WISDOM IN A NUTSHELL

Against the Tide: An

Intellectual History of
Free Trade
By
Douglas A. Irwin

Princeton Univ Press April 29, 1996

ISBN 0691011389
274 pages

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This book is a study of how free trade came to occupy such a commanding
position in economics and how it has maintained its intellectual strength despite
the numerous arguments that have arisen against it over the past two centuries.
The author is Henry Wendt Scholar in Political Economy at AEI. A summary of
the book follows.

The proposition that free trade is economically more beneficial than protection is
one of the most fundamental that economic theory has to offer for economic
policy. This proposition has survived repeated scrutiny from economists ever
since Adam Smith made his celebrated case for free trade in the Wealth of
Nations (1776), and it continues to receive overwhelming support from
professional economists today.

The first half of the book discusses the reasons for the widespread presumption
in economic thought prior to Adam Smith that import tariffs and other government
trade restrictions were likely to constitute a better economic policy than free
trade. Smith’s powerful attack on prevailing mercantilist doctrines and his
defense of free trade reversed this presumption among later economic thinkers.
The second half of the book assesses the most important and contentious
arguments made against free trade in light of both economic theory and the
historical record.

The Doctrine of Universal Economy

The doctrine of "universal economy"--that providence deliberately allocated

resources differently around the world to promote interaction among societies--
evolved from classical Greek and Roman accounts of the merits of seaborne
commerce. Subsequent economic thinkers have all acknowledged this essential
insight and have generally recognized and appreciated the gains from trade.
Indeed, the notion that countries, like individuals, stand to gain from
specialization and exchange is so powerful and so fundamental that few have
dared to refute it directly. No major school of thought has argued that complete
autarky is superior to any trade.

Yet, while not disputing the gains from trade, most philosophers and intellectuals
before Adam Smith still believed that trade should not be free. The earliest
writers were suspicious of merchants and rejected free trade on noneconomic
grounds. Greek and Roman philosophers, fearing the adverse social
consequences of commercial contact with foreign barbarians, argued in favor of
limits on interregional trade. Scholastic and religious writers in the Middle Ages
were generally unenthusiastic about long-distance commerce because of its
negative moral effects, such as promoting avarice, fraud, and excessive attention
to worldly goods and profits.
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The seventeenth- and eighteenth-century mercantilists held that appropriate

restrictions on international commerce could develop an economy’s resources to
a greater extent than was possible under free trade. The mercantilists wanted to
encourage economic development by limiting imports of foreign manufactures
and limiting exports of unprocessed raw materials. Tariffs were the main policy
instrument to achieve the desired outcome of greater employment in
manufacturing, which would promote the power and profit of the state.

The general presumption in favor of trade restrictions was gradually tempered by

criticisms from within the mercantilist camp. Opponents responded by pointing
out that such barriers would destroy profitable trade and were unlikely in
themselves to generate additional wealth and employment. In 1701, one
prescient writer (Henry Martyn) raised the fundamental issue of the efficiency of
trade in using a country’s labor to acquire goods more cheaply than otherwise
possible, arguing that protection would merely put labor to less productive uses.

By the mid-eighteenth century, moral philosophers and others were writing in

favor of economic freedom in general. Cosmopolitans of the Enlightenment
decried trade wars and the jealous hostility commonly expressed in writings
about international commerce; they stressed instead the mutual benefit and
enrichment that came with commerce. Yet even among these writers, virtually
none argued that absolutely free trade represented the best way to take
advantage of trade with others.

Adam Smith’s Case for Free Trade

Using a consistent and persuasive framework for describing economic behavior

and analyzing commercial policy, Adam Smith finally established a strong
presumption in favor of the economic benefits of free trade. Smith based his case
on the gains to output and productivity resulting from specialization through the
division of labor. Just as individuals could gain from specialization and the
voluntary exchange of goods between them, countries could also gain from the
exchange of goods across borders. Like individuals, countries would reap
benefits by freely selling what they produced best, while purchasing whatever
came more cheaply on the world market. As Smith put it, "What is prudence in
the conduct of every private family, can scarce be folly in that of a great
kingdom."

In the end, Adam Smith developed as compelling arguments against protection

as he had in favor of free trade. The economic thinkers who followed him
endorsed the proposition that free trade is superior to import protection in
producing a greater amount of aggregate economic wealth. The classical
economists solidified the case for free trade with the theory of comparative
advantage, the bedrock on which the case for free trade stands today. From this
point on, the burden of proof in economic debates has been with those

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advocating restrictions on trade to demonstrate how those policies would

contribute to a country’s economic wealth.

Arguments Against Free Trade

"Defeated as a general theory," John Stuart Mill observed, "the protectionist

doctrine finds support in some particular cases"--or, perhaps more accurately,
seeks to find support in some particular cases. The book’s second part examines
the various criticisms and arguments against free trade that have arisen since the
time of Adam Smith. Just as economic thinkers before Smith were not entirely
protectionist in orientation, those after him did not accept free trade as an
unquestioned dogma. Smith constructed powerful arguments in favor of free
trade and against protection, but this did not completely settle the issue among
economists. Since his time, economists have sought to understand the limits of
the free trade doctrine and have therefore explored many cases in which
protection might possibly be advantageous. For this reason, every serious
qualification to free trade has come from economists writing after Smith
established free trade as a central tenet of economics--perhaps because those
most conversant with the case for free trade (if not blinded by it) are well situated
to appreciate its weaknesses.

