included in the official statistics. For example, production of the world’s solar panels almost entirely in China makes the rest of the world highly dependent on China as a supplier. If something like a covid pandemic should interfere with and clog up the supply chain, the rest of the world would have to pay a heavy cost in terms of climate change and the higher potential for damage due to greenhouse gases. The fact that that cost is never calculated or allocated anywhere does not reduce the actual cost to those who must bear the burdens of excess greenhouse gas emissions.
Or, think of cost in a different way. If one country is highly dependent on another for critical products and materials like solar panels, any interruption in the flow of supply will be quite costly. The risk of that happening is always there and the cost that might be inflicted is known as the cost of risk. Yet that cost is never formally included in any accounting or profit and loss statement.
A third uncounted cost is that of loss of skills. Only a few years ago, Germany had many citizens who could make solar panels and who made a good living by doing so. Now, the industrial policy of China has led to the loss of those good German jobs. Maybe the German panel makers will find alternative jobs and maybe they will find new jobs that pay the same as the old solar panel jobs, but the probability is uncertain on both counts. Chances are good that the Germans will not find new jobs, and almost certainly they will not find new jobs that pay what the old solar panel jobs paid. Again, this cost is never counted in econometric analysis.
There is a final potential cost which is that because Germans and Germany no longer make solar panels they are highly unlikely to develop whatever new technology is the follow-on to solar panels. In effect, the loss of solar panel skills greatly reduces the chances of technological advance in the whole energy area as the former workers become increasingly reliant on their unemployment insurance and other government stress reducing programs. The cost of lost skills is never included in any economic analysis and yet it is perhaps the biggest long term loss.
A final uncounted cost of globalization is that of becoming vulnerable to coercion. Take the South Korean conglomerate Lotte. It long maintained a chain of stores in China. Then, in 2016-17, South Korea and the United States installed a radar facility on land originally owned by Lotte. From this location, the radar could look into China to detect any possible missile shots or potentially hostile aircraft flights. China very strongly objected to the construction of this radar and to show its full anger to South Korea, the Chinese government ordered Chinese shoppers to stay away from Lotte stores in China. This bankrupted Lotte’s China operations. Again, none of the econometric economic models account for such costs in their analyses, but corporations and investors would be foolish not to.
When you boil it all down, the truth is that neo-classical free trade systems and the globalization they spawned have been far from the win-win proposition the economic/business elite have claimed.
As Abraham Lincoln said when criticized for raising tariffs on imported steel in the midst of the Civil War, “ I don’t know much about tariffs, but I know this. When we buy steel from Great Britain, we get the steel and Britain gets the money. When we buy steel here in America, we get the steel and the money.”
Lincoln was not a neo-classical economist. He was a really smart guy.