The Great Economists Read online

  For reshoring and reindustrialization to take hold, therefore, will require people to see industry in a new light. Will Americans really contemplate going back to work on the factory floor? A common concern of companies is the shortage of skilled workers. I conducted an informal survey of students at the University of Tennessee and found that most didn’t see their future in manufacturing. Some wanted to finance those plants, while others said that they weren’t good enough at mathematics to work in advanced industries. But they all agreed that manufacturing has an image problem: it might have provided suitable employment for their parents’ generation, but it was not for them.

  Still, the innovation side is flourishing. At Oak Ridge National Lab, a hundred students gather after school each day to compete to build the best robot. One of the signs that I saw said ‘Made in America’, but in Chinese characters. It’s their way of signalling that the ‘Made in China’ labels in English on their clothes and electronics will soon face some serious competition. Stimulating competition and better economic output is what David Ricardo would have predicted when nations trade and spur each other on.

  How advanced manufacturing is changing trade patterns

  According to the Brookings Institution, advanced industries such as Nissan’s automated factory discussed earlier have grown 30 per cent faster than US GDP since 1980. In an era of slow wage growth, advanced industries also report earnings growth that is five times faster than the average for the US. Since the start of the 2009 Great Recession, these industries have added around a million jobs.

  However, the Information Technology and Innovation Foundation attributed the resurgence in manufacturing jobs to a rebound from the depths of recession. That opinion was echoed by the Center for Business and Economic Research at the University of Tennessee. They forecast that manufacturing jobs will decline once again and that industry will return to its long-term trend of winnowing employment in the face of both overseas competition and automation. That’s consistent with the long-term trend where American industrial output has increased since 1950 in absolute terms, but has seen its share of GDP fall as services have grown more quickly.

  It’s a similar pattern in Britain. Like the US, British manufacturing has grown in absolute size over the past few decades. But, as a share of GDP, manufacturing now accounts for about one-tenth of national output. Despite the last recession, Britain is still among the top ten largest manufacturers in the world and the bulk of R&D spending, over 70 per cent, goes into the sector. Compared with its share of GDP, manufacturing makes an outsized contribution to exports, accounting for nearly half of what Britain sells abroad. But the UK still imports more manufactured goods than it exports, so there is a trade deficit. Again like America, the industries that sell overseas tend to be in advanced sectors, so technologically oriented firms with STEM workers constitute the new face of manufacturing too. But there hasn’t been a rebound in manufacturing jobs in high-tech sectors like chemicals, pharmaceuticals or the motor industry. Only the aerospace industry has seen job growth nearly a decade after the recession. Also, labour productivity, that is output per worker, is low. Britain ranks above the world average, but lags behind other countries like the US as well as Germany. Could the UK also experience a reshoring of manufacturing? One issue is a scarcity of STEM workers, which is often mentioned as an impediment for UK employers in business surveys.

  So, where does this leave advanced economies like Britain and America? Even if manufacturing output is reshored back to the US or the UK, manufacturing is unlikely to become the biggest part of the economy. Employment will also likely face pressure from robotics and automation. Still, the US experience with the reshoring of production holds lessons for Britain and others as to how to become more competitive in high-end manufacturing, which in turn has implications for what drives growth and also a nation’s trade position.

  In the previous chapter, we learned what Adam Smith would say about governments trying to rebalance their economies. But what about the related issue of setting trade policy? What would David Ricardo advise governments to do in the face of these trends and a large and persistent trade deficit?

  Ricardo’s theory of comparative advantage

  David Ricardo’s theory of comparative advantage states that each country should produce and trade what it is relatively least bad at. Even if China can produce everything more cheaply, America should still produce what it is relatively better at, and so should China. Thus, it is in the interests of every country to specialize in terms of what it produces and trade for what it no longer produces as much of. No nation is completely closed off to the world economy (even North Korea trades with China). That is known as ‘autarky’, where there is no trade. Thus, all countries choose to trade because international trade increases efficiency for an economy as well as consumption for its people.

  Ricardo used the examples of English cloth and Portuguese wine to illustrate his theory. If it takes eighty Portuguese labourers to produce wine and ninety to produce cloth, then it should export wine and import cloth since it is more efficient at producing wine than cloth. Portugal should buy cloth from England even if it takes a hundred English workers to produce the cloth. That may seem surprising, but Portugal is more efficient at producing wine, so by specializing in wine, it can produce more and import what it is relatively less good at.

  In England’s case, it takes more labour to produce both cloth and wine than in Portugal, for example a hundred labourers to produce cloth and 120 to produce wine. So, England should specialize in cloth because it is relatively more efficient at weaving, though it is not an absolute advantage since Portugal can produce both cloth and wine with fewer workers. England would then import wine, which it is less efficient at producing.

