Economic decline and the doctrine of free trade

In my opinion the underlying reason for the impending disintegration of Europe is free trade policy as pushed by Germany (see my essay the “The ugly German – a specter is coming back”). I am, of course, aware that this view is diametrically opposed to accepted wisdom as to be found in economic textbooks. Therefore, I would like to emphasize at the outset that I do not consider those textbooks to be wrong – their theory is, indeed, hard to refute and at first glance it seems to be morally sound as well. In my new book, “From Crisis to Chaos”, I even speak of “neoliberal idealists” – a wording which may sound rather queer to some ears (1). But if they are honest, neoliberals certainly strive for the best. Unfortunately, despite of all their endeavors, they always achieve the worst, and for this there is a very simple and basic reason: Their theory and the world we happen to live in, do not share much of a common ground.

Great Britain: Let those Americans not even produce a single horseshoe-nail!

How much theory and reality became estranged from the very beginning, becomes evident as soon as we go back to the infant stage of free trade ideology. Inventing the comparative advantages of free trade David Ricardo succeeded in embellishing the pure lust of power and profit with the trappings of a seemingly plausible theory. According to the British mastermind of free trade, the Portuguese should be content with the production of wine, so that the British could use their talent in making machines (and weapons). From the outset this recommendation was based on a verdict of power. India and all other colonial territories then under the rule of Britannia were certainly not persuaded to deliver their raw materials to the homeland – they were forced to do so. For according to Ricardian theory, that was what they could do best. Nobody cared for the fact that Indians once had their own flourishing and highly developed textile industry. Britain destroyed all that by sheer force, officially justifying such doings by comparative advantage. As long as it ruled the world as a superpower, it interpreted free trade to its own advantage, namely as a license to flood the world with its high-quality industrial products and to suppress anywhere in its colonies existing or nascent industries that might develop into future competitors.

Friedrich List and John Stuart Mill. Few were those who unveiled hypocrisy.

Not all economists were impervious to the fundamental hypocrisy of English free-trade ideology. Friedrich List (1989 – 1846), the first professor of economics in Germany, was the most eloquent, the most perceptive and the most persistent critic of English “cant “, i.e. that peculiar type of hypocrisy which seeks material profit under the mask of seemingly scientific and idealistic motives. “Even in the days of Lords Chatham and North the English open parliament bluntly insisted that North America should not even be allowed to produce horseshoe-nails on its territory… With Adam Smith, however, government was offered a new device, namely to hide the true policy of England behind cosmopolitan phrases and arguments in view of preventing foreign nations to imitate the policy [of industrialization]”(2).

Mind you, these words came from an economist, who was the founder of the German customs union (Zollverein), and as such was a strong supporter of free trade – free trade within a politically unified region. Unremittingly List insisted on the fundamental difference between fair trade within a politically unified territory, and free trade between nations, which, as a rule, tends to be exploitative and unfair. As he himself put the matter: “…and so freedom of trade has become popular without people making a distinction between the freedom of internal trade and of international trade, though both are radically distinct in nature and effects” (3).

Decline: And soon Britain herself became the first victim of free trade ideology

The insights of Friedrich List should soon be proved empirically. During the early twentieth century England herself became the first victim of her ideological invention. At the very moment when England was no longer strong enough to protect her markets against the invasions of competing nations (especially Germany), it was stripped first of the monopoly of its major industries, then of those industries themselves and finally of its status as a world power. Today, virtually all once world-famous British companies have disappeared from the scene. England, the pioneer of industrialization, has become an industrial wasteland. It now survives on oil and a reckless, shady and hardly sustainable financial transactions industry.

