Free Trade and Mercantilism I

There is a story of a bitter rivalry between tow old Scottish farmers whom we shall call McGraw and McGrew. God decides to show them the error of their ways, so he said to McGraw: "I will give you anything you want, but there is a catch. Whatever I give to you, I will give two of to McGrew."

McGraw is torn between his greed and his hatred for McGrew, so he thinks long and hard. Finally he says: "Lord, put out me one eye."

Economists are nearly unanimous in their belief in free trade, but the public is much more suspicious. Economists tend to ascribe this difference to the publics failure to appreciate the subtle point of Ricardo's theory of comparative advantage. Wikipedia illustrates that point with the following nice example:

Two men live alone on an isolated island. To survive they must undertake a few basic economic activities like water carrying, fishing, cooking and shelter construction and maintenance. The first man is young, strong, and educated and is faster, better, more productive at everything. He has an absolute advantage in all activities. The second man is old, weak, and uneducated. He has an absolute disadvantage in all economic activities. In some activities the difference between the two is great; in others it is small.

Despite the fact that the younger man has absolute advantage in all activities, it is not in the interest of either of them to work in isolation since they both can benefit from specialization and exchange. If the two men divide the work according to comparative advantage then the young man will specialize in tasks at which he is most productive, while the older man will concentrate on tasks where his productivity is only a little less than that of a young man. Such an arrangement will increase total production for a given amount of labor supplied by both men and it will make both of them richer.

So is that really so hard to understand? I don't think so. I think that the real reason that the public is suspicious of that argument is an instinct more fundamental than the economists sacred principle of profit maximization, taught to us by the ages of evolution, that success and survival are mainly a matter of competition for resources.

Mercantilism, in it classic enunciation, has severe theoretical flaws which were well exposed by Adam Smith, David Ricardo, and others, but it has proved far more durable and successful as an economic policy than that theory would suggest. China, Japan and the other Asian economies have pursued effectively mercantilist policies with enormous success, while the US, a prime proponent of free trade, has stumbled badly. Britain and the US each became industrial behemoths and world powers in part due to mercantilist policies, especially by promoting and protecting domestic industry.

McGraw, our Scottish farmer, was not a pareto optimizer, and neither is evolution.

So was Ricardo wrong? Not really, of course, but oversimplified. Chinese mercantilism, combined with some American and other stupidities, has helped put the World in it's current financial mess, but China has managed to very quickly become a dominant industrial power. We, meaning mainly the US and Europe, got some benefit too - cheap DVD players and mortgages, a big limit on the governments credit card, and a chance to rethink some verities.