International Trade, Comparative Advantage and the Trans-Pacific Partnership (TPP)

I have been puzzling for some time over the relationship between international trade and the well-being of American workers. On the one hand, many American workers, and especially those in unions, have bemoaned the importation of goods that, having been produced by foreign workers at a fraction of American wages, undercut American produced goods and therefore the wages earned domestically. The counter argument as stated by American importers is that we are in a global market and so long as there is a relatively free exchange of goods and capital between countries, the American consumer wins by having the opportunity to purchase goods at a much lower price than if domestically produced.

The conundrum arises when, as Walter Ruther, past president of the AFL-CIO (the largest American union at that time) stated that if American workers don’t earn a reasonable wage, then who will be left to purchase American automobiles. This perspective assumes a closed domestic economic system, or at least one that is preeminent in the international economy, something that for the first two decades after World War II was the case for America. But as the rest of the world began to recover and rebuild from the ravages of the war, their competitive position in the world economy began to improve and though the American economy was and is preeminent globally, as a percentage of world output, it has been shrinking for decades.

The puzzle for me is based on the work of both Adam Smith and David Ricardo, two of the great theorists in the field of economics and international trade. Smith, of course, is a household name amongst those of us that have any interest at all in economics, his main contentions being that

…the increase in productivity due to the division of labour can be attributed to three factors: first, ‘to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many.’ (Meoqui, Jorge Morales, Reconciling Ricardo’s Comparative Advantage with Smith’s Productivity Theory, Economic Thought, Volume 3, Issue 2, 2014, pg. 23, World Economics Association.

Smith extended his theory to include international trade, recognizing that an expanded market increases the division of labour which in turn spurs labour productivity at home, both of which have been abundantly clear especially during the post-war years when international trade has increased exponentially. What Ricardo added, and Smith anticipated (Meoqui), is the role of comparative advantage in international trade, a concept that in many ways is counter-intuitive.

What people do understand, and is in fact the basis for most discussions about international trade, are the two concepts of competitive and natural advantage. Competitive advantage can

be thought of as those factors that make an industry or country more competitive than another: a better educated workforce, availability of more capital, a technologically advanced society, a naturally competitive culture leading to greater levels of entrepreneurship, and so on. Natural advantage could be access to the sea or major rivers, naturally occurring material such as oil, coal, wind and sunlight for the production of power and good soils for growing food to name a few things.

With America’s enormous natural resources, abundant and fertile land, large deposits of coal and oil, a publicly supported education system through college that helped create an educated workforce, networks of highways and rivers for moving goods throughout the country, and a cohesive political system that encourages a free flow of capital and labor throughout the country, these and many other factors give America both a competitive and natural advantage against other competing countries.

Comparative advantage, though, is a concept hard to understand and in a way counter-intuitive. Ricardo, in his seminal book, On the Principles of Political Economy and Taxation (1817) republished by Dover Publications, London, 1911, contended that even if country A produced every good more efficiently than country B, it would still be to the first country’s interest to trade with the second country. Talk about counter-intuitive, how could it possibly be the case that the more efficient country would benefit from trading with a less efficient country? Ricardo’s answer was stated in the simplest of terms, and relied on an understanding of ratios (though an algebraic formulae is also available). His famous (at least amongst economists) example is the following:

Assume two countries, Portugal and England, produce two goods of identical quality. Also assume that Portugal can produce both wine and cloth with less labor than it would take English laborers to produce.

Hours of work necessary to produce one unit of value

Country Cloth Wine

England 100 120

Portugal 90 80

Now, to produce a second unit of cloth, an English worker would have to work an additional 100 hours or if he preferred, that 100 hours would produce 5/6 unit of wine. In Portugal, meanwhile, though the worker could produce one unit of cloth in only 90 hours, by doing so he has foregone producing a greater amount of wine which would be 9/8’s units with those hours of labor.

Although Portugal has an absolute advantage in producing both cloth and wine, England has a comparative advantage in producing cloth.

