Free trade and the end of comparative advantage

12 March, 2016 at 12:26 | Posted in Economics | 1 Comment

The classical theory of comparative advantage has driven US trade policy for the past fifty years. That policy, in combination with technical innovations that have lowered costs of transportation and communication, has opened the global economy. Yet paradoxically, this opening has rendered classical trade theory obsolete. That in turn has left the US economically vulnerable because its trade policy remains stuck in the past and based on ideas that no longer hold.

david-ricardoThe logic behind classical free trade is that all can benefit when countries specialize in producing those things in which they have comparative advantage. The necessary requirement is that the means of production (capital and technology) are internationally immobile and stuck in each country. That is what globalization has undone.

Several years ago Jack Welch, former CEO of General Electric, captured the new reality when he talked of ideally having every plant you own on a barge. The economic logic was that factories should float between countries to take advantage of lowest costs, be they due to under-valued exchange rates, low taxes, subsidies, or a surfeit of cheap labor …

The U.S. and European response to Welch’s barge has been competitiveness policy that advocates measures such as increased education spending to improve skills; lower corporate tax rates; and investment and R&D incentives. The thinking is increased competitiveness can make Europe and the US more attractive to businesses.

Unfortunately, competitiveness policy is not up to the task of anchoring the barge, and it can even be counter-productive. The core problem is corporations are globally mobile. Thus, government can subsidize R&D spending, but the resulting innovations may simply end up in new offshore factories …

A critical consequence of Welch’s barge is the creation of a corporation versus country divide. Previously, when corporations were nationally based, profit maximization by business contributed to national economic success by ensuring efficient resource use. Today, corporations still maximize profits, but they do so from the standpoint of their global operations. Consequently, what is good for corporations may not be good for country …

Thomas Palley


As always with Palley — thought-provoking and interesting.
Re comparative advantage yours truly argues in a similar vein in The Dialectics of Globalization (sorry, only in Swedish).

1 Comment »

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  1. Dear Prof. Syll,
    Globalisation has not rendered the classical case for free trade obsolete. The original free trade case made by Smith and Ricardo recommends unilateral free trade – not preferential trade agreements. Moreover, it is not built upon comparative advantage, like the mainstream neoclassical case for free trade of economic textbooks. Ricardo often argued in favor of free trade, but only referred once to comparative advantage, and what he wrote on that occasion was very different from the contemporary notion of comparative advantage.
    See here:

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