These days, it is easy to see how a misunderstanding of economic processes can lead to enormous political conflicts. The tariffs that Europe, driven by the European Commission and its head Ursula von der Leyen, wants to impose on Chinese electric cars show once again that modern politics causes enormous damage because politicians do not even begin to understand the systems they are intervening in.
Everywhere, and not only in Europe, dangers for global trade are being painted on the wall that have to do with China, China and China. Behind this is undoubtedly the doctrine of the American neocons, who want to prevent China from even scratching at American hegemony by all means. But the fear of the Chinese danger would not be credible without the presumed economic threat. But precisely that is based on a misunderstanding. China is not the ultimate threat to ‘free trade’ because ‘free trade’, which everyone believes they have to defend, does not even exist.
Free trade sounds good, although hardly anyone knows what it really means. Typical of our misunderstanding of free trade is a quote like the following. A few years ago, the German weekly newspaper ZEIT wrote on a similar occasion: ‘The idea of free trade is that each country specialises in producing the goods that it can produce most cheaply. The surplus of goods can be exported and the proceeds can be used to import other goods. … China, for example, should therefore produce labour-intensive products such as clothing, because labour is relatively cheap in Asia. Europe, which has higher wages, should instead manufacture goods that require large production facilities’.
This is a good summary of the nucleus of traditional trade theory, but, as I show in detail in my new book, it is the crucial misunderstanding. The dogma of the free trade doctrine, according to which developing countries should limit themselves to the production of labour-intensive products, cannot be justified. However, it is repeatedly misused to justify protectionism and thus prevents emerging markets – with the exception of China and a few other Asian countries – from catching up quickly and successfully.
Although the vast majority of textile products sold worldwide have been manufactured in Asia and China for decades, the production process is by no means labour-intensive. Instead, it always involves the latest Western technology. Yet economists, trapped in their small-scale equilibrium world, are trying to salvage trade dogmas that have never corresponded to the reality of the globalised economy, despite clear empirical evidence.
Profitability and trade theory
The neoclassical theory of international trade, which still dominates the thinking of economists and politicians, assumes that investments made by producers from high-wage countries (with high labour productivity) in countries with low productivity and low wages are based on the relative prices of labour and capital. It is therefore assumed that a mobile phone manufacturer who relocates production to China invents a completely new technology for production in China that is much more labour-intensive than in Germany in order to take advantage of the low relative price of labour in China.
According to this idea, the western producer discards the technology he has successfully applied in Germany and invents a new labour-intensive technology for China with which he can produce the same product in the same quality. He then offers it at exactly the same price as he would have produced it in Germany, due to the lower productivity in China – in other words, without any additional profit. According to neoclassical theory, he therefore forgoes the profit that he would have made if he had transferred his high German productivity in the form of modern machines to China and had them operated by workers receiving low wages compared to Germany.
Neoclassical theory falls back on this more than astonishing interpretation because it assumes that companies can easily adapt their technology in any direction and that competition ultimately leads to companies making no profit. This theory completely excludes profits that arise from a monopolistic advantage or an absolute competitive advantage. According to the theory that has dominated economics for the last 200 years, companies are zombies that can neither become world market leaders (and do not want to) nor compete with other companies for market share. If companies systematically make profits from advances that they gain over other companies, then the market is not a real market in the theory on which the entire neoliberal ideology is built. This notion is more than ridiculous, but it dominates economic thinking like hardly any other doctrine.
If you look at China through these glasses, it is clear that the absolute advantages that Chinese companies have could only be achieved through state subsidies. In the eyes of the free traders in Brussels, China is a market that can easily be compared with any other market. Enormous absolute advantages and enormous profit margins of companies exporting from China are simply ignored.
So far, it has been mainly Western companies that have benefited from the huge absolute advantages. Since China opened up, direct investments have had such a huge impact that for many years, Chinese trade was in no way comparable with the trade of a Western industrialised country. For the most part, Chinese trade consisted of trade by Western companies based in China. Ten years ago, it was still estimated that 60-70% of China’s total exports were not originally Chinese companies, but exports by such outsourced Western companies.
Not the Chinese themselves
Now that Chinese companies are also using these absolute advantages with the help of the latest technology and still relatively low wages (because average overall economic productivity in China is still relatively low), Western laymen are stepping onto the scene and claiming that it could only be state subsidies that make Chinese products so cheap. As long as Western companies took advantage of China’s absolute advantages to sell at rock-bottom prices (or make excessive profits) all was well, but now that companies from emerging markets are doing the same, they are met with far-fetched arguments. Politics cannot be more absurd than this.
Taking everything into account, only one conclusion remains: the entire idea of free trade is obsolete because it is based on doctrines that cannot be justified by anything. Even if international trade were free, we would not know whether it is efficient. However, it is precisely this – the equation of efficiency and freedom – that is at the core of the free trade doctrine and the associated political conclusions, right up to the rules of the World Trade Organisation.
The simple consideration that any interference with free trade is harmful and inefficient has made life easy for economists and politicians, but it has nothing to do with the real world. We need a completely new international trade system based on real conditions and not on the neoclassical fiction of free trade. It is not just about state distortions of competition, but about what competition actually means in the real world, especially when you include further distortions of competition by the world financial system (through unjustified exchange rate changes) or distortions caused by undervaluation strategies within a currency union (as in the case of Germany).
None of this will be easy. For example, a country that defends itself against massive imports from another country in which companies (even without state aid) combine high productivity with low wages and generate extremely high monopoly profits cannot be condemned out of hand. This measure can be justified if otherwise healthy domestic companies are damaged or destroyed by such monopoly profits. On the other hand, however, developing and emerging countries can only catch up if they gain such absolute advantages and increase their market share. Is that something we want to prevent? However, anyone who welcomes cheap imports from their own companies in an emerging country like China, but imposes tariffs on cheap imports as soon as Chinese companies also benefit from them, is definitely a dangerous nationalist.
It becomes completely absurd when, as Gabriel Felbermayr has just proposed in Die Zeit, each country tries to use international trade for national strategic purposes on the basis of the wrong theory. Then there will be a lot of jostling and jostling, in which everyone will surely lose in the end, Germany most of all, because it has profited the most in the past.