Japan’s rise – a resounding success of protectionist policies

Japan presents us with another case that bluntly contradicts accepted textbook wisdom as still upheld by economic interest and its subservient scientific followers. Nippon owes its rise to an economic giant to unabashed protectionism, the need of which was not only obvious to a German professor like Friedrich List, but accepted as undisputable evidence even by John Stuart Mill (1806 – 1873), arguably the most prominent English thinker on politics and economics. But even Mill did not escape the wrath of his ideologically tough and narrow-minded colleagues when – though in an extremely cautious way – he expressed the obvious truth that “… protecting duties [import duties] can be defensible, when they are imposed temporarily (especially in a young and rising nation) in hopes of naturalizing a foreign industry “(4). The great Englishman was referring to the United States, but soon afterwards his words would apply to the land of the Rising Sun, which, since 1867, made great efforts to overcome its current status as an impoverished rural economy.

How could Japan possibly achieve its goal without turning to protectionism? All industrial products of that time either came from Europe or the United States. In order to set up its own industries, Japan had, first of all, to protect itself against the inroad of these overwhelming competitors. For decades to come the Japanese government had to force its own people to buy domestic industrial products, which for quite a time were much less sophisticated and more expensive. However, this was the only chance for a domestic industry to come into being. The Japanese blocked foreign products right at their ports by high tariffs and duties. And they continued to do so after 1945 and a lost war. At that time the United States benefitted from intact industries which could offer their products much cheaper than the rest of the world.

No loss of competitiveness or innovative capacity

Up to the present day textbook wisdom dogmatically proclaims that protectionism leads to competitive disadvantage and a decline of innovative strength. This is another dogma contradicted by the case of Japan. There was no standstill of innovative force. Quite the contrary was true, for within Japan itself competition between big companies reigned supreme. During the period of strong protectionism (always under heavy attack from abroad), Japan became one of the technologically most developed nations – so much so that in the late 70s futurologist Herman Kahn predicted Japan’s rise as the leading economic superpower for the end of the twentieth century (The Emerging Japanese Superstate).

As we now know, futurology has once again made a false prophecy. On foreign, particularly American, pressure Japan was forced to gradually open its markets. So its further rise was soon stymied. What followed was a gradual, but inexorable descent. At the same time, China was becoming more powerful – everybody knows that to this day China maintains a highly protectionist policy.

The United States of America – Rise and decline of a superpower

And what with the United States, one of the largest politically united economies? Textbooks rather tend to overlook the historical truth that between the Civil War until Word War II this country pursued a policy of more or less blatant protectionism. Abraham Lincoln had warned his countrymen: “I proceed to try to show that the abandonment of the protective policy by the American Government must result in the increase of both useless labour and idleness; and so, in proportion, must produce want and ruin among our people” (5). At that time Americans were wise enough to disregard ideological instructions from the Old Continent. Foreign goods dangerous to domestic producers were charged with import duties up to 50 percent.

Truth in the service of economic interests

This policy changed rather abruptly towards the middle of the 20th Century, when Europe’s industries had been largely destroyed. Now, Americans no longer needed to fear serious economic competition. The wall around their economy had become obsolete. Rather, they had to prevent others from erecting protective walls against their own industrial production. Pragmatic and non-ideological, as Americans have always been, they simply and radically changed their mind, turning from strict protectionists into enthusiastic followers of the free trade creed. In other words, they did what all nations do: they took care of their own advantage – but let’s not forget that the American export push took at its start the shape of generous gifts as proposed by George C. Marshall.

The consequences of this about-face proved to be quite serious for economic science. While up to then the teachings of Adam Smith had been all but disregarded, this man now rose to sudden prominence in American politics and in the academic sphere. His doctrine of free trade turned out to be just the right tool for the right moment. It served to bestow scientific respectability to the newly accepted creed. From now on, Americans divulged the free-trade gospel with missionary zeal among the rest of the world. Anyone who wanted to embark on an academic career, to earn a living in finance and industry or to achieve a position in senior management of banks or corporations knew what he was now expected to fervently believe and uphold: the gospel and dogma of free trade. By gentle and sometimes quite ungentle pressure America made sure that the new gospel would start a triumphal march around the globe.