The most obvious qualification relates to a weakness in the analogy between an

individual’s and a country’s benefits from trade. The analogy ignores the fact that
countries are composed of different individuals, not all of whom may reap
benefits from free trade. Even if free trade maximizes economic wealth (and
therefore, potentially at least, economic welfare), it still cannot be said that
everyone will be better off, unless compensation is paid to those whose income
falls. This income distribution effect constitutes an important practical
qualification to the free trade argument, perhaps weighing more heavily in actual
policy making than the other theoretical issues considered herein. Of course, this
problem with income distribution is not solely restricted to commercial policy, but
afflicts almost every economic policy.

The Terms of Trade Argument

The most powerful economic objection to free trade ever developed is the terms
of trade argument. The analogy at the individual or firm level is that if one has
significant market power, in the sense of being able to influence the market price
of one’s output, it may be worthwhile to exercise that market power by restricting
one’s output to raise its price. Similarly, if the ratio at which a country exchanges
its products with the rest of the world depends on the volume of a country’s
exports and imports, government restrictions on trade can potentially manipulate
that ratio to bring about larger gains to that country than would otherwise be the
case. For example, no economist would suggest that Saudi Arabia would be
better off by expanding production of petroleum to push its price closer to its
marginal cost.

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The terms of trade argument generates a unilateral motive for trade intervention:
free trade may be undesirable for any individual country, even though its gains
are achieved by inflicting an even greater loss on its trading partners. Not all
countries, however, can gain if each of them acts upon this unilateral motive and
imposes tariffs in an effort to improve its terms of trade at the expense of the
others. For this reason, international cooperation to establish free trade can
dominate a situation in which all countries seek to influence their terms of trade
through trade restrictions.

Protection has been proposed as being superior to free trade in other instances
as well, many of which rest on the assumption of fundamental differences
between agriculture and manufacturing (or between the primary sector and
processing industries). From the days of the seventeenth-century mercantilists to
the present, manufacturing has been thought to have distinct advantages over
agriculture (or certain manufacturing industries are believed to be superior to
others) in ways that are not fully taken into account by the market (such as their
not being reflected in market prices and therefore not recognized by market
participants). These beliefs have led to the wage differential argument, the infant
industry argument, the increasing returns argument, and the strategic trade
policy argument for trade intervention.

Second-, Third-, or Fourth-best Options

Although several of these attempts to provide a valid argument for protection

have proven successful in achieving some standing as a logical proposition, all
are subject to a crucial qualification: in none of these cases is protection the
optimal, or first-best, intervention to correct for the assumed shortcomings of the
market. While some measure of protection may, under certain circumstances, be
a second- or third- or fourth-best improvement over the nonintervention
equilibrium, other policy instruments dominate import controls in achieving the
highest level of economic efficiency. Protection is therefore not desirable on
economic grounds unless there are sound reasons for ruling out more direct and
less costly alternative policies. The use of trade intervention to correct domestic
wage distortions, for example, is at least a third-best policy option when
compared with other possible corrective actions.

Not just for this important reason has each of these cases failed to overthrow the
general presumption in favor of free trade. They have also foundered under the
weight of manifold qualifications that narrow the range of circumstances under
which the argument is valid. The strategic use of trade policy to shift rents
between countries hinges critically on numerous assumptions about competitive
behavior and market structure. This case, along with the wage distortions
argument, has at least the advantage of being clearly defined with a
comprehensible, underlying economic structure. The infant industry argument
has gone for centuries without being well specified, and it has persisted even
though import protection does not correct the market failures thought to prevent

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infant industries from arising without government assistance. The vagueness

surrounding the concept of increasing returns as external economies has
hampered resolution of the debate over its impact on the free trade doctrine.

In sum, these other arguments for protection are frail in comparison with the
terms of trade rationale. Their propositions are entirely conceptual and theoretical
in nature, even though most cases have drawn upon observable phenomena to
motivate the issue they address. As such, they do not necessarily convey any
indication about their practical importance or any explanation about how they
might be implemented. Each case has fundamental difficulties in its operational
value that serve to keep the presumption in favor of free trade intact. How are
true wage divergences to be identified? Where are rents in international markets
to be uncovered? Which industries are suitable infants? Where precisely are
external economies to be found? These questions are exceedingly difficult to
answer, and exceedingly difficult for economic policy to exploit.

A Sound Proposition in Economic Theory

In his monumental History of Economic Analysis, Joseph Schumpeter

emphasized the importance of "distinguish[ing] sharply the development of free-
trade policies and free-trade doctrines from the development of analysis that was
associated with both." My book is an intellectual history. It attempts to relate how
economic analysis has supported or invalidated the free trade doctrine; that is, it
is about the economic analysis that was associated with the free trade doctrine.
My book is not an economic history of commercial policy, and it neither
addresses the particular trade policies of a given country at any given time nor
explains what accounts for those policies, whether they be free trade or
protectionist. The fact that free trade is often not adopted as an economic policy
for political reasons has nothing to do with its strength as a theoretical
proposition. As economist Frank Taussig once wrote, "The doctrine of free trade,
however widely rejected in the world of politics, holds its own in the sphere of the
intellect."

Opponents of free trade usually claim that its champions among economists are
simply dogmatic and ideological in their support of it. This criticism ignores the
close and searching scrutiny to which the analysis behind the doctrine has been
subjected for more than two centuries. Yet it has survived largely intact, and it is
sometimes even strengthened by this examination, as the weaknesses of
proposed exceptions come to be better understood. Free trade remains as sound
as any proposition in economic theory that purports to have implications for
economic policy is ever likely to be. Inquiry, however, is a never ending process,
and the questioning of free trade will never cease.

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