While America's nation-destroying trade deficit amounts to a black eye for the modern neoclassical school of economics, it has raised calls by non-economists to "level the playing field" in the form of fair trade. As one astute commenter pointed out, the term Fair Trade is generally used in the context of ensuring equitable treatment of workers, along with necessary legal reform in developing countries. I on the other hand am using the term as one might find it proposed in currency reform legislation (i.e. Currency Reform for Fair Trade Act). Currency manipulation debates are typically considered by their critiques as a form of "unfair trade" with an implied trade deficit as the driving concern. The goal then of my critique is to suggest that currency exchange reform will solve nothing if balanced trade is the ultimate goal. To help hammer this point home, I've added a previous critique of the Euro fantasy, arguable the fairest form of free trade, to this third revision of the discussion below. In summary, we are simply focused on a simplistic feel-good interpretation of international trade, balanced and fair are synonymous. I give you one dollar for an import, and you give me a dollar for an export. Everyone is happy.
To help us understand the fantasy of balanced trade as an economic panacea, let's begin with a powerful observation made by the father of free trade theory David Ricardo. Ricardo, observed that “the labour of a million of men in manufactures, will always produce the same value [embedded labor hours], but will not always produce the same riches." An example will help clarify this point. Assume a technologically backward nation produces one million toothpicks with a million hours of labor, while a technically advanced nation produces one million automobiles with a million hours of labor. The so called value of the total final output, using Ricardo’s definition, in both cases is one million labor hours. The wealth (riches) is the final product. The former is something you can measure, the latter you cannot. It is easy to see the obvious difference in wealth (toothpicks verses cars), but how can you quantify it? Is it possible then to compare riches (wealth) between the two countries? Using our common sense by looking at the final output we might be inclined to say yes, because cars are “worth” much more than toothpicks. By claiming this we have moved into the slippery world of subjective economics. Note that modern economics is at its heart subjective economics. A modern day theorist would suggest a car provides much more subjective satisfaction than a toothpick, but that is just his subjective opinion. An eccentric artist who builds colossal works of art out of toothpicks might disagree with this conclusion. By making such a claim of worth or wealth we are deceiving ourselves. If I were to ask you by what measure or method you had established your conclusion cars were of greater riches than toothpicks, I suspect you would be hard pressed to explain it. If this example seems a bit ludicrous, simply substitute boats for toothpicks. Which nation is richer now, the one which makes boats or the one which produces cars? Suddenly the distinction between the riches of boats and cars is much more difficult to make. In fact, it is impossible.
What is the immediate implication? Simply consider a single nation that builds boats and cars. For the boat builders and car builders to be able to exchange using a just measure, they must price their products on the cost of production (labor content) in order to maintain full employment. Though Ricardo was right with his focus of on a labor theory of value (rejected by modern economics), he became double-minded when faced with international trade price formation: "The quantity of wine which she [Portugal] shall give in exchange for the cloth of England is not determined by the respective quantities of labour devoted to the production of each, as it would be if both commodities were manufactured in England, or both in Portugal." In short, Ricardo applied his labor theory of value to the domestic product, and then sweeps it under the rug in the arena of international trade. If there ever was a red flag in economics this is it.
But why is he forced to abandon the labor theory of value when it comes to international trade? Because his understanding of money is defective. What seems to escape him is that measuring domestic labor content of an indusrial good is based on domestic money. Specifically, one nation may require 100 hours to dig out an oz of gold, while another nation may require 10 hours for the equivalent. This mean each country has a different "arbitrary scale" from which wages are established. This critical distinction appears to be overlooked by Ricardo. As a result, he is forced to bring barter pricing mechanics into his free trade model (money becomes the modern notion of an afterthought--i.e. a "veil"). Ricardo relies on Hume's gold-like-the-wind fantasies in the form of national deflation/inflation due to international gold flows to achieve this theoretical objective. Thus Ricardo has unwittingly destroyed his labor theory of value by rejecting the key purpose of money (i.e. define a unit of domestic of labor, not vise verse as modern theory would have us believe). He also fails to grasp that worker mobility among domestic industry sectors following productivity gains is tightly integrated to this mechanism. In other words, short term unemployment resulting from less labor content (productivity gain), also means an equivalent consumer saving which will be spent in a new sector resulting in long term reemployment. Thus money is also the critical mechanism for domestic economic growth (increasing standard of living).
