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The Perils
of Free Trade


Economists routinely ignore its hidden costs
to the environment and the community


    by Herman E. Daly

No policy prescription commands
greater consensus among econ-
omists than that of free trade
based on intemational specialization ac-
cording to comparative advantage. Free
trade has long been presumed good un-
less proved otherwise. That presump-
tion is the cornerstone of the existing
General Agreement on Tariffs and Trade
(GATT) and the proposed North Amer-
ican Free Trade Agreement (NAFTA).
The proposals in the Uruguay Round of
negotiations strengthen GATT's basic
commitment to free trade and econom-
ic globalization.
Yet that presumption should be re-
versed. The default position should fa-
vor domestic production for domestic
markets. When convenient, balanced in-
ternational trade should be used, but
it should not be allowed to govern a
country's affairs at the risk of environ-
mental and social disaster. The domes-
tic economy should be the dog and in-
temational trade its tail. GATT seeks to
tie all the dogs' tails together so tightly
that the international knot would wag
the separate national dogs.
The wiser course was well expressed
in the overlooked words of John May-

nard Keynes: "I sympathize, therefore,
with those who would minimize, rather
than those who would maximize, eco-
nomic entanglement between nations.
Ideas, knowledge, art, hospitality, trav-
el-these are the things which should
of their nature be intemational. But let
goods be homespun whenever it is rea-
sonably and conveniently possible; and,
above all, let finance be primarily na-
tional." Contrary to Keynes, the defend-
ers of the proposed Uruguay Round
of changes to GATT not only want to
downplay "homespun goods," they also
want finance and all other services to
become primarily intemational.
Economists and environmentalists
are sometimes represented as being,
respectively, for and against free trade,
but that polarization does the argu-
ment a disservice. Rather the real de-
bate is over what kinds of regulations
are to be instituted and what goals are
legitimate. The free traders seek to max-
imize profits and production without
regard for considerations that repre-
sent hidden social and environmental
costs. They argue that when growth has
made people wealthy enough, they will
have the funds to clean up the damage
done by growth. Conversely, environ-
mentalists and some economists, my-
self among them, suspect that growth
is increasing environmental costs faster
than benefits from production-there-
by making us poorer, not richer.
A more accurate name than the per-
suasive label "free trade"-because who
can be opposed to freedom?-is "dereg-
ulated intemational commerce." Dereg-
ulation is not always a good policy: re-
call the recent experience of the U.S.
with the deregulation of the savings and
loan institutions. As one who formerly
taught the doctrine of free trade to col-
lege students, I have some sympathy for
the free traders' view. Nevertheless, my
major concem about my profession to-
day is that our disciplinary preference

for logically beautiful results over fac-
tually grounded policies has reached
such fanatical proportions that we econ-
omists have become dangerous to the
earth and its inhabitants.
The free trade position is grounded in
the logic of comparative advantage, first
explicitly formulated by the early l9th-
century Bntish economist David Ricar-
do. He observed that countries with dif-
ferent technologies, customs and re-
sources will incur different costs when
they make the same products. One
country may find it comparatively less
costly to mine coal than to grow wheat,
but in another country the opposite
may be true. If nations specialize in the

products for which they have a com-
parative advantage and trade freely to
obtain others, everyone benefits.
The problem is not the logic of this
argument. It is the relevance of Ricar-
do's critical but often forgotten assump-
tion that factors of production (espe-
cially capital) are intemationally immo-
bile. In today's world, where billions
of dollars can be transferred between
nations at the speed of light, that es-
sential condition is not met. Moreover,
free traders encourage such foreign in-
vestment as a development strategy. In
short, the free traders are using an ar-
gument that hinges on the impermabil-
ity of national boundaries to capital to

support a policy aimed at making those
same boundaries increasingly pemme-
able to both capital and goods!
That fact alone invalidates the as-
sumption that international trade will
inevitably benefit all its partners. Fur-
thermore, for trade to be mutually ben-
eficial, the gains must not be offset by
higher liabilities. After specialization,
nations are no longer free not to trade,
and that loss of independence can be a
liability. Also, the cost of transporting
goods internationally must not cancel
out the profits. Transport costs are en-
ergy intensive. Today, however, the cost
of energy is frequently subsidized by
governments through investment tax

credits, federally subsidized research
and military expenditures that ensure
access to petroleum. The environmen-
tal costs of fossil-fuel burning also do
not factor into the price of gasoline. To
the extent that energy is subsidized,
then, so too is trade. The full cost of en-
ergy, stripped of these obscuring subsi-
dies, would therefore reduce the initial
gains from long-distance trade, wheth-
er international or interregional.

