You can not buck the market

In the post I referenced on Iain Dale's blog yesterday, I left a comment about the fallacy of "capitalism with a conscience" which someone replied to. Their reply was the standard "head in the sand" response and full of holes. Here is what they said.

"Yep, the law of comparative advantage. Excellent isn't it? Country A can use its comparative advantage to get wealthier by making trainers and country B can move on and make higher value added products which it can sell to country A because it is now wealthy enough to buy them. Free trade. Doncha just love it?"

First of all, the "law of comparative advantage" is not a law. It is a theory based on bilateral trading agreements between nations. It assumes that each of the two countries trading have things that the other can either not make at all or can not make at reasonable costs. It works very well when you have something that another country does not - like oil, as the Middle Eastern nations know only too well - but when you don't, it sucks.

Secondly, the author forgets that there is a basic law of markets which is that a market will always work to find a level. In other words, market distortions have to be eradicated and an equilibrium reached. Globalisation creates market distortions - so the market has to adjust to eradicate those distortions.

Using trade tariffs and restrictions we can compensate for that, but without these things in place there is only one way that the market can find a level - production costs. Either theirs has to rise until it balances with ours or ours has to fall to balance with theirs - and it has to balance quickly.

As good an indicator of production costs as any is GDP per capita. In the UK this is around $37000 per person per year. In China it is $6400 per person per year and in India it is $2900 per person per year.

Just as a company producing trainers can not compete against another company with considerably lower production costs, neither can a country. In the absence of trade restriction, the market has to find a balance.

The person who responded to my comment suggested that we move on to selling "higher value added products". They didn't say what these were, but it is either a stupid or an arrogant suggestion. It is stupid because, in a globalised economy, companies will move their production to wherever it is cheapest whatever it is they are making. If costs are broadly similar then there is also some sense in moving your production to wherever the market for your goods is. If the market is also where production costs are considerably cheaper there is absolutely no point whatsoever in retaining a high cost production facility in the west when you can do it cheaper in China and the Chinese are the ones buying what you make!

It is arrogant because it assumes that those emerging economies are too backward to produce those "higher value added products" - it is saying, "don't worry, we're just go on to making stuff they can't". Who says they can't? Nations like China and India are churning out hundreds of thousands of high calibre graduates every year - with degrees in technical skills - and they all get jobs. Here, meanwhile, the relatively few graduates we produce struggle to find enough graduate placements for their skills. We have the most highly educated bar staff in the world, but something tells me that isn't going to be enough to base our economy on.

The technology gap closes very quickly - particularly when those emerging economies have become industrial giants in their own right - and you can not buck the markets. Recessions happen when a market becomes distorted and has to correct itself. Depressions happen when this happens on a global scale and the market distortion is even more marked. The market correction we are seeing now is as a result of the disparity between the per capita wealth of the emerging economies and our own - the market has to find a level.

This can not be stopped by pumping money (which you don't have) into an economy that produces nothing the world wants in the global market or that it can not produce itself for less. It can only be stopped by employing mechanisms to compensate for the market distortions and that - whether you like it or not - means protectionism.