The classical theory of comparative advantage has driven US trade policy for the past fifty years. That policy, in combination with technical innovations that have lowered costs of transportation and communication, has opened the global economy. Yet paradoxically, this opening has rendered classical trade theory obsolete. That in turn has left the US economically vulnerable because its trade policy remains stuck in the past and based on ideas that no longer hold.
The logic behind classical free trade is that all can benefit when countries specialize in producing those things in which they have comparative advantage. The necessary requirement is that the means of production (capital and technology) are internationally immobile and stuck in each country. That is what globalization has undone.
Several years ago Jack Welch, former CEO of General Electric, captured the new reality when he talked of ideally having “every plant you own on a barge”. The economic logic was that factories should float between countries to take advantage of lowest costs, be they due to under-valued exchange rates, low taxes, subsidies, or a surfeit of cheap labor. Globalization has made Welch’s barge a reality. However, in doing so it has made capital mobility rather than country comparative advantage the engine of trade. And with that change, “free trade” increasingly trades jobs and promotes downward wage equalization.
The U.S. and European response to Welch’s barge has been competitiveness policy that advocates measures such as increased education spending to improve skills; lower corporate tax rates; and investment and R&D incentives. The thinking is increased competitiveness can make Europe and the US more attractive to businesses.
Unfortunately, competitiveness policy is not up to the task of anchoring the barge, and it can even be counter-productive. The core problem is corporations are globally mobile. Thus, government can subsidize R&D spending, but the resulting innovations may simply end up in new offshore factories. Moreover, competitiveness policy easily degenerates into a race to the bottom. For instance, if the US cuts corporation taxes, other countries may match to stay competitive. The result is no gain for the US, while profit taxes are lowered and tax burdens shifted on to wages, which widens income inequality.
Worse yet, capital mobility prompts countries to adopt unfair policies to increase their relative business attractiveness. These policies include disregard of environmental damage; suppression of labor to keep wages low; direct subsidies; and under-valued exchange rates. All are visible in China, which is the poster-child for such abuses.
A critical consequence of Welch’s barge is the creation of a “corporation versus country” divide. Previously, when corporations were nationally based, profit maximization by business contributed to national economic success by ensuring efficient resource use. Today, corporations still maximize profits, but they do so from the standpoint of their global operations. Consequently, what is good for corporations may not be good for country.
.....The emergence of barge-like corporations has reduced the scope for effective competitiveness policy, increased the temptations for unfair policy, and created a wedge between corporate and national interests. This poses two critical policy challenges. First, there is need for rules against unfair competition, which is where exchange rate rules and labor and environment standards enter.
Second, there is need to close the wedge between corporation and country. In the U.S. that calls for such measures as ending preferential tax treatment of profits earned offshore; making it illegal for corporations to reincorporate outside the US to escape US tax laws; and new tax arrangements that encourage jobs and value creation within the US.
......These economic challenges are compounded by political difficulties. In Washington, elite policy thinking is funded and lobbied for by corporations. Consequently, corporations control trade policy at a time when corporate interests differ from the national interest. That is also increasingly true in Brussels. Fifty years ago what was good for GM may really have been good for the US. With Jack Welch’s barge, that may no longer hold.
Ricardo's point was tied to agricultural products, where different climates and terrains along with the developed skills of the workforce allowed for a "comparative advantage" in production (it being more efficient to grow grapes in Portugal and Sheep in Britain as I recall). This still holds true as far as it goes. It is much more efficient to grow grain in Ohio and Oranges in Florida and trade them than to try to grow Oranges and Wheat both places. The problem begins when we start talking about multinational corporations in the same terms as 19th century farmers. Production has become separated from Resources due to the transportation revolution which has made it possible to bring the raw materials to the worker rather than vice versa (as well as the depletion of resources near Western industrial areas). Knowledge has been abstracted from the worker with the rise of the engineer and the decline of the skilled trades worker. A multinational will use the knowledge gained by advanced research in high wage research labs to develop (perhaps in a mid wage country) the product they will produce in a low wage country. Today, a Multinational can afford to bring resources and expertise to the lowest cost worker and then transport the finished product to a high cost environment and still have a profitable arbitrage. This works spectacularly until enough high wage workers are replaced with low wage workers and the formerly high wage economy collapses.
China is a symptom, not the problem. As China suffers from inflation, manufacturers will move to other desperate low wage countries where the same phenomena will play out.