Free trade can also introduce new
inefficiencies. Contrary to the im-
plications of comparative advan-
tage, more than half of all internation-
al trade involves the simultaneous im-
port and export of essentially the same
goods. For example, Americans import
Danish sugar cookies, and Danes import
American sugar cookies. Exchanging
recipes would surely be more efficient.
It would also be more in accord with
Keynes's dictum that knowledge should
be international and goods homespun
(or in this case, homebaked).
Another important but seldom men-
tioned corollary of specialization is a
reduction in the range of occupation-
al choices. Uruguay has a clear compar-
ative advantage in raising cattle and
sheep. If it adhered strictly to the rule of
specialization and trade, it would afford
its citizens only the choice of being ei-
ther cowboys or shepherds. Yet Uru-
guayans feel a need for their own legal,
financial, medical, insurance and educa-
tional services, in addition to basic agri-
culture and industry. That diversity en-
tails some loss of efficiency, but it is nec-
essary for community and nationhood.
Uruguay is enriched by having a sym-
phony orchestra of its own, even though
it would be cost-effective to import bet-
ter syrnphony concerts in exchange for
wool, mutton, beef and leather. Individ-
uals, too, must count the broader range
of choices as a welfare gain: even those
who are cowboys and shepherds are
surely enriched by contact with coun-
trymen who are not vaqueros or pas-
tores My point is that the community di-
mension of welfare is completely over-
looked in the simplistic argument that
if specialization and trade increase the
per capita availability of commodities,
they must be good.
Let us assume that even after those
liabilities are subtracted from the gross
returns on trade, positive net gains still
exist. They must still offset deeper,
more fundamental problems. The argu-
ments for free trade run afoul of the
three basic goals of all economic poli-
cies: the efficient allocation of resourc-
es, the fair distnbution of resources and
the maintenance of a sustainable scale
of resource use. The first two are tradi-

tional goals of neoclassical economics.
The third has only recently been recog-
nized and is associated with the view-
point of ecological, or steady-state, eco-
nomics. It means that the input of raw
materials and energy to an economy and
the output of waste materials and heat
must be within the regenerative and ab-
sorptive capacities of the ecosystem.
In neoclassical economics the efficient
allocation of resources depends on the
counting and intemalization of all costs.
Costs are internalized if they are directly
paid by those entities responsible for
them-as when, for example, a manu-
facturer pays for the disposal of its fac-
tory wastes and raises its prices to cov-
er that expense. Costs are externalized
if they are paid by someone else-as
when the public suffers extra disease,
stench and nuisance from uncollected
wastes. Counting all costs is the very
basis of efficiency.
Economists rightly urge nations to
follow a domestic program of internal-
izing costs into prices. They also wrong-

ly urge nations to trade freely with oth-
er countries that do not intemalize their
costs (and consequently have lower pric-
es). If a nation tries to follow both those
policies, the conflict is clear: free com-
petition between different cost-internal-
izing regimes is utterly unfair.
Intemational trade increases compe-
tition, and competition reduces costs.
But competition can reduce costs in two
ways: by increasing efficiency or by low-
ering standards. A firm can save money
by lowering its standards for pollution
control, worker safety, wages, health
care and so on-all choices that exter-
nalize some of its costs. Profit-maximiz-
ing firms in competition always have an
incentive to exterr*lize their costs to the
degree that they can get away with it.
For precisely that reason, nations
maintain large legal, administrative and
auditing structures that bar reductions
in the social and environmental stan-
dards of domestic industries. There are
no analogous international bodies of
law and administration; there are only

national laws, which differ widely. Con-
sequently, free international trade en-
courages industries to shift their pro-
duction activities to the countries that
have the lowest standards of cost inter-
nalization-hardly a move toward glob-
al efficiency.

