Capital Exports and Free Trade
by J.G. Hülsmann
[Posted January 29, 2004]
The
benefits of the division of labor are widely acknowledged. Even the
opponent of the market economy recognizes the fact that the
coordination of productive efforts yields material benefits for all
parties involved. But only the economists are intellectually consistent
enough to draw all the necessary political implications from this
insight. In particular, the case for free trade is squarely based on
the fact that it makes all parties better off than they would have been
without free trade.
Notice
the nuance in the message. The point is not that free trade necessarily
makes people better off than they have been so far. Rather, it makes
them better off than they would be if trade were to be henceforth
obstructed by government interventions, or by other violations of
property rights.
This
distinction has some importance in the present political context. For
the first time in many decades, the United States might be confronted
with the possibility of net capital exports. The consequence could
be a relative impoverishment of the working population. But even if
this were so, the case for free trade would stand unshaken. The stark
fact is that the only logical alternative, government obstruction of
international trade, would impoverish the population even more.
The Division of Labor
Joining
forces entails material benefits. Two individuals working in isolation
from one another produce less physical goods and services than if they
coordinated their efforts. This is probably the most momentous fact of
social life. All reflections on economic organization must start from
here.
To
illustrate the fact, consider the following example from a primitive
island economy. John and Mike work in isolation from one another. They
both spend their entire time plucking berries and hunting rabbits. John
spends 8 hours per day hunting 1 rabbit, and another 2 hours plucking 3
ounces of berries. Mike spends 6 hours per day hunting 3 rabbits, and
another 4 hours plucking 7 ounces of berries.
Now
they get together and decide to coordinate their activities. They could
then easily find a way to divide their tasks in a way that benefits
both of them. For example, Mike could devote all of his time to
hunting, while John devotes all of his time to berry plucking. The
aggregate output of the island economy before and after the division of
labor would look as follows:
Before: 4 rabbits, 10 ounces of berries
After: 5 rabbits, 15 ounces of berries
John
and Mike have now have one rabbit and five ounces of berries more per
day than they would have had if they had not joined their efforts. No
matter how they divide the surplus, each of them will be better off
than before.
Notice
that the division of labor is beneficial for all parties involved not
only when each producer is superior to the other in some special field.
It also holds true when one of them is more productive than the other
in all fields. In our above example, Mike is better than John as a hunter, but he is also
superior when it comes to plucking berries. For most noneconomists,
this is certainly a surprising aspect of the division of labor.
Many
people will be intuitively inclined to think that all-round superior
producers such as John can draw no material benefits from cooperating
with productive underlings such as Mike. If John deals with Mike at
all, it is only out of courtesy and generosity. Such was indeed the
social philosophy of the old European conservatives such as Carl-Ludwig
Haller and Joseph de Maistre. As they say it, inferior producers could
not possibly be the equal economic partners of superior ones. The only
possible social relationship between them was one of subordination. The
superior man granted favors, and in exchange he could expect obedience.
As
we have just seen, this view of things is wrong. Economists do not of
course exclude that favors be granted and obedience be due in certain
cases. They merely point out that the bonds of favor and obedience are
far from exhausting the reality of social cooperation. And these bonds
certainly cannot compare in importance to the bonds that result from
shared material benefits. The division of labor is a blessing for all
people. Superior and inferior producers can be true social partners.
From Ricardo to Mises
It was the British economist David Ricardo who first highlighted this fact in his Principles of Economics and Taxation,
in the context of an analysis of foreign trade. Ricardo did not truly
grasp that he had hit a general economic law that applied to all cases
of human cooperation. He merely claimed that free trade between nations
was beneficial. Moreover, he emphasized that he assumed in his
deduction that labor and capital were mobile factors only within the
borders of each nation. In other words, he assumed that only raw
materials and consumer products were traded across national borders.
This trade, Ricardo stated, was beneficial.
Unfortunately, later writers have wrongly inferred that Ricardo's assumptions were also conditions for the validity
of his argument. They reasoned as follows: "Ricardo proved that free
trade was beneficial when capital and labor were immobile. Therefore,
the case for free trade relies on these assumptions." The error in this
argument is not difficult to see. Suppose someone said: "The physicist
XY proved that the Law of Pythagoras held true for a triangle with a
hypotenuse measuring 3 inches, within an error margin of plus-minus
0.001 inches. Therefore, the validity of that law is proven only for
such triangles." Clearly, this is faulty reasoning. The Law of
Pythagoras holds true for any right triangle; demonstrating that it
holds true for a specific triangle must not be taken to mean that it
only holds true for that triangle. And similarly, from the fact that
Ricardo made the case for free trade under the assumption that capital
and labor are immobile, it does not follow that free trade is
beneficial only in this case.
The
first economist who stressed the general validity of Ricardo's
discovery was Ludwig von Mises. In two works from the late 1910s, the
Austrian economist dropped Ricardo's assumptions and concluded that, in
a world of free trade and universal capitalism, all factors of
production would be allocated at the places that by virtue of their
geological characteristics offered the highest marginal revenue for
these factors. Capital would be exported to these places, and laborers
would migrate there. Once all factors had found their right place, wage
rates would be equal throughout the world, and so would interest rates.
