Population Density and Trade

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Here's Another Flawed Theory!

"One of the speculations I have made from time to time is that the very assumptions underlying neoclassical economic theory are so flawed in comparison with reality ...."

Truer words were never spoken! I'd like to serve up another example. In 1815, Ricardo introduced his "principle of oomparative advantage" in which he hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. He offered up hypothetical examples to support this theory, but no empirical evidence.

But no matter. Although the United States had built itself into the wealthiest nation on earth - its preeminent industrial power - our leaders believed that Ricardo's theory was a path to even greater riches. So in 1947 we signed the Global Agreement on Tariffs and Trade and "bet the ranch" on Ricardo's unproven theory. Six decades later, the U.S. has been transformed into a skid row bum, literally begging the rest of the world for cash to keep us afloat. While this free trade policy has certainly benefitted global corporations, it has been an unmitigated disaster for the common good of the American people. Median income and net worth have fallen. Debt has soared out of control. The life blood has been drained from our economy.

Why? We were already the most productive nation on earth and we continue to improve. While our quality may not have measured up at one time, we are now on a par with the best in the world. Our workers have taken cuts in pay and benefits and have worked tirelessly to improve their competitiveness, but still our trade deficit grows and manufacturing jobs flee the country.

Clearly, something is amiss with free trade and Ricardo's theory. Is it possible that he missed something?

At this point, I should introduce myself. I am a self-published author of a book titled "Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America." To make a long story short, my theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (which always rises), inevitably yields rising unemployment and poverty.

This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It's because these effects of an excessive population density - rising unemployment and poverty - are actually imported when a nation attempts to engage in free trade in manufactured goods with a nation that is much more densely populated. Their economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.

One need look no further than the U.S.'s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!

Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. In fact, our largest per capita trade deficit in manufactured goods is with Ireland, a nation twice as densely populated as the U.S. Our per capita deficit with Ireland is twenty-five times worse than China's. My point is not that our deficit with China isn't a problem, but rather that it's exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one sixth of the world's population.

Ricardo's principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it is a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.

If you're willing to consider a new economic theory that has originated beyond the hallowed halls of academia, one that sheds new light on how trade actually functions in the real world, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface for free, join in the blog discussion and, of course, buy the book if you like. (It's also available at Amazon.com where you'll be able to have it shipped outside the U.S.) However, because your site obviously has a large following, I'd be very happy to send you a free copy. Just E-mail me your shipping address.

Please forgive me for the somewhat "spammish" nature of the previous paragraph, but I don't know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.

Thanks for your time and attention.

Pete Murphy
Author, Five Short Blasts

Additional consideration

It was not a coincedence that the housing bubble burst, when the Comprehensive Immigration Reform effort failed. Investors realized that America would soon run out of sub-prime customers.

When we compete directly with undeveloped countries, salary-requirement comes into play.

Housing, food, fuel etc. make up the salary requirement. When nomadic workers are added to a high-cost economy, this creates a personal asset equity imbalance. The nomadic worker forgoes real property equity in both economies, forcing the domestic worker to compete at the nomadic worker's level, enhancing equity inflation here and retarding equity inflation abroad.

Now that the sub-prime is dead, we are left with hyper-inflated housing costs, and an excessive supply of labor. The end result is wages that do not keep up with housing inflation, and now, a have a lack of qualified home buyers with "traditional" mortgage qualifications.

To compete globally, the administration's plan seems to include allowing housing equity to crash, lessening the American housing costs -- thereby lessening salary requirement at the global level.

The "other" option is drive the USD down to "competitive" levels.

Ricardo's "principle of comparative advantage" still works. What we see happening here is an absolute-advantage, the comparative-advantages are not being discovered.

The "free movement of human capital" defeats the need to provide investment capital in the emerging nations. (AKA a second shift/cheaper labor is being added to existing factories.)

Inflation in emerging nations is retarded and the absolute-advantage persists.

Costs Factor in Emerging Nations is Over-blown

Thanks for the reply, Weaver. I understand what you're saying about labor costs being retarded in developing countries. There is some element of truth to what you're saying.

However, when we examine our trade data closely, we find that, of the top twenty per capita trade deficits in manufactured goods, only two of the top ten deficits are with nations with per capita purchasing power parity less than $20,000 per person. Only seven of the top twenty deficits have purchasing power parity less than $20,000. In other words, our worst per capita deficits tend to be with rather wealthy nations - Ireland, Japan, Taiwan, Switzerland, Malaysia, Germany, Austria, Denmark, Mexico, Korea and Italy. (Yes, Mexico's per capita purchasing power parity is $23,600.)

However, like I said in the original post, 18 of the top 20 deficits are with nations much more densely populated than our own. Clearly, population density plays a much more dominant role in driving our trade deficit. While labor cost can be an initial draw to lure away manufacturing jobs and establish a trade deficit, the deficit doesn't reverse as the workers earn more money. Take Japan for example. Decades ago their workers earned very little. Today, Japan is one of the wealthiest countries on earth, yet we have a per capita trade deficit in manufactured goods with them that is more than four times worse than our deficit with China.

Ricardo's theory may work when applied to nations of roughly equal population density, but it completely breaks down when attempting to trade freely with nations whose markets are stunted by over-population.

Pete Murphy
Author, Five Short Blasts