A ttaining cheapness by ignoring
real costs is a sin against effi-
ciency. Even GATT recognizes
that requiring citizens of one country
to compete against foreign prison la-
bor would be carrying standards-low-
ering competition too far. GATT there-
fore allows the imposition of restric-
tions on such trade. Yet it makes no
similar exception for child labor, for un-
insured risky labor or for subsistence-
wage labor.
The most practical solution is to per
mit nations that internalize costs to
levy compensating tariffs on trade with
nations that do not. "Protectionism"-
shielding an inefficient industry against
more efficient foreign competitors-is
a dirty word among economists. That is
very different, however, from protect-
ing an efficient national policy of full-
cost pricing from standards-lowering
international competition.
Such tariffs are also not without pre-
cedent. Free traders generally praise the
fairness of "antidumping" tariffs that
discourage countries from trading in
goods at prices below their production
costs. The only real difference is the
decision to include the costs of environ-
mental damage and community welfare
in that reckoning.
This tariff policy does not imply the
imposition of one country's environ-
mental preferences or moral judgments
on another country. Each country should
set the rules of cost internalization in
its own market. Whoever sells in a na-
tion's market should play by that na-
tion's rules or pay a tariff sufficient to
remove the competitive advantage of
lower standards. For instance, under the
Marine Mammal Protection Act, all tuna
sold in the U.S. (whether by U.S. or Mex-
ican fishermen) must count the cost
of limiting the kill of dolphin associat-
ed with catching tuna. Tuna sold in the
Mexican market (whether by U.S. or Mex-
ican fishermcn) need not include that
cost. No standards are being imposed
through "environmental imperialism";
paying the costs of a nation's environ-
mental standards is merely the price of
admission to its market.
Indeed, free trade could be accused
of reverse environmental imperialism.
When firms produce under the most
perrnissive standards and sell their prod-
ucts elsewhere without penalty, they
press on countries with higher stan-

dards to lower them. In effect, unre-
stricted trade imposes lower standards.
Unrestricted intemational trade also
raises problems of resource distribu-
tion. In the world of comparative ad-
vantage described by Ricardo, a nation's
capital stays at home, and only goods
are traded. If firms are free to relocate
their capital intemationally to wherev-
er their production costs would be low-
est, then the favored countries have not
merely a comparative advantage but an
absolute advantage. Capital will drain
out of one country and into another,
perhaps making what H. Ross Perot
called "a giant sucking sound" as jobs
and wealth move with it. This special-
ization will increase world production,
but without any assurance that all the
participating countries will benefit.
When capital flows abroad, the oppor-
tunity for new domestic employment
diminishes, which drives down the price
for domestic labor. Even if free trade
and capital mobility raise wages in low-
wage countries (and that tendency is
thwarted by overpopulation and rapid
population growth), they do so at the
expense of labor in the high-wage coun-
tries. They thereby increase income in-
equality there. Most citizens are wage
earners. In the U.S., 80 percent of the
labor force is classified as "nonsupervi-
sory employees." Their real wages have
fallen 17 percent between 1973 and
1990, in significant part because of
trade liberalization.
Nor does labor in low-wage countries
necessarily gain from free trade. It is
likely that NAFTA will ruin Mexican
peasants when "inexpensive" U.S. corn
(subsidized by depleting topsoil, aqui-
fers, oil wells and the federal treasury)
can be freely imported. Displaced peas-
ants will bid down wages. Their land

wiU be bought cheaply by agribusiness-
es to produce fancy vegetables and cut
flowers for the U.S. market. IronicaUy,
Mexico helps to keep U.S. com "inexpen-
sive" by exporting its own vanishing re-
serves of oil and genetic crop variants,
which the U.S. needs to sustain its com
monoculture.
Neoclassical economists admit that
overpopulation can spiU over from one
country to another in the form of cheap
labor. They acknowledge that fact as
an argument against free immigration.
Yet capital can migrate toward abun-
dant labor even more easily than labor
can move toward capital. The legitimate
case for restrictions on labor immigra-
tion is therefore easily extended to re-
strictions on capital emigration.

