The case for free trade is often based on the view that man is a rational and individualistic homo economicus. This paper analyzes free trade from a broader, relational picture of mankind. After introducing this view, we discuss the blessings of free trade from this relational perspective. Next we explore three developments that put international trade under pressure.

  1. Free trade requires shared norms
  2. Complexity requires relationships governed by local rules
  3. Creative destruction requires sound social security and education

We investigate a number of policy options to prevent free trade from impairing interpersonal relationships, and end with some conclusions.

This is a translated and slightly revised version of the following article written in Dutch: Lans Bovenberg (2017). “Vrijhandel vanuit relationeel perspectief: kansen en bedreigingen.” In: Christen-Democratische Verkenningen, Herfst 2017 (pp. 53-63).

Relational view of mankind

Limited rationality and socially formed preferences

Recent developments in economic science support a less rational and a more relational view of mankind than the rational and individualistic homo economicus. Behavioral economics, for example, claims that we often do not act rationally (1). We are limited in our ability to understand ourselves and our environment. Faced with fundamental uncertainty, we have no choice but to rely on trust in others. Our preferences and moral values are co-shaped by our social environment (2). We rely on others to discover what is valuable.

Intrinsic motivation

People are thus not autonomous individuals, but relational persons – in part because they are often intrinsically motivated to make an effort for others. They want their lives to have meaning by being of service to a larger, ‘holy’ community (3). People derive self-respect and identity from the group with which they identify (4). They also value the quality of relationships and appreciate the good intentions and trust of others (5). Relationships are thus not just a means for achieving material prosperity, but also an end in itself. Our unique meaning for the people we are involved with, in which we are not interchangeable with others, gives our life meaning.

Limited rationality

A more relational view of mankind pays attention to not only our rational, but also our moral limitations. It does not imply a naive belief in the goodness of man (6). The desire to belong to a group often limits our empathy for those outside of that group. Benevolence depends not only on the identity, but also on the behavior of others. Our intrinsic preference for reciprocity and justice implies that we are willing to pay a price for harming others who have hurt us or our group. When assessing the moral intentions of others, however, we make systematic mistakes: we usually overestimate our own moral qualities and underestimate those of others (7). All of this makes relationships fragile. Mistakes and misunderstandings may result in a destructive cycle of contamination – a vicious circle fear, distrust and revenge.

Blessings of free trade

Strangers and differences as an opportunity instead of a curse

Also from this broader, relational perspective of mankind free trade contributes to human flourishing. The market is a platform for collaboration in which people aim to serve mutual interest. Free trade transforms conflicts about the distribution of scarce resources in a common interest in transcending scarcity. An example is the European internal market. By converting conflicting interests into parallel interests, free trade has contributed to forging swords into plowshares. The poison of poverty and conflict has been transformed into the gift of well-being and parallel interests. Free trade contributes to a civilization process in which we learn to trust and appreciate strangers. Unknown people become a blessing instead of a curse.

Trusting strangers

Competition disciplines people, with their bounded moral rationality, to learn more about and serve the interests of strangers. Merchants who trade a lot have an incentive to build a reputation of reliability and service. These extrinsic motives can be internalized over time in the form of certain virtues, such as thrift, justice, empathy and prudence (8). Adam Smith saw Dutch people as a textbook example of the reciprocal link between the economy of the merchant and the morality of the minister: ‘Of all the nations in Europe, the Dutch, the most commercial, are the most faithful to their word’ (9). It turns out that in countries where the free market plays an important role people trust and respect each other more than in countries where markets are less important – even if these people do not know each other personally and belong to different social groups (10). As a result of free trade differences between people constitute opportunities rather than threats; the more people differ from each other, the more they can benefit each other. Free trade not only exploits diversity, it can also increase this diversity: through further division of labor in a larger international market one can specialize more and become more oneself. It thus results in unity in diversity.

