06/11/2010 05:12 am ET | Updated May 25, 2011

Yes, Virginia, There Is a Legitimate Case Against Free Trade

There is a myth in wide circulation that the superiority of free trade is simply a settled question on which all serious economists agree. The flip side of this myth, of course, is that anyone who criticizes free trade must either be ignorant of economics, or the spokesman of some special interest which hopes to benefit from trade restrictions. Such critics are not only wrong, the story continues with admittedly impeccable logic, but profoundly worthy of public contempt, as they are necessarily either dumb or corrupt.

Unfortunately, this myth is just that: a myth, promoted by special interests which benefit from free trade, whatever the harm to the rest of the economy. Serious economists actually recognize a number of very serious criticisms of free trade -- even economists who ultimately decide that free trade is better than the alternatives. They generally don't talk about the flaws of free trade too loudly, for fear of provoking the public into supporting stupid forms of protectionism, but they certainly know they are there.

Thanks to recent developments in economics (most visibly signaled by Paul Krugman's winning the 2009 Nobel Prize), these criticisms are becoming more serious every day. There is, in fact, an inexorable erosion of the credibility of free trade going on in the academy, not that you'd know it from watching the economists who show up on TV.

The rest of this article is just a wee bit technical. The point is not to baffle the reader, but to pry open the mysterious "black box" of free trade economics a little, and let non-economists in on the big secret that economists regard as dangerous to talk about too loudly: free trade economics is a package of mechanisms that, like any piece of machinery, can and do break down all the time. And when they break down, free trade ceases to be a good idea.

Let's crack open that intimidating black box, shall we, and have a look at the machinery inside? Free trade has roughly ten very serious problems.

The first problem is the assumption that trade is sustainable. But a nation exporting non-renewable resources may discover that its best move (in the short run) is to export until it runs out. The flip side of this problem is overconsumption, in which a nation (like the present-day U.S., maybe?) borrows from abroad in order to finance a short-term binge of imports that lowers its long-term living standard due to the accumulation of foreign debt and the sale of assets to foreigners.

The second problem is that free trade increases inequality even if it makes the economy grow overall (which is itself questionable). Because free trade tends to raise returns to the abundant input to production (in America, capital) and lower returns to the scarce input (in America, labor), it tends to benefit capital at labor's expense. Economists call this the Stolper-Samuelson theorem.

The third problem is so-called "negative externalities," the economists' term for when economic value is destroyed without a price tag being attached to the damage. Environmental damage is the most obvious example, but there are others, like the cost of writing off expensively-developed human capital (otherwise known as "people") when free trade wipes out entire American industries.

The fourth problem is positive externalities, like the way some industries (mainly high technology) open up paths of growth for the entire economy. All industries are not alike, and the profits of an industry today do not necessarily predict the industry's long-term value for the economy. Free trade can allow these industries to be wiped out because it ignores this hidden value, harming the rest of the economy for decades to come.

The next four problems concern the all-important Theory of Comparative Advantage, the theoretical keystone of free trade economics. This theory, invented by the British economist David Ricardo in 1817, says that free trade will automatically cause nations to specialize in producing whatever they are relatively best at, and that this will lead to the best of all possible worlds. To wit:

Problem number five is that Ricardo's theory assumes factors of production are mobile within nations. Unemployed autoworkers become aircraft workers, and abandoned automobile plants turn into aircraft factories. But this doesn't always happen, and when it does, it is often at considerable cost.

Problem number six is the assumption, in Ricardo's theory, that the inputs used in production (like labor, capital, and technology) are not mobile between nations. His theory says that free trade automatically reshuffles a nation's factors of production to their most productive uses. But if factors of production are internationally mobile, and their most-productive use is in another country, then free trade will cause them to migrate there--which is not necessarily best for the nation they depart.

Problem number seven is that Ricardo's theory assumes the economy is always operating at full output--or at least that trade has no effect on its output level. But if trade puts people and factories out of action, this isn't true.

Problem number eight is that Ricardo's theory assumes short-term efficiency is the origin of long-term growth. But long-term economic growth is about turning from Burkina Faso into South Korea, not about being the most-efficient possible Burkina Faso forever. History has shown time and again that the short-term inefficiencies of a tariff, properly implemented, are more than compensated for by the long-term spur to industry growth it can provide, largely because growth has more to do with the industry externalities mentioned above (problem number four) than short-term efficiency per se.

Problem number nine is that Ricardo's theory merely guarantees (if true, which is itself questionable due to problems five through eight) there will be gains from free trade. It does not guarantee that changes induced by free trade, like rising productivity abroad, will cause these gains to grow rather than shrink. So if free trade strengthens our economic rivals, then it may harm us in the long run by stiffening international competition, even if it was advantageous for us to buy goods from these rivals in the short run.

The final problem is that, in the presence of scale economies, the perfectly-competitive international markets presumed by the theory of comparative advantage do not exist. Instead, industries tend to be imperfectly competitive and quasi-monopolistic. Under these conditions, outsize profits and wages accrue to nations that host such industries. And free trade will not necessarily assign any given nation these industries.

Hopefully, the above list should convince the reader that free trade is, at the very least, an extremely complicated question, and by no means something that anyone is entitled to consider simply settled. Therefore it is high time that free trade's critics were given the serious hearing that they deserve. America desperately needs a full-fledged debate on whether to continue with its Cold War policy of free trade or return to the protectionism we embraced from Independence until roughly the end of WWII.

Ian Fletcher is the author of Free Trade Doesn't Work: What Should Replace It and Why (USBIC, $24.95) He is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933. He was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at