On March 3, 2018, The Economist declared that the free world had “made the wrong bet” in trying to make China “a responsible stakeholder in the rules based, liberal global order.” Last week, major hedge fund manager and long-time globalization champion Larry Fink declared that “globalization is over.”
When the former high priests of globalization admit it’s not working, the time has come not only to ask why they’ve changed their minds, but also why they were so wrong for so long. Oren Cass’s exposé of the abuses of classical economic theory offers a valuable starting point. But the problems lie even deeper and extend much further.
The fundamental flaw of globalization has been that academics and policymakers have strived to apply a theory of free trade developed in 1817—Ricardian comparative advantage—to the world of the late 20th and early 21st century. The theory depends on some key assumptions: absence of economies of scale, fixed exchange rates, constant full employment, absence of innovation, absence of cross border investment, absence of economics as an element of national security, and complete neglect of carbon emissions.
In the early 19th century, these assumptions were not unreasonable. Exchange rates were fixed to gold. Farming, an industry of diseconomies of scale (costs rise with production), was the major driver of the economy. Employment may not have been constantly full, but there was no unemployment compensation. And while innovation occurred sometimes by accident, it was not yet a major economic factor. There were few corporations, and with some notable exceptions, very few of them invested abroad. National security depended on having a lot of soldiers, and no one knew what greenhouse gases were.
The global economic environment of the past 50 years has been almost diametrically opposite that of 1817. Exchange rates float, and many countries actively intervene in currency markets to undervalue their currencies to favor export-led growth strategies. Most major industries (e.g., automobiles, aircraft, semiconductors, computers, steel, lawn mowers, and so on) are characterized by economies of scale. Cross-border investment is greater than cross-border trade. Innovation is the most important driver of economic growth as well as a key element of national security. Unemployment rates are high as often as they are low. Economic development is as important to national security as armies, and if the cost of carbon is not included in pricing, there will soon be no economies to worry about.
A major reason why it took so long for these false assumptions to come to light was the almost exclusive focus of Washington’s foreign policy on geopolitical issues. In the mid-1980s, as Japan’s export industries were killing off their American competitors, I sat in White House meetings in which National Security Council staff declined to take any measures to halt some unfair Japanese trade practices. The reason stated: “We need those bases. Now that’s the bottom line.” Geopolitical considerations trumped trade, economic, and competitive issues every time.
This was partly the result of hubris, and partly the result of the inculcation into the Anglo-American intelligentsia an unquestioning faith in free trade. For decades, students were taught that free trade is always and everywhere a win-win proposition. Indeed, they were taught that even if a country puts rocks in its harbors to prevent imports from entering, its exports should be welcomed by other countries. Free trade was a kind of religious dogma, and those who questioned it were subject to being cast into outer darkness.
A final pillar of the dogma was provided by global corporations that—free trade assumptions to the contrary notwithstanding—invested and exported back to America from countries that subsidized the investment, purposely kept their currencies undervalued to stimulate export-led growth, banned labor unions, failed to recognize fundamental human rights, and stole intellectual property. The corporations made out like bandits, and when their shift to production abroad caused the loss of millions of American jobs, the economists said not to worry. They promised that inexpensive imports were good for consumers, and the laid-off workers could easily move away from their families and long-time homes to find jobs elsewhere. Of course, the economists never quantified the long-term costs of these disruptions or the inevitable loss of skills and innovation due to the displacement of workers.
Fortunately, reality has at last caught up with the myth—not so much because the myth is wrong as because it has itself become a threat to national security. After all, if all the cutting-edge technology production is to be done abroad, how will America protect freedom in the age of Aquarius?