  By specializing and then trading, both countries can consume more than if they produced everything themselves. It’s not an intuitive concept. Nobel laureate Paul Samuelson observed that this fundamental premise of international trade, comparative advantage, was the best example of an economic principle that is undeniably true yet not obvious to intelligent people.22

  Does Ricardo’s comparative advantage help us to understand whether we should be concerned about trade deficits? Firstly, there are criticisms of his theory to note. Ricardo has been accused of neglecting some of the most important issues in international trade, including presenting a static rather than a dynamic model. In Ricardo’s model, countries cannot influence their comparative advantage – a country that is richly endowed with natural resources would specialize in agriculture, for example. But sometimes countries shape their comparative advantage in an attempt to influence what they specialize in, for example with government policies that promote certain sectors. This has become known as ‘new trade theory’. This extension of Ricardo’s model has been developed, notably by Paul Krugman who won the Nobel Prize for his work on a dynamic theory of trade. New trade theory implies for Britain that, even if it’s not abundantly endowed with a large population, it can still promote high-tech manufacturing and need not be entirely squeezed out by lower-cost manufacturing nations.

  Ricardo was also criticized for making unrealistic assumptions about the immobility of labour and capital. His theory of comparative advantage works because capital is not as freely mobile between countries as it is within a nation. If it were, English capital would move to Portugal and cloth as well as wine would be produced there too. The movement of labour is scarcely mentioned by Ricardo.

  This leads to another problem as to whether or not Ricardo was assuming complete or incomplete international specialization. Countries don’t usually entirely abandon a sector, so complete specialization is rare. But Ricardo doesn’t examine the consequences of incomplete specialization, nor does he work out where prices of traded goods settle and just assumes it’s at a mid-point between the prices of the two trading nations.

  Perhaps more important than the technical objections is that Ricardo was thought to have ignored the question of the ‘distr
ibutional’ impact of trade as well as the politics of when nations trade. For instance, he assumes full employment and automatic adjustments of sectors of the economy to the introduction of international trade, neither of which is usually the case. Also, he doesn’t address what happens to those who become redundant when their industries are abandoned or downsized following specialization. As ever, even though the country is better off, some will benefit more than others.

  Ricardo has also been criticized for neglecting the unequal power relations between England and Portugal, the illustrative countries he used in Principles. The Cambridge economist Joan Robinson argued the Ricardian tradition would ‘imply trade between countries of equal weight and at the same level of development. This rules out imperialism and the use of power to foster economic advantage.’23 She added:

  in real life Portugal was dependent on British naval support, and it was for this reason that she was obliged to accept conditions of trade which wiped out her production of textiles and inhibited industrial development, so as to make her more dependent than ever.

  … When [capital] accumulation is brought into the story, it is evident that Portugal is not going to benefit from free trade. Investment in expanding manufactures leads to technical advance, learning by doing, specialization of industries and accelerating accumulation, while investment in wine runs up a blind alley into stagnation.24

  It’s worth pointing out that trade theory accounts for just one chapter in Principles. So, had Ricardo focused more on trade and less on the other economic theories in his seminal work, some of these criticisms might have been addressed.

  Nevertheless, economists are agreed that Ricardo’s theory helps to explain the basis of why and how nations trade. Economists recognize that the country as a whole gains from trade, but there will be losers in the industry in which the nation no longer specializes. They also see that, once politics is considered, less developed economies may struggle with negotiating the terms of trading with richer countries that provide them with aid.

  For post-industrial economies like the United Kingdom’s, cheaper manufactures from the developing world have made it harder for Britain to compete and hastened the move into services. So, globalization adds to the challenge of rebalancing the economy. Ricardo would see this as inevitable, but also as related issues to be addressed together.

  David Ricardo wouldn’t focus government policy on the current account deficit alone. The core of Ricardo’s theory is that production and exchange were what determined economic prosperity, not the mercantilist policy deployed to foster a trade surplus in his day.25 This is similar to Adam Smith, who believed that such efforts to promote a favourable balance of trade were ‘absurd’.26

  Like Smith, David Ricardo would instead urge policymakers to look at the health of the domestic economy and not focus solely on the trade position. How efficient a country is at producing goods and services will help determine its comparative advantage, and that leads to its trade balance. Aiming for a trade surplus without examining what needs to be done in the domestic economy to make exports more desirable to the rest of the world would have struck Ricardo as the wrong way to go about it.

  Ricardo on whether trade deficits matter

  There’s no doubt that David Ricardo’s theories held sway in his day as they do now. Trade barriers began to decline in the 1830s. In 1843, a weekly magazine titled The Economist, which supported the emergence of free trade and markets, was founded by James Wilson. It included work by Wilson’s son-in-law Walter Bagehot. After the Corn Laws were repealed in 1846 and Britain became an industrial powerhouse, the rest of the world soon followed. When the United States was founded in the second half of the eighteenth century, tariffs represented nearly 100 per cent of the new government’s revenues. By 1910 it was 50 per cent and it’s since fallen to less than 2 per cent of the government budget.27

  But, even as trade barriers persist in services and agriculture, the World Trade Organization’s liberalization agenda has stalled in the twenty-first century.