“In the absence of trade, England requires 220 hours of work to both produce and consume one unit each of cloth and wine while Portugal requires 170 hours of work to produce and consume the same quantities. If each country specializes in the good for which it has a comparative advantage, then the global production of both goods increases, for England can spend 220 labor hours to produce 2.2 units of cloth while Portugal can spend 170 hours to produce 2.125 units of wine. Moreover, if both countries specialize in the above manner and England trades a unit of its cloth for 5/6 to 9/8 units of Portugal’s wine, then both countries can consume at least a unit each of cloth and wine, with 0 to 0.2 units of cloth and 0 to 0.125 units of wine remaining in each respective country to be consumed or exported.” (Ricardo as reprinted in Wikipedia, Comparative Advantage).

What Ricardo realized is that comparative advantage recognized the differences in production costs between different items within a country and then compared them with that of a second country showing that it was a benefit to both countries to trade because of the difference in efficiency within each of the countries. Of course, as elegant as the theory is, the practical application is another thing for the idealized world of economics is far from the messy world of real trade.

China, for one, has pursued a policy of Mercantilism, that is to say, a national economic policy aimed at accumulating monetary reserves through a positive balance of trade. This is a very common strategy, especially for an economy at the early stages of development, though in the long run a more open system will benefit the economy to a greater degree as Ricardo and Smith have demonstrated.

Paul Krugman, the Nobel winning economist, further wrote that though free trade over time will benefit the greatest number of people and countries, there are many factors that can hinder such advances, such as underinvestment in import-competing sectors, imperfect competition with a misallocation of capital, and distortion in domestic labor markets that may reduce wages or cause unemployment.

America, with its dominant economy, has had the luxury to champion and benefit from free trade, much as England had in the nineteenth century. This continues to be the case today, though we are constantly faced with the domestic challenges of addressing the normal dislocations of labor and employment as a result of a highly competitive culture both domestically and internationally.

The Trans-pacific partnership (TPP) is an example of the struggle between the theory of comparative advantage and international trade and the reality of its impacts on the domestic economy and especially the success of labor in the face of international competition. President Obama received fast-track approval by congress so that whatever agreement is reached between the various countries (Brunei, Chile, New Zealand, Singapore, U.S., Australia, Peru, Vietnam, Malaysia, Mexico, Canada, Japan, Taiwan, South Korea) will not be pecked to death by

numerous amendments during the legislative process. My wife and I attended a very interesting discussion at the Pacific Council on International Policy chaired by a past U.S. ambassador to Argentina and including a past U.S. ambassador to France as well as Mickey Cantor, a top NAFTA negotiator during the Clinton administration. All were in favor of TPP and were very convincing that passing this legislation would be a big win for American business and labor. According to the website of the Office of the United States Trade Representative, TPP includes: Comprehensive market access by eliminating tariffs and other barriers to goods and services trade and investment. A fully regional agreement by facilitating the development of production and supply chains among TPP members, which will support the goals of job creation, improving living standards and welfare, and promoting sustainable growth among member countries. Promoting trade and investment in innovative products and services, including the digital economy and green technologies, and to ensure a competitive business environment across the TPP region. Living agreement by enabling the updating of the agreement when needed to address trade issues that materialize in the future as well as new issues that arise with the expansion of the agreement to include new countries. TPP includes four new cross-cutting issues: 1. Regulatory coherence: Commitments will promote trade between the countries by making trade among them more seamless and efficient. 2. Competitiveness and business facilitation: Commitments will enhance the domestic and regional competitiveness of each member country’s economy and promote economic integration and jobs in the region, including through the development of regional production and supply chains. 3. Small- and Medium-Sized Enterprises: Commitments will address concerns small- and medium-sized businesses have raised about the difficulty in understanding and using trade agreements, encouraging these sized enterprises to trade internationally. 4. Development: Comprehensive and robust market liberalization, improvements in trade and investment enhancing disciplines, and other commitments will serve to

strengthen institutions important for economic development and governance and thereby contribute significantly to advancing TPP countries’ respective economic development priorities.