The initial advantage of free trade did not persist

Was the gospel of free trade really to the benefit of US-national interest? In the aftermath of Europe’s and Japan’s wartime collapse this was indeed the case – America lived through two happy decades. But this state of affairs did not last for Europe and Japan recovered at an amazing pace. Soon, national interests were redefined: they became the interests of a shrinking, but powerful minority. Free trade no longer served America as a whole, but increasingly only secured the further enrichment of an already very rich part of society. This had serious consequences for social cohesion. Protectionism as demanded and upheld by Abraham Lincoln and his followers had welded the American people into one firmly integrated whole. Free trade reversed this process. It began driving a wedge into the American population, as a majority turned out to be a loser while the economic elite reaped all the fruits of unrestrained international trade.

Who belongs to this elite? American investors, for instance, who put their money in companies outsourcing to Asia because, by doing so, they achieve much higher profits. China-made products now filling the shelves of supermarket were, of course, much cheaper than American ones – a huge gain for the outsourcing companies and their financial backers. Initially, American consumers too were quite satisfied, because they could substantially cheaper – they saw their purchasing power steeply increasing. At that time many thought that America after turning to free trade and abandoning its previous policy of protection had discovered something like the philosopher’s stone. All seemed to benefit from this change.

And now again a superpower accomplished its own demise

But this was true only for quite a short time. It soon became apparent that more and more American jobs got lost as the corresponding products were now produced outside America. And if jobs did not get lost, they had to get cheaper. Only by reducing labor and production costs could America hold on against the cheap products of Asian competitors. US economic historian Ravi Batra has shown that as far back as the 70s, US wages and the middle class were subject to steady corrosion, which itself was caused by the removal of large parts of America’s industrial base (6). Today the United States suffer from mass poverty – the former American dream has gradually turned into the beginnings of a nightmare. How did American scholars and intellectuals – a part of the elite – react to the process of economic decline? On the whole it was the last to open its eyes to factual evidence even as the latter so blatantly contradicted its ideological stance. The real impact of free trade was only grasped when it could no longer be denied that economic decline had eroded America’s standing as a superpower. Political scientist Francis Fukuyama, for example, a veteran neo-liberal, who recently had so eloquently praised the American model of capitalism (see The End of History), was one of the last to understand what had really happened. It was not before January 2012 that he revealed his latest insight: namely that the U.S. had lost their industries, and thus their status as an economic superpower to China! “We thought to make the best of globalization by producing nothing ourselves and offering services instead. This was a mistake. We forgot that socialism never was a big issue in the United States, because enough people always managed to move into the burgeoning middle class. Nowadays, this is no longer the case, because they have worked in industries that we have outsourced to countries like China… ” (7).

The last sentence is crucial, because Fukuyama here points to an important fact. In the long run imports and exports will be equal in value (otherwise one nation would make presents to the other). But there is no equilibrium in job creation. In addition to exporting raw materials such as corn or wheat, which in a highly mechanized agriculture are practically produced without human labor, the U.S. sells services, e.g. patents and licenses, and, of course, some technologically highly sophisticated products – though in a shrinking number. For these they may still demand monopoly prices – but only as long as Asia does not overtake them in this field too. High tech industries and research do not, however, create jobs for the majority of American people. Fukuyama is quite right in his diagnosis: Work is being outsourced to Asia at a staggering pace.

The elite’s loss of credibility

Have “neo-liberal idealists” drawn the right lesson from their failure, will they finally rewrite their textbooks? This is hardly to be expected. As Einstein put it: False theories rarely die, only those who uphold them are, fortunately, mortal beings. And after all, there can be no doubt that America greatly benefited from outsourcing. The only question is who and what we understand by “America”. By now everybody should know the answer. It is the America of the super rich, a small layer that has invested its money in China and outsourcing companies. This new plutocracy (as Noam Chomsky calls it), this one percent, which the Occupy movement has chosen as the target for its Union-wide protest movement, has turned free trade and free financial transactions to its exclusive benefit. This one percent still governs US politics and economics and still dominates much of the rest of the world. And this one percent still manages to pull scientific truth by the nose. Free trade ideology continues to represent the official western creed.