  So, in an imperfect global trade regime, America’s and Britain’s comparative advantage hasn’t been able to deliver all of the benefits postulated by Ricardo. He would also be concerned about the lack of a level playing field in international trade. Ricardo would have pushed harder for the opening of global markets, particularly the relatively closed services sector. Services trade liberalization would help both America’s and the UK’s trade position and the global economy too, since over 70 per cent of world GDP consists of services.

  With greater opening of trade and investment in services, Britain’s deficit position may improve if its dominant sector can gain greater traction in world markets. In the meantime, Ricardo would not have been excessively concerned about Britain buying more from the rest of the world than it sells. He would have viewed the trade deficit of Britain as symptomatic of the structure of the economy. Specifically, the UK specializes in services, which, unlike manufactured goods, are partly non-tradeable. So, Britain imports goods that contribute to its trade deficit, while what it produces is in part consumed at home. In any case, he would have pushed for the UK to maintain the openness that it has had since the repeal of the Corn Laws. Finally, had Ricardo had the chance to expand his exposition of his trade model, given his recognition of the conflict among classes, he may well also have accepted measures to redistribute the gains from trade away from rent-seekers and more to those harmed. That would help those left behind when an economy begins to specialize in certain sectors and less in others.

  The final chapter will tackle this issue and what Ricardo, and the other Great Economists, would say about how to help the losers from trade and what the backlash seen in various advanced economies means for the future of globalization.

  CHAPTER 3

  Karl Marx: Can China Become Rich?

  Karl Marx was one of the most influential, and also one of the most controversial, economists in history. Marx and his collaborator, Friedrich Engels, proclaimed in the opening sentence of the Communist Manifesto: ‘The history of all hitherto existing society is the history of class struggles.’1

  Marx was a man of contradictions. He advocated for the working class, but lived in genteel though poor circumstances. That was not uncommon for the time. Most nineteenth century European revolutionaries were middle-class intellectuals and not labourers. For instance, although Jenny Marx was the wife of a revolutionary, she continued to print stationery embossed with ‘Baroness von Westphalen’.2

  Despite Karl Marx’s widespread influence, John Stuart Mill, one of the foremost thinkers of that time, had never heard of him,3 perhaps because Marx published little in English during his lifetime. Marx’s seminal book, Capital, was published in German. He was well known in German debates, but less so to an English audience.

  Posthumously, Marx’s theories of communism transformed the economies of some of the largest countries in the world. From Russia to China, communism took hold in some form as these nations sought an alternative to the US-led capitalist model at the start of the twentieth century. The notions of economic equality and communal effort were among the reasons Russia turned to Marx. Their communist revolution in 1917 led to the establishment of the Soviet Union, which vied with the capitalist United States as the economic model du jour during the Cold War which lasted from the end of the Second World War until the fall of the Berlin Wall in the late 1980s.

  Marx’s most notable success is communist China. The world’s second largest economy and its most populous nation adopted communism after its 1949 revolution and has remained governed by the Chinese Communist Party ever since. But starting in 1979, when economic stagnation led its leader Deng Xiaoping to adopt reforms, China has moved away from a planned economy towards a more market-based one. These reforms generated remarkable economic growth, which propelled China from being one of the poorest economies in the world to challenger to the United States. But China’s transition is ongoing and numerous difficulties remain, includin
g how to sustain economic growth in a system that is still dominated by the communist state in certain sectors.

  What would the father of communist ideology make of China’s transition to a market economy and its reform challenges? Can a communist country like China grow rich?

  The life and times of Karl Marx

  Like David Ricardo, Karl Marx came of age during the Industrial Revolution, though in Germany, which it reached later than in Britain. Born in 1818, Marx grew up in Trier, an agrarian town which belatedly experienced industrialization. There was no industry there during his childhood, and not even a railway until 1860. As Marx commented of his hometown: ‘there are simply no sources of earning a living on which we can count’.4 Until the end of the eighteenth century the city was organized in a ‘society of orders’. Rights pertained not to individuals but to groups based on birth or religion, and were even set out in legally binding charters. Under this system, Catholic clergy and petty nobles collected payments from peasants. It was far from fair or equitable, which are recurring themes in Marx’s communist philosophy.

  Marx is usually described as being descended from a long line of Trier rabbis. Marx’s Jewish ancestors had to pay special taxes to their lords for the privilege of residing within their territory and were generally restricted in terms of their occupation to commerce and finance. There were often special restrictions on where Jews could dwell and even in their social relations with Christians. In Trier, some Jews paid ‘protection money’ and an annual ‘New Year’s Donation’.5

  This social order came to a violent end after the French Revolution when, in 1797, Trier was annexed to the French Republic, which took the territory from the Holy Roman Empire. It then became a place in which all citizens were equal under the law. In 1812 the Prussian Chancellor Prince Karl August von Hardenberg issued an Edict of Emancipation for Jews, granting them freedom of residence and occupation, and the right to serve in the armed forces. For Heinrich Marx, Karl’s father, the French Revolution offered an opportunity. He could become a lawyer, a profession which previously had been closed off to Jews.