Friday, January 11, 2013

Charlatanism On The Theory Of Foreign Trade

I’ve noticed some foolish things said about free trade in the news recently. Yes, Ricardo showed that trade in two goods generates surplus for both countries under free trade. Samuelson later gave a more formal, general proof of the benefits of Ricardian trade for a nation, though his theorem with Stopler explains which individuals may be made worse off. Samuelson also showed that even when individuals are worse off, there is enough surplus that transfers can be made to the harmed individuals such that free trade is a Pareto improvement on autarky. Note that the last sentence is absolutely not implied by Ricardo, and how could it have been: he didn’t have the apparatus of ordinal utility nor the concept of Pareto improvement nor the idea of the Hicksian demand curve.

All of the above is true, but ..."

-- Kevin Bryan, "'Gains From Trade Without Lump-Sum Compensation'"

I have yet to read the paper referenced in the blog post linked to above. But contrast the following two quotations with the above:

"We have examined a version of the familiar H-O-S analysis, with two countries, two commodities and two factors; we have made all the normal assumptions except that, instead of a common zero rate of profit, we have assumed a common positive rate of profit. Since the existence of a positive profit rate does not affect the properties of the familiar relationship between commodity-prices and factor-prices it does not affect the factor-price-equalisation and Stolper-Samuelson theorems. In general, however, nothing can be said a priori about the relationship between factor-prices and the factor-intensity of production methods, when the profit rate is positive, and it follows that nothing can be said a priori about the shape of the relative supply curve. This does not prevent the H-O-S theorem about the pattern of trade from holding in its 'quantity' form, but does make the theorem invalid in its 'price' form, does mean that trade need not 'harm' a country's scarce factor, and does mean that uniqueness of international equilibrium is to be regarded as a special case when the common rate of profit is positive."

-- Ian Steedman and J. S. Metcalfe (1977). "Reswitching, Primary Inputs and the Heckscher-Ohlin-Samuelson Theory of Trade", Journal of International Economics

"7.5. The idea that the opening of foreign trade bears a close resemblance to technical progress, in that in both cases additional processes of production are made available to the economy, is clearly expressed in Ricardo's Principles in the chapter 'On Foreign Trade'... Ricardo in fact compares the extension of trade to improvements in machinery, and, taking the real wage rate as given, investigates whether trade or improved machinery will have an impact on the general rate of profit. He concludes that if 'by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise,' whereas 'if the commodities obtained at a cheaper rate... be exclusively the commodities consumed by the rich, no alteration will take place in the rate of profits'...

7.6. In recent years the pure theory of trade has been reformulated, using a 'classical' approach to the theory of value and distribution and paying special attention to the fact that capital consists of produced means of production. A start was made by Parrinello (1970), followed by several contributions by Steedman, Metcalfe and Steedman, and Mainwaring... It was shown that several of the traditional trade theorems, derived within the Heckscher-Ohlin-Samuelson model, do not carry over to a framework with a positive rate of profit (interest) and produced inputs (capital goods). (As is well known, the Heckscher-Ohlin-Samuelson model of international trade assumes two countries producing the same two commodities by means of the same constant returns to scale technology, using the same two primary inputs, each of which is taken to be homogeneous across countries.) With a positive rate of interest that is uniform across countries some, though not all, of the standard theorems are undermined (including the 'factor price equalization theorem'), while with different rates of interest in different countries all standard theorems except the Rybczynski theorem turn out to be untenable. The 'gains' from trade for the single small open economy need not be positive. When in the Heckscher-Ohlin-Samuelson theory one of the two primary factors (land) is replaced by a factor called 'capital', the 'quantity' of which is represented in terms of a given total value of capital, then the theory is deprived of its logical coherence..."

-- Heinz D. Kurz and Neri Salvadori, Theory of Production: A Long-Period Analysis, Cambridge University Press, 1995.

I happen to know the factor price theorem is false, once one takes into account the existence of capital.

My post here was inspired by a comment on Noah Smith's query, "Why do people think economists are charlatans"? Empirically, I expect most mainstreams economists to not give a fair overview of the literature, whether from incapacity or dishonesty. In this case, the author of the blog, "A Fine Theorem", does not even seem to be aware of the existence of work on international trade by such authors as L. Mainwaring, J. S. Metcalfe, Sergio Parrinello, Ian Steedman. Instead he just blithely claims ideas to be true that I consider to have been falsified a third of a century ago. Thus, he cannot refute their conclusions or quickly evaluate any literature on the topic.

I consider the point of this example to be general.


zopolan said...

"Samuelson also showed that even when individuals are worse off, there is enough surplus that transfers can be made to the harmed individuals such that free trade is a Pareto improvement on autarky."

That is also not true, because a Pareto improvement would require that individuals actually are better or at least as well off and not that they could hypothetically be compensated. That would only be a Kaldor-Hicks improvement.

Matias Vernengo said...

The case of trade is also very relevant since it is a direct application of the marginalist theory of value.

BruceMcF said...

@zzoplan, The statement itself does not claim that it is a Pareto improvement in the absence of those compensations.

The statement "transfers can be made to the harmed individuals such that free trade is a Pareto improvement on autarky" MEANS that it WOULD BE a Pareto improvement IF those transfers were in fact made.

Robert Vienneau said...

Thanks for the comments. I agree with Bruce that the quote could be read so as to only be speaking of a potential Pareto improvement.

I find some stuff I read by economists on trade to be strange. They seem to claim that the scientific character of economics can be seen in the consensus position that free trade is a good policy. I have noted some arguments that normative and positive propositions cannot be neatly separated, but this seems ridiculous to me.