Friday 1 April 2022

Trade, Brexit and 'comparative advantage'

The possible (likely) delay in implementing checks on EU imports for the fourth time as been welcomed by some Brexiteers although it gives EU exporters a continued free run at our market while adding to the costs and delays for UK exporters into the EU market. This is like giving performance enhancing drugs to your competitors while tying your own shoelaces together. Lord Frost thought we should just carry on and not even bother with checks at all - ever.  Another one was Lord Moylan, who is always quite active on Twitter and has some bizarre ideas at the best of times. Here is a tweet of his in response to the story appearing in The Times:

He got a bit of stick and came back with this one:

Now Ricardo may not be altogether familiar to you, it wasn't to me until a couple of years ago. He is talking about David Ricardo (1772 – 1823), a British political economist, who invented the idea of comparative advantage 200 years ago. If you're not aware of the concept there is an explanation on Wikipedia HERE.

Essentially, it's about international trade with an example of England and Portugal and trade in cloth and wine. In Ricardo's example, Portugal could (and probably still can) produce both cheaper than England - it had an absolute advantage in both - but was more efficient at wine. England was more expensive but produced cloth more efficiently than wine.

In the Ricardian model, it is better for Portugal to focus on producing more wine and less cloth and England to focus on producing more cloth and less wine. Each then trades with the other in the goods (cloth and wine) they no longer make for themselves and both counties consume more (output rises) for less cost (input lowered) and are therefore better off.  There is an optimal point where an equilibrium is reached short of England making all cloth and Portugal making all wine, but in a nutshell this is the theory.

Each country produces that good in which they have a comparative  advantage. This was a fundamental tenet of international trade. However, it's a bit like relying on the Bible for a history of the world. We now know a lot more and the world has changed since Ricardo came up with his idea.

Specifically, he assumed two things. First, that (a) capital would remain in the originating country and (b) the currency exchange rates are more or less fixed or changed only by market forces.

I read a paper by the School of Law at Loyola University Chicago entitled : Why Ricardo's Theory of Comparative Advantage regarding Foreign Trade Doesn't Work in Today's Global Economy, by Charles Murdock. Read it HERE.  Murdock debunks the whole theory.

First on capital movement across borders. He first quotes Ricardo:

It would undoubtedly be advantageous to the capitalists of England, and to the consumers in both countries, that under such circumstances, the wine and the cloth should both be made in Portugal, and therefore that the capital and labor of England employed in making cloth should be removed to Portugal for that purpose.

Ricardo, Murdock says, rejected this possibility on the basis that capitalists, namely, men of property, are 'loyal to their country of birth', even though a greater profit might be made elsewhere. Ricardo again:

Experience, however, shews that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and intrust himself with all his habits fixed, to a strange government and new laws, check the emigration of capital. These feelings, which I should be sorry to see weakened, induce most amount 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. 

You only have to read the second paragraph to realise this is just not true any more. As Murdock puts it:

"It goes without saying that Ricardo's view of the loyalty of capital is not only utterly incorrect today, but would be regarded as foolishness by most business managers and business academics. One comparative advantage that the United States once had was its supply of capital but, as discussed below, such advantage has been squandered by the investment of capital by American bankers and American businesses in low-wage countries."

So, essentially if capital is not loyal to the country of origin, but flows to wherever costs are low and returns are high, this simply leads to "labor arbitrage" - that is buying labour cheap in one country and selling it expensively in another. 

This is what global businesses do.  

And decisions are not always taken on the grounds of comparative advantage anyway. He gives an example of Boeing and the 777 Dreamliner.  The main fuselage is made by Alenia in Italy, the forward fuselage by Kawasaki in Japan, the wings by Mitsubishi in Japan, some parts of the wing tips are made by Boeing Australia and by KAL-ASD in Korea and so on. 

This may not always be because the bidder is cheap but to help gain or keep market share in the countries where sub assemblies are produced.

Comparative advantage may still work in commodities like bananas or oranges but global trade and particularly intra-EU trade, is nowadays about complex manufactured goods.

And now, with the Ukraine war and the realignment of the democratic western world there is greater pressure on self-sufficiency and sustainability, not just in food but in energy and advance manufacturing and elsewhere.

Intel, for example, the US semiconductor chip maker, recently announced a 10 year programme to boost chip production in Europe so that it's less reliant on its plants in China. Intel proposes to spend 80 billion euro in six EU countries but not the UK. This is real investment with real jobs.

Meanwhile, Moylan has welcomed an announcement that "leading Australian businesses have announced investments totalling £28.5bn for projects across the UK" - which includes an Aussie company called  Macquarie, buying 60 per cent of National Grid.  Macquarie owned Thames Water and is said to have a poor track record when it comes to managing public utilities in the interest of consumers rather than shareholders. It's an opportunity to suck more money out of the UK economy rather than put it in.

Anyway, it has nothing to do with comparative advantage or Ricardo and is a spectacular example of capital moving across borders, something that wasn't supposed to happen in Ricardo's view.

And as for currencies, Murdock points to China manipulating its own currency to keep it at a low rate and maintain a trading advantage. 

I use a small part of his conclusions, which he summarises well:

"It is important that the United States economy operates upon rules that provide for the benefit of all Americans, including workers, and not just investors. If we are to stem the outflow of jobs from the manufacturing sector and their replacement, if in fact they are replaced, by lower paying service jobs, we need an industrial policy that values manufacturing and American workers, and not just financial engineering.

"Equally important, from a national security perspective, we cannot rely upon either products that originate in, or supply chains that run through, a potential adversary."

The utter folly of Brexit is going to become ever clearer as time goes on. The world is an uncertain place and small countries must join together in alliances of one sort or another in order to maximise their strengths against powerful anti-democratic forces which are on the rise.

The Tory minister James Cleverly posted this on Twitter the other day without apparently realising what he was saying:

You would think he'd never heard of Brexit.

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