On the other side of the argument, there is strong opposition to the process of negotiations on the basis of secrecy, a lack of input by our elected officials while private business has a hand in fashioning the international agreement, and the contention that though corporate interests would stand to benefit, the American worker could lose as he/she had done as a result of NAFTA. In 2014, Noam Chomsky, the well-known linguist, philosopher and scientist, warned that the TPP is “designed to carry forward the neoliberal project to maximize profit and domination, and to set the working people in the world in competition with one another so as to lower wages to increase insecurity.” Senator Bernie Sanders (I-VT), who opposes fast track, stated that trade agreements like the TPP “have ended up devastating working families and enriching large corporations.” Economist Paul Krugman reported, “… I’ll be undismayed and even a bit relieved if the T.P.P. just fades away,” and said that “… there isn’t a compelling case for this deal, from either a global or a national point of view.” Krugman also noted the absence of “anything like a political consensus in favor, abroad or at home.”] Economist Robert Reich contends that the TPP is a “Trojan horse in a global race to the bottom, giving big corporations and Wall Street banks a way to eliminate any and all laws and regulations that get in the way of their profits.” In a letter to Michael Froman, a US Trade Representative, Senator (and now contender for the Democratic nomination for president of the United States, Bernie Sanders wrote: It is incomprehensible to me that the leaders of major corporate interests who stand to gain enormous financial benefits from this agreement are actively involved in the writing of the TPP while, at the same time, the elected officials of this country, representing the American people, have little or no knowledge as to what is in it (Wikipedia, TPP).

The above arguments are economic in nature, yet the real and underlying motivation behind TPP and international trade may hinge on a more fundamental element, that is the rising influence of China and America’s attempts to manage that in a way which does not damage her political-economic role in the world. President Obama’s “pivot to Asia” is much more than moving military assets to the Pacific Ocean. More profoundly, it is pivoting America’s economic

interests or rather, doubling down on the massive investments and economic relationships that have been building over decades.

American economic policy reflects an underlying commitment to free markets, a legal and enforceable framework for economic activity, and the continuing development of an international economic system which underpins Smith’s and Recardo’s concept of capitalism and comparative advantage.

China has demonstrated the success of state capitalism which “…gives political officials a powerful role in directing market activity. By using state-owned companies, state-run banks and loyal firms to achieve political goals, China has tilted the commercial playing field away from foreign companies and the U.S. (Ian Bremmar, Trading Block: The Trans-Pacific Partnership could help the U.S. counter China in Asia, May 11, 2015, Time Magazine.) TPP, as the European Union had done, is focused on advantaging private-sector competition and liberalizing labor, trade and investment standards, all American strengths and a direct answer to China’s state-owned and politically influenced economy.

TPP,”…would provide a landmark win for free markets, the rule of law and Western labor and environmental standards while inviting Beijing’s’ neighbors to hedge their bets on China by also strengthening investment ties with the U.S. and other TPP members. It would signal that America intends to remain in Asia as a stablilizer even as China becomes an ever more influential player (Bremmer).”

As noted above, arguments for and against TPP are varied and difficult to reconcile. Yet America must hold on to its core beliefs and interests that encompass both capital and labor. Our challenge for the future is to continue to support private enterprise through the rule of law, the benefits of public education and affordable higher education in supplying the skilled workforce to remain internationally competitive, and the free and unhindered flow of capital. At the same time we must remind our elected representatives (local, state and federal) that underinvestment in public capital stock (highways, national grid, and education, to name just a few sectors), and a willful disregard of the importance government plays in establishing and enforcing rules of fair play between various economic interests, whether labor or capital, national or international, undermine America’s standing and are a hindrance to a thriving and successful economy

Michael Pinto, Ph.D.

June 2015

Show your support

Clapping shows how much you appreciated Michael Pinto’s story.