Driving
home the Ricardian message in the most general context, Mises
emphasized that this geographical allocation of resources would be
optimal from the point of view of consumer satisfaction. A few years
later, in his book Socialism, Mises pointed out that the
material benefits of the division of labor are a fundamental incentive
for human cooperation. And in his mature work Human Action, he called the workings of these incentives the "law of association."
Notice that Mises did not say that the factors of production should move to the places that offer the highest remuneration. He said that as a matter of fact they would
move to these places, and that this would in fact be beneficial from
the standpoint of consumers. Notice further that Mises made in fact two contributions.
One, he digested the nub of Ricardo's argument and pointed out that it was universally valid.
Two,
he applied this argument to a hypothetical world of global capitalism,
in which no political obstacles would hamper the free movement of labor
and capital
--
the exact opposite of the Ricardian world. In the period
leading up to World War I, the Misesian hypothesis reflected to some
extent the political conditions of the real world. The scenario that
Mises analyzed could be observed in a good number of concrete cases,
most notably, in the case of the British Empire. Capital and labor
constantly left Great Britain and moved to overseas provinces such as
Australia, India, and Canada, where they could be employed at greater
returns.
The Economics of Capital Exports
Now
this setting is of some relevance for the understanding of our
present-day conditions. In the past twenty years or so, an increasing
number of countries outside of the traditional western hemisphere have
adopted free-market policies. Rather than seizing the assets of foreign
capitalists, as they did before, they now protect the property rights
of foreigners and allow them to re-export revenue to their home
countries. Investments in some of these countries are now much
more profitable than in the West. As a consequence, they attract
western funds. Capitalists from the U.S., western Europe, and Japan
have already invested considerable sums of money in these countries,
and they are likely to increase these capital exports in the near
future.
Thus we have a situation that in many respects resembles the British case of the 19th
century. Great Britain constantly exported labor and capital. Now it is
obvious that the exported factors of production earned higher revenue
abroad than they would have earned at home. Thus for the owners of
these factors (the workers and the capitalists), crossing the borders
of the nation state was undoubtedly beneficial. But what about the
factor owners who stayed at home?
The emigration of workers had the tendency to increase wage rates
in Britain. Good news for the workers who stayed. Bad news for the
capitalists, because they now had to pay higher wage rates
--
but who
cares for the capitalists? Well, as usual they took care of themselves
and exported their money overseas, to the places where the workers went
and where higher returns could be earned on capital investments too.
Capital exports had the tendency to increase interest rates
in Great Britain until they matched those of the colonies, which was of
course precisely the reason why capital was being exported in the first
place. Most importantly, the capital exports tended to decrease the wage rates
of British workers, because wages can only be paid out of the available
capital pool. They therefore had the tendency to impoverish people
working for wages
--
more precisely they reduced wage rates below the
level they could otherwise have reached.
Thus capital exports essentially entail a relative impoverishment of the wage earners. This is not the same thing as an absolute
impoverishment. Wages are lower than they could have been, but they are
not necessarily lower than before. For example, suppose the net
increase of the capital stock is 15 percent. If two-thirds of that
increase is exported, the capital invested at home still increases by 5
percent, thus entailing an absolute increase of wage payments.
It
appears that in the British case, the decline in domestic wages was
only relative, not absolute. Real wage rates in Great Britain
constantly increased in the very period in which the country exported
capital all over the world. But today things might be different. It
cannot be excluded that the decline of wage rates will be absolute in
the western countries, if capital exports to the less-developed world
are allowed. Should this not be reason enough to revise the case for
free trade? Some writers think so. They realize that capital exports
will increase the wage rates and the productivity of foreign workers.
They concede that this higher productivity of foreign workers might
entail an indirect increase of real wage rates in our
western countries. And they even accept that from an overall global
point of view, capital exports are unobjectionable. However, they
refuse to adopt any such global perspective. All they care about are
domestic wage rates. As they see it, the case for free trade holds
water only as long as international transactions do not diminish absolute wage rates for domestic workers. Yet they are wrong, as we will now proceed to show.
The Case For Free Trade
To
see their error, we have to do above all one thing: We have to think in
terms of alternatives; we have to adopt the economic point of view.
Let
us therefore clearly define the question that is at stake. The question
is not whether absolutely decreasing wage rates are good or bad from
some aesthetic or ethical standpoint. Most economists will probably
share the present writer's wish that all people in the U.S. and
elsewhere shall constantly progress in prosperity. But this is beside
the point. The question is not even whether it is likely that current
capital exports will not only entail a relative, but also an absolute
decline of wage rates in the western hemisphere.
We
might for the sake of argument assume that the decline will be
absolute
--
impoverishment of all people who depend on wage income. All of
this cannot in the least affect the case for free trade. The only
relevant question is how free trade stands up to its only logical
alternative: government intervention. Can we make ourselves better off
by letting government prevent capital from crossing borders? That is the only relevant question, and the answer is in the negative.