When confronted with such
problems, neoclassical econo-
mists often answer that growth
wiU solve them. The aUocation problem
of standards-lowering competition, they
say, will be dealt with by universaUy
"harmonizing" aU standards upward.
The distribution problem of faUing wag-
es in high-wage countries would only
be temporary; the economists believe
that growth wiU eventuaUy raise wages
worldwide to the fommer high-wage lev-
el and beyond.

Yet the goal of a sustainable scale
of total resource use forces us to ask:
What wiU happen if the entire popu-
lation of the earth consumes resourc-
es at the rate of high-wage countries?
Neoclassical economists generaUy ignore
this question or give the facile response
that there are no lirnits.
The steady-state economic paradigm
suggests a different answer. The regen-
erative and assimilative capacities of
the biosphere cannot support even the
current levels of resource consumption,
much less the manyfold increase re-
quired to generalize the higher stan-

dards worldwide. StiU less can the eco-
system afford an ever growing popu-
lation that is striving to consume more
per capita. As a species, we already pre-
empt about 40 percent of the land-
based primary product of photosynthe-
sis for human purposes. What happens
to biodiversity if we double the human
population, as we are projected to do
over the next 30 to 50 years?
These lirnits put a brake on the abil-
ity of growth to wash away the prob-
lems of misaUocation and maldistri-
bution. In fact, free trade becomes a rec-
ipe for hastening the speed with which
competition lowers standards for effi-
ciency, distributive equity and ecologi-
cal sustainability.
Notwithstanding those enormous
problems, the appeal of bigger free
trade blocs for corporations is obvious.
The broader the free trade area, the less
answerable a large and footloose cor-
poration will be to any local or even
national community. Spatial separation
of the places that suffer the costs and
enjoy the benefits becomes more fea-
sible. The corporation wiU be able to
buy labor in the low-wage markets and
seU its products in the remaining high-
wage, high-income markets. The larger
the market, the longer a corporation
will be able to avoid the logic of Henry
Ford, who realized that he had to pay
his workers enough for them to buy his

cars. That is why transnational corpo-
rations like free trade and why workers
and environmentalists do not.

In the view of steady-state econom-
ics, the economy is one open sub-
system in a finite, nongrowing and
materially closed ecosystem. An open
system takes matter and energy from
the environment as raw materials and
returns them as waste. A closed sys-
tem is one in which matter constantly
circulates internally while only energy
flows through. Whatever enters a sys-
tem as input and exits as output is
called throughput. Just as an organism
survives by consuming nutrients and
excreting wastes, so too an economy
must to some degree both deplete and
pollute the environment. A steady-state
economy is one whose throughput re
mains constant at a level that neither
depletes the environment beyond its
regenerative capacity nor pollutes it be-
yond its absorptive capacity.
Most neoclassical economic analyses
today rest on the assumption that the
economy is the total system and na-
ture is the subsystem. The economy
is an isolated system involving only
a circular flow of exchange value be-
tween firms and households. Neither
matter nor cncrgy enters or exits this
system. The economy's growth is there-
fore unconstrained. Nature may be fi-

nite, but it is seen as just one sector
of the economy, for which other sectors
can substitute without limiting over-
all growth.
Although this vision of circular flow
is useful for analyzing exchanges be-
tween producers and consumers, it is
actively misleading for studying scale-
the size of the economy relative to the
environment. It is as if a biologist's vi-
sion of an animal contained a circula-
tory system but not a digestive tract or
lungs. Such a beast would be indepen-
dent of its environment, and its size
would not matter. If it could move, it
would be a perpetual motion machine.
Long ago the world was relatively
empty of human beings and their be-
longings (man-made capital) and rela-
tively full of other species and their
habitats (natural capital). Years of eco-
nomic growth have changed that basic
pattern. As a result, the limiting factor
on future economic growth has changed.
If man-made and natural capital were
good substitutes for one another, then
natural capital could be totally replaced.
The two are complementary, however,
which means that the short supply of
one imposes lirnits. What good are fish-
ing boats without populations of fish?
Or sawmills without forests? Once the
number of fish that could be sold at
market was primarily lirnited by the
number of boats that could be built and

