Stabroek News
May 20, 2001

Recently there have been several exchanges in the press with regard to Guyana's comparative advantage, in the age of globalisation. Today, I want to revisit an aspect of these exchanges to point out a matter that we need to bear in mind constantly. Several months ago I had made the point that, globalisation as a process and liberalisation as the prescriptive policies which accompany it, find their economic rationale in mainstream neo-classical economics, reproduced in every standard economics text. Regrettably, there is much mystification in these texts, which creates a bias towards a dogmatic view of economic principles. As a consequence, too many persons exposed to some economics go through life the prisoner of an economics text they had read (five, ten, 15 and even 20 years ago) blissfully unaware of the serious methodological and conceptual shortcomings, which occur in economics textbooks because of the nature of the discipline.

Model building
The problem identified here arises from the fact that in real life, economic phenomena are extraordinary complex. In order to reduce this complex reality to a manageable situation for the purpose of analysis, economists build what are termed, "models". A model is really a formal or informal framework of analysis, which seeks to abstract from the real world those characteristics of an economic system or economic behaviour, which are considered essential for understanding the way the system works, or the behaviour of economic actors. The objective in building a model is to promote understanding. They are not designed to deliberately deceive.

However, the danger in model building occurs when the results obtained from the model are then treated as literal descriptions of the real world, and are no longer confined to the boundaries of the model. The danger is greater when, as is the usual case, the characteristics isolated in the model are only a few and these in turn are based on extreme versions of those characteristics. The most well-known example of this is the assumption of the "economic man" (síc). This person is assumed to be always consistently rational. There is no emotion or sentiment. Within the confines of the model, this person sets about maximizing his or her satisfaction or other objective, in a rational self-consistent manner at all times and in every situation. Of course, no such person has ever existed, and it would be very naive to imagine that the real world operates this way.

Optimizing
Another limiting feature of models is that they are usually built on very restrictive general economic conditions. For example, such conditions as perfect competition, perfect knowledge, perfect foresight, and no transaction costs are regularly assumed. Indeed, it is from such assumptions that economists define the ideal or optimal allocation of resources in a society or optimal benefits from trade. The optimum is called a "Pareto" optimum, after the Italian economist with the same name. In economics, when this optimum is achieved, society's resources are allocated in a manner so that no reallocation can make anyone better off, without making one or more other persons worse off. At this optimum welfare is maximized for all consumers, and efficiency maximized for all producing units

Free trade
It is this line of argument, based on these restrictive assumptions, on which the case for comparative advantage and free trade as global ideals are built. In practice, however, there has never been a country, let alone group of countries, which has ever subscribed to unrestricted free trade. No country has ever been convinced of the merits of free trade to the point that they are willing to practise it. This is indeed a sensible outcome, because the case for free trade is based on extraordinary restrictive conditions, which are unlikely to exist in the real world.

The early development and elaboration of the doctrine of comparative advantage as a basis for profitable international trade, developed at a time when much of global trade involved exchanges between very different industries. As for example, when agricultural goods were mainly exchanged for manufactures. These exchanges were possible because countries had very different endowments in terms of their productive factors. Some were suited for agricultural export because of their land and labour resources. While others may have been suited to manufacturers because of their technology, the industrial skills of their labour force, or available capital. This type of trade is known as "inter-industry" trade.

New trade
Today the bulk of world trade is no longer such inter-industry trade. Instead it is a new type of trade concentrated between the already industrialized economies, who exchange products in the same industry. For example, these countries are exporting and importing motor-cars, electronic equipment, pharmaceuticals, chemicals, and consumer goods. This new type of trade is called "intra-industry" trade. Its explanation is better suited to theories that relate to economies of scale, monopolistic and not perfect competition, and economies external to the firm, than comparative advantage.

There is also the further consideration that many of the firms engaged in this type of trade have branch plants, which are producing and selling their products on a world wide basis. These are the familiar TNCs. The greater proportion of trade today is such intra-company trade or exchanges of products within the same corporate structure. Clearly, if this is the case, such exchanges do not take place at "arms-length". In effect therefore, the price paid for such products are more likely to reflect the accounting strategies of these firms, than the play of competitive demand and supply factors in an open competitive market.

With such occurrences rapidly transforming the global economy, we have to be wary, if not impatient, with those who repeat dogmas of yesteryear as if they are eternal verities applicable to today's very changed environment.

Yesteryear's dogmas
If, the arguments I have advanced so far are not convincing, then look at the practice of the major countries in world trade. At present, the United States subsidizes each farmer to the tune of more than US$30,000 each year, and the US is the world's largest exporter of agricultural products. Indeed, over 98 per cent of global agricultural subsidies are found in the US and Europe, yet as we all know it is these same countries that preach the virtues of free trade to the Third World. With this knowledge, how can we therefore, without the careful sifting of fact from fiction follow these policies and rationalize them to ourselves on the basis of outdated economic dogmas.

One of the leading economists in the development of this field of new trade theory is Romer at the University of Berkeley at California. His work on strategic trade policy, intra-industry trade, endogenous growth, technology, imperfect competition, and external economies, provide the rationale for present day US trade policy. He was at one time economic advisor to President Clinton, whom as we all know presided over one of, if not the greatest performance of the US economy in its history. For those puzzled by the twists and turns of US trade policy, the work of Romer would represent a useful entry point towards understanding it.

I recommend the principle we should follow is that: comparative advantage makes greater sense, the closer we are to competitive situations, and the less is the extent of governmental interference in global trade, which is designed to protect national interests. We should design our interventions based on this reality, and not the other way around, that is, to take comparative advantage and free trade as granted. This other way around means succumbing to dogma and not being pragmatic.