Been having a back and forth with a friend over the issue of off-shoring by US corporations. I recently sent him an article in Naked Capitalism about why Apple manufactures the I-Phone in China.

As to his arguments. He claims that China has a “comparative advantage” because of a concentration of resources there. (I assume he means a concentration of cheap labor) He says that we shouldn’t try to compete where we are at a disadvantage. And that it does no one any good, and wastes resources that could be used productivly, and we will lose. The answer is to do things for which we have a comparative advantage, and to educate our children better so that our advantages are in higher paying jobs.

The problem with this argument is that it is made with a flawed understanding of David Ricardo’s theory of comparative advantage; in which a country specializes in economic activities in which it performs best and trades for those goods that other countries do best. In my brother-in-laws defense, many pro-free trade economists make the same mistake in that they confuse comparative advantage with absolute advantage.

Ricardo, an early 19th century economist, based his theory of comparative advantage, as it relates to free trade, on two necessary conditions: 1) that a country’s capital seek comparative advantage at home and not seek absolute advantage abroad. 2) countries have different relative cost ratios of producing tradable goods.

Instead of seeking comparative advantage at home what we have is American corporations, who offshore their production for domestic US markets, using advanced technology and capital, chasing absolute advantage abroad by using super low cost labor in locations like China. And in Ricardo’s day, capital was captive and labor mobile, Today it is the reverse, with capital as internationally mobile as tradable goods, and knowledge based production functions having the same relative cost ratios regardless of the country of location.

The famous Ricardian conditions for free trade are not present in todays world.

Back before US firms began off-shoring production, American workers had nothing to fear from cheap labor abroad. Americans worked with superior capital, technology and business organization. But American multi-national corporations lobbied to close down their US plants and move to places with a vast overhang of cheap labor. This labor, that is equally productive but paid a fraction of the wage paid to US workers is a magnet for US capital and technology. The fact that these workers are obedient, regimented and subservient, working 12 hours a day, 6 days a week, doesn’t hurt either.

It is this replacement of US workforces by foreign workers that helps explains the extraordinary rise in CEO compensation and flow of most of the income and wealth gains to the few people at the top, leading to the type of income inequality that has become a topic in Republican debates and OWS protests. The reality is that, corporate America, with the support of the government, is using this resulting unemployment from off-shoring as “bludgeon” to drive down wages, destroy working conditions and force US workers to accept sweatshop conditions–like those in China.

Among mainstream pundits, there is generally no acknowledgment of the social costs of this off-shoring of American jobs. The poverty, foreclosure, homelessness, and hunger that are the result. Although this could be changing.

Historian, Francis Fukuyama, who wrote, The End of History, declaring that liberal free market capitalism had triumphed over communism, is having second thoughts. In a new essay in Foreign Affairs, the journal of the Council on Foreign Relations, he argues that some very troubling economic and social trends spell bad news for liberal democracies. Specifically, Fukuyama, says that global capitalism and free trade doctrine, combined with new technologies, along with the steady offshoring of American jobs are destroying the middle-class--the necessary foundation for democracy in advanced economies.

But many mainstream economists cannot recant their most beloved shibboleth. Free trade has become an unexamined article of faith. And now, they cannot admit that they base this faith on mistaking absolute advantage with comparative advantage. Of course, their faith just so happens to massively benefit the corporations that take advantage of “free trade.”

But, the US economy did not develop on the basis of free trade. Whatever the costs of protectionism, the costs did not prevent America’s economic rise. In fact every advanced economy used protectionism, in the form of tariffs to protect their domestic industries. If the US had practiced the sort of free trade orthodoxies now so prevalent, we would be advised to focus on our comparative advantages in cotton and beaver hides.