Law & Liberty has been hosting a forum on trade. The first entry was by Oren Cass of American Compass, in which he writes about what he calls the “origin myth” of free trade. In his telling, free trade wasn’t something economists really agreed on until after World War II, when they became doctrinaire free-traders. He portrays English and then American supporters of free trade as making arguments motivated by the fact that free trade benefited first England and then America, and that the conditions under which those benefits accrued are no longer extant.
Phillip Magness of the Independent Institute rebutted Cass’s historical arguments in his entry. He notes that Cass’s economic history is reminiscent of the left-wing field of “neoliberalism studies,” where support for free trade is portrayed as part of a nefarious political project, not as an application of economic reasoning. He recounts how Cass misreads sources that he quotes. He also corrects misimpressions about the supposed arch-protectionism of 19th-century America and writes about the negative economic and political effects of tariffs throughout American history.
Magness’s treatment of the history is thorough and worth your time. I’d just like to add one other way in which Cass’s narrative doesn’t add up.
In Cass’s telling, economists became doctrinaire free-traders, as a class, after World War II. That isn’t correct. Many economists argued in favor of import substitution in developing countries. Developing countries implemented various forms of import substitution, the replacement of imports with domestically produced goods, and failed to develop. It was the manifest failure of this policy that induced many economists to change their minds and argue for different trade policies instead.
As trade economist Douglas Irwin wrote in a 2020 paper, “The idea of import substitution emerged shortly after World War II, when many economists believed that the prospects of developing countries achieving economic growth through trade were slim.”
Irwin writes that proponents of import substitution believed that “the conclusions derived from standard economic theory were based on assumptions that were not germane to the economic circumstances of developing countries” and that “any policy conclusions that might emerge from standard theory would be inappropriate for those countries.” So much for post-war economists being doctrinaire free-traders.
Irwin describes what was actually in vogue among economists after World War II:
For example, the theory of comparative advantage, it was believed, implied that developing countries would be locked into a disadvantageous pattern of specialization and trade — exporting primary commodities in exchange for imports of manufactured goods — which would keep them poor and from which they would never escape. The principle path to development was seen as industrialization, and specialization for trade was seen as preventing developing countries from establishing a manufacturing base. . . .
In addition, it was believed that market prices would not produce the right allocation of resources, because high wages in manufacturing (compared with agriculture and primary sectors) meant that industry would be “too small” relative to the social optimum. As a result, extensive government intervention would be needed to allocate resources more efficiently and mobilize the capital needed for economic growth.
So much for “market fundamentalism.”
Exactly what economists wanted instead of free trade was hotly debated. Irwin recounts the different views of Raúl Prebisch, Gunnar Myrdal, W. Arthur Lewis, Albert Hirschman, and Ragnar Nurske on what kinds of trade restrictions were desirable. (Myrdal, who would go on to win the Nobel prize in 1974, attacked “the logically untenable and fallacious doctrine of free trade” in a 1957 book.) But they all agreed that some kind of government intervention in trade would be necessary for developing nations to succeed.
As Irwin notes, economists who supported import substitution were largely providing intellectual reasoning for something that was happening anyway. Many developing countries at the time had socialist or socialist-adjacent governments that were keen to control trade as part of a broader program of economic planning. Across Latin America, Africa, and parts of Asia, governments imposed protectionism in the 1950s and maintained it in the decades following.
The practice of import substitution discredited the theory, and by the 1960s, most economists had abandoned the idea, Irwin writes. Even Prebisch, perhaps the most prominent advocate of import substitution, never abandoned it in principle but shuddered at how it worked in practice. “Whatever intellectual support there had been for import substitution in the 1950s was significantly weaker by the mid-1960s,” Irwin writes. “The change was recognized by the very group that was most sympathetic to the idea of import substitution in the first place.”
Irwin records that economists surveying the wreckage of import substitution in the 1960s found disastrous results, such as that, due to a lack of competition, “many Pakistani industries had negative value added at world prices.” Import substitution in the Philippines had slowed growth and increased inefficiency in production.
India was one of the top countries that pursued import substitution to try to spur growth. Indian economist Jagdish Bhagwati was one of the top critics of this approach. He and others influenced the Indian government’s decision in 1991 to open up to international markets.
The difference after the restrictions were removed is night-and-day. “Postindependence, the Indian government disfavored free trade and imposed heavy restrictions on imports using tariff and non-tariff barriers while trying to encourage exports using subsidies,” economist Anupam Manur wrote in 2022. “In the years following the [1991] reforms, the Indian economy grew at significantly higher rates, the share of trade in India’s GDP increased, and the share of Indian goods and services in global trade increased.”
In the 41 years between 1950 and 1991, Indian GDP per capita grew by only $495 in constant dollars. In the 28 years from 1991 to 2019, it grew by $5,265. India now has the fastest-growing major economy in the world. Its GDP per capita was lagging behind Pakistan’s as recently as 2009.
In a 1987 paper, Bhagwati wrote, “In economics, consensus is produced by sharpening differences; in politics, by obfuscating them.” Economists’ consensus around free trade came about as a result of having tried different approaches, both in theory and in practice. Cass is obfuscating that history.