Living in a nuclear powder keg, we can no longer afford “The Rise and Fall of the Great Powers”

Scientific ideology – as opposed to scientific truth – is the conscious or unconscious immunization against factual evidence, caused by the pressure of interests. Ideology has succeeded in making the word “protectionism” taboo – indeed it is nowadays so objectionable as to resemble in words like rape or pedophilia. Hardly any economist caring for his personal reputation will openly commit himself to protectionism (8). This state of things is a great misfortune especially for Europe; the old Continent being, in this respect, a blind follower of its American master.

May development in one part of the world only be achieved at the cost of industrial destruction in other parts?

Nothing less than peace is at stake when we turn to what to my mind is the paramount task of politics and economics. How do we ensure that the development of poor countries is not paid for with the decline of the formerly rich? The outsourcing of America’s industrial base to Asia, which now threatens Europe (first its periphery and later its industrial core), accurately describes this development. Once it is completed, the former prosperity of one region will have permanently drifted to another part of the world. (9) But do we have to accept as a kind of natural law that the rise of one nation necessary leads to the eclipse and demise of another? Must we acknowledge as historic necessity that the American and European age will soon be followed by an era of triumphant Asia? Will the United States and a few decades later even Europe turn into an industrial wasteland like the former world power Great Britain?

If you believe such an outcome to be inevitable, quite natural or even desirable (may others too get their chance!), I would rather think that you are not just naive but a dangerous dreamer. For you must be pretty blind to history in order not to see that leading powers rarely lose their supremacy voluntarily to others. War would be the most likely result. But modern mankind living side by side with a nuclear powder keg can no longer afford the devastations of war. Nuclear war between superpowers would lead to world wide destruction. Our utmost endeavor must be directed to the prevention of a “world war for wealth”. We must find a way to protect existing industrial structures while at the same time offering development to poorer nations. Otherwise war constantly lingers behind the seemingly noble façade of free trade. The pace of current Chinese military armament should serve as a warning. It uncannily resembles the similar efforts of Germany one hundred years ago – both nations felt themselves oppressed by a dominant superpower.

Europe

In a period of a great crisis destabilizing the world no less than last century’s Great Depression, we should first of all liberate our own heads from prejudices, biases and ideological constraints. I mean, that Europe would be well advised to turn to former America as its inspiration and guide. The great century of the United States roughly stretches from the mid-19th to two decades before the mid-20th Century (10). During this time, as they granted themselves protection against the outside, the United States not only coalesced into a nation, they could pride themselves as being the only originators of their own wealth and well-being. Everything the New Continent needed in terms of resources was found and obtained on their own territory. Americans produced for and purchased in their own country. Unlike Britain, Japan and China, which flooded the outside world with their own products, while at the same time keeping off foreign goods, the United States did not resort to unilateral protectionism (the only justification of which is temporary support of poor by rich countries). Americans protected themselves, but they also protected the rest of the world – from themselves. They did not outsource production in order to have others work for themselves, nor did they conquer colonies, thus reducing others to the status of mere suppliers for raw materials. At that time, in 1892, a columnist for the New York Harald could in earnest propose that the Ministry of Foreign Affairs be abolished since the United States had no real tasks to fulfill beyond their borders…

On close inspection, the word protectionism even turns out to be rather inappropriate within the present context. For the U.S., this period in question was one of self-determination and complete independence – arguably the happiest period of their history, when wealth was created for all and represented no threat to anyone. As already mentioned, this era was initiated by a President still admired today, namely by Abraham Lincoln. With regard to Europe, Lincoln had said: “Abolish duties and support free trade, then you will see our workers brought down to the level of serfs and paupers like in [mainland] Europe on.”