manned; now it is limited by the num-
ber of fish in the sea.
As long as the scale of the human
economy was very small relative to the
ecosystem, no apparent sacrifice was
involved in increasing it. The scale of
the economy is now such that painless
growth is no longer reasonable. If we
see the economy as a subsystem of a fi-
nite, nongrowing ecosystem, then there
must be a maximal scale for its through-
put of matter and energy. More impor-
tant, there must also be an optimal
scale. Economic growth beyond that op-
timum would increase the environmen-
tal costs faster than it would the pro-
duction benefits, thereby ushering in
an antieconomic phase that impover-
ished rather than enriched.
One can find disturbing evidence that
we have already passed that point and,
like Alice in Through the Looking Glass,
the faster we run the farther behind we
fall. Thus, the correlation between gross
national product (GNP) and the index of
sustainable economic welfare (which is
based on personal consumption and ad-
justed for depletion of natural capital
and other factors) has taken a negative
turn in the U.S.
Like our planet, the economy may
continue forever to develop qualitative-
ly, but it cannot grow indefinitely and
must eventually settle into a steady
state in its physical dimensions. That
condition need not be miserable, how-
ever. We economists need to make the
elementary distinction between growth
(a quantitative increase in size result-
ing from the accretion or assirnilation
of materials) and development (the qual-
itative evolution to a fuller, better or dif-
ferent state). Quantitative and qualita-
tive changes follow different laws. Con-
flating the two, as we currently do in
the GNP, has led to much confusion.
Development without growth is sus-
tainable development. An economy that
is steady in scale may still continue to

develop a greater capacity to satisfy hu-
man wants by increasing the efficiency
of its resource use, by improving social
institutions and by clarifying its ethical
priorities-but not by increasing the re-
source throughput.

In the light of the growth versus de-
velopment distinction, let us return
to the issue of international trade
and consider two questions: What is the
likely effect of free trade on growth?
What is the likely effect of free trade on
development?
Free trade is likely to stimulate the
growth of throughput. It allows a coun-
try in effect to exceed its domestic re-
generative and absorptive lirnits by
"importing" those capacities from oth-
er countries. True, a country "exporting"
some of its carrying capacity in return
for imported products might have in-
creased its throughput even more if it
had made those products domestically.
Overall, nevertheless, trade does post-
pone the day when countries must face
up to living within their natural regen-
erative and absorptive capacities. That
some countries still have excess carrying
capacity is more indicative of a shortfall
in their desired domestic growth than of
any conscious decision to reserve that
capacity for export.
By spatially separating the costs and
benefits of environmental exploitation,
international trade makes them harder
to compare. It thereby increases the ten-
dency for economies to overshoot their
optimal scale. Furthermore, it forces
countries to face tightening environmen-
tal constraints more simultaneously and
less sequentially than would otherwise
be the case. They have less opportunity
to learn from one another's experiences
with controlling throughput and less
control over their local environment.
The standard arguments for free trade
based on comparative advantage also
depend on static promotions of efficien-

cy. In other words, free trade in tox-
ic wastes promotes static efficiency by
allowing the disposal of wastes wher-
ever it costs less according to today's
prices and technologies. A more dynam-
ic efficiency would be served by out-
lawing the export of toxins. That step
would internalize the disposal costs of
toxins to their place of origin-to both
the firm that generated them and the
nation under whose laws the firm oper-
ated. This policy creates an incentive to
find technically superior ways of deal-
ing with the toxins or of redesigning
processes to avoid their production in
the first place.
All these allocative, distributional and
scale problems stemming from free
trade ought to reverse the traditional
default position favoring it. Measures
to integrate national economies further
should now be treated as a bad idea un-
less proved otherwise in specific cases.
As Ronald Findley of Columbia Univer-
sity characterized it, comparative ad-
vantage may well be the "deepest and
most beautiful result in all of econom-
ics." Nevertheless, in a full world of in-
ternationally mobile capital, our adher-
ence to it for policy direction is a rec-
ipe for national disintegration.


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