Thus,
assume the U.S. government enacted clearly defined laws aiming to
prevent capital exports; that these laws were effectively enforced; and
that therefore no more nonauthorized export of capital would take
place. What would be the consequences?
The
first consequence would be of course that some capital that otherwise
would have left the U.S. is now blocked at its borders. It would not
necessarily be the case, however, that all of this money would be
reinvested. Part of it might go into personal consumption; another part
might be donated to political campaigns aiming at the reversal of the
neo-protectionism. As soon as the government starts telling everyone
what to do with their money, capitalists grow suspicious and ask
themselves what might well come next. Reinvesting their money into any
long-term venture would turn it into a sitting duck. It is therefore
safe to assume that American capitalists would seek to invest only in
rather liquid short-term projects or, better still, use the money for
consumption expenditure while they still have it. The consequence would
be a reduction of the overall capital fund and thus a decrease of wage
rates in all but the consumer-goods industries.
But
the intervention will not only incite greater consumption of existing
capital. It will also curtail the formation of new capital. American
citizens and residents would diminish their savings and indulge in
greater consumption. Some of the savings are only made because of the
prospect of interest returns that, at present, can only be realized on
investments abroad. Preventing these investments means preventing the
savings that are made in the first place. Again, the result would be
decreasing wage rates.
Foreign
capitalists would deal with their blocked U.S. investments in exactly
the same way as their American fellows, and with the same consequences
for U.S. wages. But most importantly, they would stop making any
further investments in the U.S. There is no point in buying U.S. assets
if it is impossible to re-export the revenue. It is clear to all
informed readers that this alone weighs heavily against such
interventions. No western country benefits more from capital imports
than the U.S. Discouraging these foreign investments means reducing
American wage rates.
Moreover,
one should avoid conceiving of "capital exports" in too narrow terms.
Just about any good can be capital. Capital export does not only take
place when machines and other industrial equipment are sent abroad. It
also happens when dollars are exchanged against other currencies, or
when consumer goods are exported. A rigorous control of capital exports
thus requires government control over the entire foreign exchanges and
the entire trade of the nation. In short, it requires government control over all economic transactions involving residents and foreigners.
It follows that foreign trade would be cut back to a fraction of what
it is at present. It is a great error to assume that this intervention
would affect only imports. As John Stuart Mill and many others have
pointed out, you cannot cut back imports without cutting back your own
exports. Thus, American wage rates would shrink in more or less all
export-related industries.
In
the light of these considerations, it is clear that a policy of
blocking capital movements out of the U.S. would not automatically
preserve the present stock of capital; and thus it would not
automatically prevent a fall of U.S. wage rates. The policy entails
strong tendencies that counteract its intentions. The only remaining
question is whether the net effects are positive or negative.
The answer is that the net effects will most certainly be negative in
the long run; and that even in the short run they are more likely to be
negative than positive.
In
the long run, it is unavoidable that the unintended consequences of
blocking capital movements become far greater than any short-run
benefits. Preventing capital from moving to foreign places where
it can be used at greater returns means to deprive Americans of cheaper
products. It means depriving them of the benefits of a large-scale
division of labor. Protectionism produces poverty.
Even
in the very short run, the net effect is likely to be negative. In the
light of our above analysis alone, it certainly cannot be excluded that
they be negative. And so far we have assumed that the new policies
would be effectively enforced! Yet it is naïve to expect that capital
exports could be prevented, especially if high returns wait just behind
the border. As in all similar cases, we would rather have to assume
that a huge black market would develop rather quickly, and that in its
wake corruption and organized crime would flourish.
Notice
that these are purely practical considerations. Blocking capital
movements just does not make much sense. It is bound to produce more of
the evil it seeks to combat, and a host of other evils on top of that.
Conclusion: The Great Parenthesis
A
few years ago, the French historian Jean Baechler remarked that the
period from the onset of World War I until the demise of the Soviet
empire in 1991 was a "great parenthesis" in western history. We might
add: It was also a great parenthesis in international economic
relations. During this period
--
a time of revolution and war in most other parts of the world
--
the United States offered virtually the only
safe haven for capital investments. Many people realized this, and many
brought their money to the U.S. American prosperity of the past eighty
years was therefore to a large extent, and to an increasing extent, a
borrowed prosperity. From all over the world, persecuted capitalists
brought their money to the U.S. Among the beneficiaries of this
somewhat artificial increase of the capital stock were the American
wage earners.
Now
this epoch is drawing to an end. The parenthesis is closing and things
are returning to a more normal state of affairs. Capital begins to
leave the developed capitalist countries and spreads into other regions
of the world economy, certainly to the benefit of these areas, but
ultimately to the benefit of all of mankind. It is possible
--
though by no means sure
--
that Americans might experience falling wage rates for a
few years. But they would be ill advised to let fear outweigh their
sober judgement. Free trade is not merely the policy that alone is
worthy of a free nation. It is also from a narrow materialistic point
of view far superior to its only logical alternative: letting
government ruin trade and the worldwide division of labor.
--------
Jörg Guido Hülsmann
(jgh@mises.org) is a senior fellow of the Mises Institute.
Email:
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