A Robust Theory of Trade

Economists are often accused of ignoring moral consequences of trade, or in particular, being focused too much on material well-being (for example, see here).  There is a lot of truth to this claim; much of our models to focus narrowly on measurable items like material wealth.  I agree with this criticism very much and lots of my research focuses on ways of re-inserting moral man into economic models.

But it is incorrect to argue that free trade is either immoral or amoral.  The earliest free trade philosophers (Adam Smith, David Hume, Frederic Bastiat) all approached trade from a moral point of view.  Hume gives us a justice argument for free trade, Smith demonstrates the strong presumption of liberty in a modern society, and Bastiat shows how protectionism can quickly become a perversion of law and justice.  Economists have long spent time considering the moral aspects of trade.

But one thing that really rubs people the wrong way regarding trade is the concept of competition.  Firms and individuals compete with one another for scarce resources and that competition can sometimes lead to outcomes that make some observers uncomfortable (workers getting laid off in favor of machinery, for example.  Or low-cost labor overseas).  Because of the unpleasant nature of this competition, free trade often gets labeled immoral.  But let’s look at the nature of competition and how it is used in economics.

Economics appears to begin with the assumption of a somewhat Hobbseian jungle world: all actors are self-interested and looking to maximize their own gains.  From this, we derive the concepts of competition and the “invisible hand” which leads to improvement for everyone while appealing to their self-interest.  To quote Adam Smith: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

But surely altruism exists!  Surely people are not so wrapped up in self-love they dismiss all of humanity!  How can this dismal view of humanity, that we are merely self-interested, dominate economics?  The answer is two-fold: 1) Everyone is, to some extent, self-interested (what Russ Roberts likes to call “the Iron Law of Me”).  We tend to focus on events close to us and our loved ones far more than events separate from us.  2) This method of conceptualizing humanity makes our models robust.  Lots have been written on #1, so I’d like to focus on #2.

The idea of self-interested humans makes economic models robust.  In a sense, by assuming humans at their “worst,” it allows for humans to act at their “best.”  For example, simple economics indicates that, after a disaster, prices should rise in order to incentivize people to bring more supplies into the area.  The pursuit of profit will bring in people looking to make a buck.  This is the self-interested story.  But what happens if the community and nation band together and donations fly to the area?  The effect is the same: an increased supply to where it is needed most.  By weakening the assumption, the result remains: the model is robust.

So, why the assumption of self-love in the first place?  Well, let’s reverse the scenario.  A disaster strikes.  People are altruistic and chip in and send supplies to the disaster area.  People will band together when things get tough.  This is our model.  But let’s weaken the assumption of altruism.  Disaster strikes.  People are only self-interested.  What happens?  Nobody sends supplies.  Since the results of the model change, it is not robust.

The concept of self-love does nothing to reduce the usefulness of our models.  Whether true or false is irrelevant as the results of the model do not change.  So long as the presumption of liberty is upheld, in other words, no central planning is attempted, then the assumption of human behavior and its results are largely irrelevant and economic models are robust to the changes.

6 thoughts on “A Robust Theory of Trade

  1. That’s a very fine piece of writing you should be proud of Jon! It flows for your reader and you have an astute anticipation of possible questions that may arise in one paragraph answered in the next paragraph. Keep up the great work.

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  2. Jon, You have nicely captured the essence of free trade, which as someone (perhaps DB) pointed out is cooperation, not competition, between parties. People compete for the privilege of cooperating.

    The self interests of two or more parties must complement each other for trade to occur, and both will be made better off.by the exchange, or no exchange will occur.

    You disaster example is a good one, and suggests that self interest drives not only those who would donate freely, and whose reward is psychic and non-material, but also those who see an opportunity for profit in rushing much needed relief to victims of the disaster. If allowed to act freely, this wider range of self interests ensures maximum relief arrives as quickly as possible.

    So, why the assumption of self-love in the first place?

    i think self interest and self love are inherent in our nature as human beings (endowed by our creator). They help ensure the survival of the individual, and thus the survival of the family, tribe, or larger group, and ultimately the survival of the species. The theory of natural rights and self ownership rest on this presumption.

    I’ve never agreed with the Hobbesian model of war of all against all, as it ignores our very real need to socialize with others, and the very real benefits of group cooperation.

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  3. An important contribution to this intellectual tradition of justifying the morality of capitalism was made by George Gilder. He argued that capitalism should be viewed as REQUIRING a form of altruism because entrepreneurs can only succeed by serving and satisfying the interests of their customers better than their competitors do. More than any other system, capitalism forces entrepreneurs to give priority to their customer’s interests even if they would prefer not to.

    Gilder had many other crackpot ideas and I invoke his name here simply to avoid plagiarizing an idea I wish I had thought of and not as a more general endorsement of his other ideas.

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