Free-trade realities are hard to swallow

This is the second of two columns on foreign outsourcing.

Economics is built on slippery ground made softer by frequent rains of change. To be effective in this environment, an economist must be what horseracing enthusiasts call “a good mudder” – able somehow to find firm footing on a very sloppy track.

One of the few things that economists can count on to provide firm ground has been the benefit of foreign trade. It wouldn’t be far from the truth, in fact, to say that without the free trade vs. protectionism debate, economics as a science might not exist. It was certainly the desire to puncture the self-serving, protectionist arguments of mercantilism that led Adam Smith, the granddaddy of all modern economics, to publish his “Wealth of Nations” in 1776 (which was a particularly good year for puncturing self-serving arguments).

Adam Smith favored trade over protectionism. In the “Wealth of Nations” he wrote, “If a foreign country can supply us with a commodity cheaper than we can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.”

But the strongest, most rigorously developed, arguments for free trade are based on an economic theory called “comparative advantage.” This concept was first clearly described and analyzed by David Ricardo. He was an admirer of Smith, a practical, successful businessman who was also a brilliant economist, perhaps the best ever.

In his “Principles of Political Economy and Taxation” Ricardo argued and proved that trade between two countries benefits both even in situations where one of them is more efficient at making everything. He used an example of wheat and wine being made in England and in Portugal and proved his argument for trade so convincingly that after nearly two centuries of dissection by tenure-seeking academics the theory of comparative advantage, virtually unchanged, remains a revered element of economics dogma.

And revered it should be. There aren’t that many theories of anything that are still unchanged after the last 190 years.

Pretty much all economists, then, with the possible exception of those in the direct employ of labor unions, are free-trade enthusiasts. Economic theory supports it, unequivocally and doubt-free.

But any theory only works when its assumptions are met. Newton’s law covering the effect of gravity on falling bodies such as a rock and a feather, for example, works perfectly in a vacuum. But in our world, where air friction is substantial, anyone betting on the feather to drop as fast as the rock is going to come out a sure loser.

And there are two key assumptions in Ricardo’s theory of comparative advantage that we who occupy the real world should be looking at. The first is that capital does not move freely from country to country. The second is that labor doesn’t move that way, either.

In today’s world, the validity of both of these assumptions is questionable. International capital markets have developed to the point where they are a major, sometimes worrisome, factor in the global economy. And Internet-based technologies are allowing a “virtual migration” of labor that could not have been imagined two decades ago, let alone in Ricardo’s time.

But while it is clear that the key assumptions are now invalid, we don’t know how much damage this does to comparative advantage in practice. The assumptions behind the theory of perfect competition, for example, are so unrealistic and so unachievable as to be works of fantasy. Still, the value and benefits of competition remain evident in our economy.

So, what to do? Should we view Internet-based offshore outsourcing as just another form of international trade that we can adjust to, or look at it as a form of economic sabotage attacking the underpinnings of our economy and our society?

The truthful answer is that we do not know. The idea most recently voiced by Federal Reserve Chairman Alan Greenspan, that education is the answer is not very reassuring, given (a) the state of education in our country and (b) that jobs requiring post-graduate degrees can now be outsourced as easily as any others.

One thing that we can say for sure is that it is pure silliness to describe offshore outsourcing either as uniformly wonderful or as the work of traitorous corporate CEOs. We can also say with certainty that offshore outsourcing is a powerful economic force, and simply trusting that it will work in our favor would be foolhardy.

Foreign outsourcing, like foreign trade and immigration, can be considered healthy for our economy only to the point that we can absorb it without losing our footing. We need to blow the dust off our economic thinking, stop relying on dogma, and find out exactly where that point is. Now.

James McCusker is a Bothell economist, educator and consultant. He also writes “Business 101,” which appears monthly in The Snohomish County Business Journal.