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Forget 'Free Trade' - It's All About Capital Flows

Charles Hugh Smith profile picture
Charles Hugh Smith

In a world dominated by mobile capital, mobile capital is the comparative advantage.

Defenders and critics of "free trade" and globalization tend to present the issue as either/or: it's inherently good or bad. In the real world, it's not that simple. The confusion starts with defining free trade (and by extension, globalization).

In the classical definition of free trade espoused by 18th century British economist David Ricardo, trade is generally thought of as goods being shipped from one nation to another to take advantage of what Ricardo termed comparative advantage: nations would benefit by exporting whatever they produced efficiently and importing what they did not produce efficiently. While Ricardo's concept of free trade is intuitively appealing because it is win-win for importer and exporter, it doesn't describe the consequences of the mobility of capital. Capital - cash, credit, tools and the intangible capital of expertise - moves freely around the globe seeking the highest possible return, pursuing the prime directive of capital: expand or die.

Capital that fails to expand will stagnate or shrink. If the contraction continues unchecked, the capital eventually vanishes.

The mobility of capital radically alters the simplistic 18th century view of free trade. In today's world, trade cannot be coherently measured as goods moving between nations, because capital from the importing nation owns the productive assets in the exporting nation. If Apple (AAPL) owns a factory (or joint venture) in China and collects virtually all the profits from the iGadgets produced there, this reality cannot be captured by the models of simple trade described by Ricardo.

In today's globalized version of "free trade," mobile capital can arbitrage labor, currencies, interest rates, regulatory burdens and political favors by shifting between nations and assets. Trying to account for trade in the 18th century manner of goods shipped between nations is nonsensical

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Charles Hugh Smith profile picture
Charles Hugh Smith writes the Of Two Minds blog (www.oftwominds.com/blog.html) which covers an eclectic range of timely topics: finance, housing, Asia, energy, longterm trends, social issues, health/diet/fitness and sustainability. From its humble beginnings in May 2005, Of Two Minds now attracts some 200,000 visits a month. Charles also contributes to AOL's Daily Finance site (www.dailyfinance.com) and has written eight books, most recently "Survival+: Structuring Prosperity for Yourself and the Nation" (2009) which is available in a free version on his blog.

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Comments (8)

yeah, really called this one out well, especially the apple example ! thanks for sharing
change is the only constant profile picture
"Capital that fails to expand will stagnate or shrink. If the contraction continues unchecked, the capital eventually vanishes"

Normally, Charles, you are extremely insightful. This missive misses the mark horribly. Capital does not decay. During a contraction standing still is like moving forward - and during an expansion moving forward is like running in place. It is the pace of inflation - which is the bugaboo of productivity and innovation - that muddies your arguments here. An article about how to measure and whose measure of inflation we should believe, in a global environment, would be extremely useful - but its, as you may know, extremely difficult to quantify 'real' and 'expected' inflation as each country's currency bobs up and down in the sea of dollars.
mdmrjsds profile picture
Your thesis reveals that one of the premises of Ricardo's theory is no longer true. He assumed that it was impossible for all demand to be met by existing resources. But if that was true, then there would be no arbitrage of capital as you describe, because all capital would be put to use producing goods until it was exhausted. Since it isn't, the premise isn't true anymore. That is, technology has created a global economy that is productive enough that all demand can be met without using all available resources, especially labor.

Or, to put it another way, suppose there was a productive, economically viable task for all labor on earth. Would it still be possible to arbitrage capital? I think that under that condition, which doesn't currently hold, the process you describe is not feasible.
This excellent article may cause some to realize that our government statistics for our trade deficits, are a fraudulent fiction, and quite likely more than those for unemployment, inflation etc.
As an uninformed "free trader," anti-tarriff person this article has cleared up a great deal for me and provides a lot to reconsider. Tarriffs are simply taxes on the consumers of the nation charging the tarriffs which, off course, also damages businsses in the same countries by either weakening companies "protected" by tarriffs or creating more and more companies who want "protection" too "because it's only fair." I'm sure there are others.
It seems to me everything done by our central planers causes more problems than before they decided to "help." Floods of funny money from central banks create hordes of globalist manipulators (nothing wrong with that, we all must play the cards we're given) but comparative advantage is now not who's the most efficent producer it's who's the biggest financial fraudsters which seriously damages the world economy and inspires more government "help" which, inevitably makes the problem worse.
Maybe it's time for the national government to take constitutional limits seriously and stop grabbing control of everything.
Politicians fight on free trade which is just merchandise trade. There’re other border crossing trades: labor, skills, finance, intellectual properties...
mulligangs profile picture
Great article!
Well, at least economists can explain the economy we had 100 years ago, even if they can't figure out what is going on today. We'll have to leave that to the economists of the future.
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