Does free capital mobility invalidate the basic comparative advantage argument for free trade in goods?

Question

In Herman Daly's article "Economics for a Full World", Daly states that international trade must be regulated because free capital mobility would invalidate the principle of comparative advantage (Daly, 2015, p.12). As a reference, he cites John Stuart Mill's "Principles of Political Economy" IV.VII.I. However, there doesn't seem to be a chapter 7 in book 4, so I cannot check what he is referring to.

I would greatly appreciate your help in understanding the argument made by Daly here!

References

Daly, H. (2015). Economics for a Full World. Great Transition Initiative.

Answer 1

Daly actually does explain further what he means by that in footnote 7 of his paper:

Capitalists are interested in maximizing absolute profits and therefore seek to minimize absolute costs. If capital is mobile between nations, it will move to the nation with lowest absolute costs. Only if capital is internationally immobile will capitalists bother to compare internal cost ratios of countries and choose to specialize in the domestic products having the lowest relative cost compared to other nations, and to trade that good (in which they have a comparative advantage) for other goods. In other words, comparative advantage is a second-best policy that capitalists will follow only when the first-best policy of following absolute advantage is blocked by international capital immobility. For more on this, see Chapter 18 in Herman Daly and Joshua Farley, Ecological Economics (Washington, DC: Island Press, 2004).

But IMHO, the absolute conclusion that international trade must be regulated as following from that seems silly. After all, one can regulate capital flows too negating that first-best policy (argument). In fact there are plenty of barriers to capital flow, some implicit and some explicit.

Having said that, I cannot quite find the ultimate conclusion stated in those absolute terms by Daly, although he does say (we should) "Move from free trade and free capital mobility to balanced and regulated international trade." Which is frankly pretty vague. I mean doesn't the WTO do at least some of the latter?

The whole writeup of Daly smacks of a certain social agenda. Later he says

Restore the US Full Employment Act of 1945 and its equivalent in other nations in order to make full employment once again the end, and economic growth the temporary means.

I think Bernie Sanders also said he wants something like that. Daly also says

Un/under-employment is the price we pay for growth from automation, off-shoring, deregulated trade, and a cheap-labor immigration policy.

And finally, Dally says (we should)

strengthen the original Bretton Woods vision of interdependent national economies, and resist the WTO vision of a single integrated global economy

That's basically a slogan in disguise, to put it diplomatically. You could just as well phrase it as "take back control of our economy/tariffs/borders/immigration". So his conclusions are more or less socio-political goals; it's hard to take them at face value as pure economic arguments. So there will undoubtedly be disagreement on such statements.

Perhaps to save his "ecological economics" creds Daly does say that in contrast

climate change and arms control require global institutions

To use a political science neologism, that's an ambivalox with demanding no world-wide regulatory institutions for any other economic issues, like trade.

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But to come back to the more serious economic topic, glossing over Daly's black-and-white approach, capital mobility as partially substituting for goods exchange is hardly a new discovery. See Nadel (1971) for example.

It has long been recognized that commodity movements and factor movements [e.g. capital, my note] are, to a degree, substitutes for each other in international exchange [...] Yet, until recently, the dominant theory of international trade, the Heckscher-Ohlin model, had been rather thoroughly recognized under the rigid assumption of the immobility of factors. Only in 1957, with the publication of Robert Mundell's important article, was capital mobility in the H-O model explored.

(That important article being: Mundell, Robert, “International Trade and Factor Mobility,” American Economic Review 67 (1957):321–35. It has around 2800 citations in Google Scholar.)

What is somewhat novel (in ecology-related economics) is that under some models of pollution, capital movement is preferable to goods movement:

Using a Heckscher–Ohlin model, this paper re-examines Robert Mundell’s famous thesis that free trade and unimpeded capital mobility are perfect substitutes. Under very general conditions which, according to many economists, have caused international convergence of factor rewards,we show that in a polluted environment free trade is inferior to free international investment.This happens even though commodity prices and factor rewards are the same with both policies.The practical side of our thesis is that the world will be better off by reducing the volume of trade while removing all barriers to foreign direct investment that at present hamper the service industries.

That paper Batra and Belladi (2012) does also say that

Daly (1996), Batra (1992), and Batra et al. (1998) argue that transportation is highly pollution intensive, specially relative to production

That seems to be a cornerstone assumption of the model. It is [to me at least] an interesting separate question if economists outside of this narrow field of "ecological economics" agree with these premises.

Answer 2

Daly gets a lot wrong, including (in my view) the idea that capitalists pursue absolute profits in an economy that rests on fiat currencies and foreign exchange markets. Indeed, the very notion of opportunity cost implies that it is relative, not absolute, costs that matter most to the rational agent. Does the capitalist seek the lowest absolute cost, or the highest relative return, net relative tax rates, net relative currency risk, net relative geopolitical risk, etc. etc.?

Like most ideas in economics, comparative advantage rests on a host of assumptions that don't play out perfectly in the real world. Many of these assumptions fail to hold if one looks at global trade. Possibly the most important: the assumption that agents are identical except in their production functions. In fact, geopolitical agents are diverse and varied - and most importantly, they have the power to impose arbitrary restrictions on trade.

Now, the real world is full of frictions, and I'm certainly not making an anti-regulation argument here. But I am suggesting that it is impossible to assert that whatever misallocations are occurring in global trade today can be put down to the freedom of capital, rather than the haystack of conflicting policies. The best of policymakers work with limited information, and I think it's fair to say that not all trade policy has global welfare in mind. The so-called "theory of second best" implies that any new rule that conflicts with the existing set of rules is likely to be overall welfare-decreasing.

So I would disagree that "capital mobility" invalidates comparative advantage, if for no other reason than that true capital mobility is an experiment we've never run. I would also disagree that if the present global trade paradigm is sub-optimal, additional regulation is guaranteed to be the answer. This is like suggesting that the needle will be easier to find if we dump more hay onto the haystack.