To begin to grasp why this mechanism can only work in a closed economy, let’s take the next step and give the free trader the benefit of the doubt and assume balanced trade has been achieved by the wave of the magic wand. Is it enough to save fair trade? To answer this question, let’s build another simple model. Assume country A has a population of 100 million and 1/10 the wages of country B which has a population of 10 million. Also assume Country A exports the equivalent of the annual output of 9 million workers at 1/10 the price of what Country B could produce it at. The imports in country B would appear as merely 9% of Country B’s GDP in dollar amounts. Keep in mind it therefore only takes 9% of the work force in Country B to produce the exports needed to balance trade in dollar amounts. How much harm if any could this do if trade is balanced? Astonishingly, Country B will have 90% unemployment (9 million workers) due to imports “price-masking” of the labor hours embedded the imported products. Trade remains balanced in dollar amounts, while the nation is ruined.
So while Ricardo correctly understood labor units critical to the price formation of an industrial good (unlike modern economic theory), he failed to grasp the macroeconomic (employment) implications of his theory of labor. It is this failure to grasp money as a unit of domestic labor that put Ricardo on the wrong side of the English banking debates of the 1800s. Unfortunately for America's future, nearly all schools of economics make the same mistake as Ricardo by subscribing to the Quantity Theory of Money (quantity of money determines price and wage level) which allows their flawed models of micro, macro, and international economics to stand as barter economics.
The Euro is the latest intellectual fruit of free trade theory. But economic theory, like Marxists who ultimately reject the reality of nations, has no place in models for the implications of language on worker mobility. Let's take my core argument that money is a "domestic arbitrary scale" and apply it to the Euro. Keep in mind that the Euro is arguable the fairest form of international trade imaginable. The workers across much of the continent share a similar wage level, a similar standard of living, and they have similar laws. What more could you ask for as a fair trade economist? The economist using the neoclassical approach known as the Hecksher-Ohlin model relies on four theorems: 1) H-O theorem, 2) Stolper-Samuelson theorem, 3) Rybczynski theorem, and 4) factor-price equalization theorem. The factor-price equalization theorem is the most troubling of them all. It claims prices of goods, along with wages and rents (i.e. price of land use) will equalize between countries. Yes, your wage and a peasant’s wage are going to meet somewhere along the way, with yours in the required free fall to get there. Thus, every nation in the long run has the same wages and prices when H-O is done with us. Again, mainstream economics sees elastic wages as the panacea, not as a distortion of an economy. It is through the incomplete definition of money that these models are able to convince politicians of the virtues of free trade. Fortunately, for the economist, the Euro setting already has achieved most of these objectives, so all should be well in Spain with its record unemployment levels. Milk and honey should be flowing endlessly.
With the Euro we've also managed to eliminate another pesky problem that mainstream theory tends to ignore which adds another domestic component to money. As Keynes noted, wages are the result of a relative comparison process. In other words, an unemployed steel worker looks to an employed America steel worker's wages when seeking employment. He is not comparing his future wage to a Chinese, Indian, Vietnamese, or a Russian steel worker, yet modern theory tells us his wage must some how converge to that of a hundred foreign competitors'. The only thing we are reminded is that a national minimum wage (which I have argued is ABSOLUTELY necessary to give worthless fiat money its value) is a hindrance to H-O model. Remember, reality is never allowed to get in they way of theory.
So will all the stars aligned with the Euro, what could be wrong here? The critique offered is simple. Imagine a theoretical scenario where the German metal-working industry is the superior competitor across all of Europe. What then is the unemployed Italian metal worker to do if he does not speak German? In a closed economy, he would normally move to the superior Italian metal-working leader. Again, his lost salary in a closed economy is directly reflected as a consumer saving that will be spent else where in the closed economy, thereby offering long term re-employment for the newly unemployed. This is normal economic growth driven by competition. With the Euro this key mechanism is broken. End of story.
Fair trade is therefore a fantasy, because money is a rigid domestic phenomenon. Borders and language matter. Money is not made out of bungee cord material so to speak (i.e. supply and demand pricing). It is precisely because of this intellectual defect that Hume's model of money did not prevent economic chaos from being unleashed under the Articles of Confederations due to low cost British manufactured goods (the protectionist Constitution was to be the big fix). Since the spirit of Hume lives on in modern economic theory today, we have effectively returned to the economic principles of the Articles of Confideration. Expect the same results.
Additional reads by this author: http://www.economicpopulist.org/content/myth-middle-class-economics-5665
Note2. This discussion did not address the other neoclassical myth that the wages in the developed nation will have to drop to that of an impoverished peasant for balanced trade to work. This notion is only possible under QTM which we fully reject. Perhaps a topic for the next essay. Critique is of course welcome. Only by putting our heads together with a healthy debate we can save our country.