A new international order of peaceful coexistence will not come about by what Gabor Steingart quite realistically described as a “World War for Wealth”. Such an order will be realized only if (sufficiently large) economic entities rely for their own development on their own resources and reject external dependency for themselves as well as for others. That is what the United States achieved during their best time of history and that is what Europe should strive to achieve by turning to renewable energies and gradually moving towards self-sufficiency with regard to all vital resources. Outsourced jobs, destroyed industries, the constant pressure on wages accompanied by an exorbitant enrichment of a minority – in other words, all evils connected to the current “race to the bottom” may be warded off once Europe makes use of its own riches. No doubt, that its ecological future is totally dependent on such self-determination. Nobody denies that we may not deposit our environmental poisons in Africa thus destroying the nature of other countries, but in the same way we should not shun our own responsibility with regard to industrial production. This, however, is what we do when we outsource to Asia or let our wages and standards of living fall prey to worldwide low-price competition. If we want Europe to permanently coalesce into a unit as did America a century ago, we must guarantee its weakest members that they do not compete with the entire globe but only within Europe, where they may expect a secure market for their products.

France always wanted a more independent Europe

In a recent campaign speech, French President Nicolas Sarkozy exhorted French as well as European consumers to buy domestic instead of foreign products. He did this for electoral reasons, and his appeal was uncannily mixed with xenophobic slogans, i.e. with a good deal of unforgivable stupidity. He hoped to draw voters from the far Right of Marie Le Pen into his own camp. A decisive and honest turn to self-determination will, certainly, not be the result of populism and demagogy. And such a turn will, of course, affect exports in the same way as incoming goods. Nevertheless, France has shown a better understanding than Germany for the necessary foundations of a truly united Europe. Mitterrand already knew that free trade in which each member tried to gain maximum benefits for itself, even at the expense of its neighbors, would never weld Europe into a solid whole.

1 From Crisis to Chaos (Von der Krise ins Chaos), Signum 2012, pp. 126ff.

2 The National System of Political Economy. Jena, 1910; p. 475.

3 op cit., p. 87.

4 The Principles of Political Economy, book 5, chapter 10. Exactly the same theses are found in Chang, Ha-Joon, Kicking Away the Ladder (London, 2002).

5 See “http://lcweb2.loc.gov/mss/mal/maltext/rtf_orig/mal001_4.rtf”.

6 Ravi Batra, The Myth of Free Trade, New York, 1994.

7 See Der Spiegel, 30.1.2012 (my translation of the German text).

8 There are a few exceptions though. See the article of Harvard professor Dani Rodrik (http://www.project-syndicate.org/commentary/rodrik68/English).

9 How far American impoverishment has already gone with regard to the majority of people may be learned from the impending bankruptcy of the pension system. According to Northwestern University Professor John Rauh, the latest estimate of the total amount of unfunded pension and healthcare obligations for state and local governments across the United States is 4.4 trillion dollars (http://theeconomiccollapseblog.com/archives/broken-promises-pensions-all-over-america-are-being-savagely-cut-or-are-vanishing-completely).

10 The happy century was terminated by turbo-capitalism. During the 20s society was split into the few super-rich and a majority of gradually impoverished people. 1932 at his nomination as presidential candidate in Philadelphia Franklin D. Roosevelt made a remarkable speech: “Throughout the Nation, opportunity was limited by monopoly … For too many of us the political equality we once had won was meaningless in the face of economic inequality … A small group had concentrated into their own hands in almost complete control over other people’s property, other people’s money, other people’s labor – other people’s lives. For too many of us life was no longer free, liberty no longer real what, men could no longer follow the pursuit of happiness “(Franklin D. Roosevelt, Public Papers, Vol. 2, pp. 232-233.).

Marriner Eccles, chairman of the Fed and second most important man after the president, pointed to the economic causes of the Depression: “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth… to provide men with buying power equal to the amount of goods and services offered by the nation’s economic machinery… Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth…” (Marriner Eccles, cited from William Greider, Secrets of the Temple, Simon & Schuster 1989, p. 306).

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