Impersonal institutions ensure balance of power

A free market where everyone has to compete on an equal footing to win the favor of customers requires a rule of law in which everyone is equal for the law – even if one belongs to a minority. The impersonal institutions of the market and the rule of law treat people the same, irrespective of personal differences. Its ordering power thus contributes to inclusive societies in which the interests of all citizens count. One group cannot just confiscate the fruits of the efforts of another group. This results in a more stable balance of power, which increases the incentives to work together. Instead of citizens fighting and oppressing each other to protect or conquer privileged positions of power, they develop their talents for the benefit of each other. By strengthening checks and balances international trade is an important force behind the substantial reduction of global inequality in terms of poverty reduction during the past four decades (11).

Competition disciplines people to learn and work together

Competition resulting from free trade contributes to growth of prosperity also because it encourages companies to innovate and experiment. It not only encourages entrepreneurs to undertake technological innovation, but also social innovation. Competition means that companies only survive if they motivate employees to work well together for the benefit of the customer. Despite limited rationality people thus discover and learn how to serve each other better. Also the international knowledge sharing that goes hand in hand with free trade contributes to continuous innovation. In this way competition results in better functioning corporation – both at the level of companies and at the level of networks. Competition teaches people with their limited rationality how they can best benefit each other. In that way free trade also contributes to stronger personal relationships.

Free trade requires shared norms (development 1)

A number of developments put pressure on free trade. For each of these developments we will look at a number of policy options that are aimed at limiting the disadvantages associated with free trade. A first relevant development concerns the increasing complexity and interconnectedness of international trade. This calls for a shared identity and morality. .

The challenges for free trade…

Most trade barriers in developed economies concern differences in standards in the fields of consumer protection, intellectual property, animal welfare, sustainability and social protection. Free trade requires norms that are shared internationally. In addition, countries must be able to trust each other in enforcing the corresponding uniform standards. Furthermore, network effects naturally result in positions of power on international markets. Combating this by promoting competition requires international coordination between public competition authorities. The increasingly complex interdependencies between national economies make the trade-off between free trade and national policy sovereignty a pertinent issue. Every instance of cooperation between persons requires self-restraint to do justice to the interests of all partners involved. Collaboration is therefore at odds with complete individual discretion to do as you please. This tension also applies to countries. In this connection Rodrik (12) formulates a trilemma between globalization (‘international cooperation’), sovereignty of the people (‘democracy’) and the nation state (limited joint ‘identity’). Only two of these three desires can be reached simultaneously. The deepest origin of this trilemma is international diversity in values and norms.

… imply a need for joint rules and underlying ethical standards

Free trade exploits and enlarges not only international diversity through division of labor, but also requires unity in the sense of a minimal degree of agreement about the rules regulating the market. For every kind of cooperation an optimal distance between people exists: on the one hand enough variety in order to be able to exploit differences in talents and tastes, but on the other hand sufficient agreement on the standards regulating that cooperation and safeguarding all interests. In a complex, modern economy public regulation of international trade is not only expanding, but legal rules are also becoming less and less effective to protect all interests. In addition to public regulation, other forms of governance this become increasingly important. Examples are reputation mechanisms and intrinsic motivation, which stimulate companies to voluntarily take into account non-contractible interests. However, even this self-regulation requires international agreement on the implicit standards that companies must adhere to. Not just government regulation, but also self-regulation of international trade thus demands an internationally shared morality. The scope of shared values and norms determines the scope for international trade and the associated degree of specialization.

Complexity requires relationships governed by local rules (development 2)

Complexity requires relationships instead of transactions…

A second relevant development is the increasing complexity of human interactions. Transactions are short-term interactions with people that you do not know well . They work well if these interactions are standardized and the relevant information is public. It requires homogeneous, simple goods and services for which all relevant aspects can easily be included in a contract that secures all interests. More complex, non-standardized interactions cannot be contracted, or only at excessive transaction costs. Protecting all interests then requires sustainable, personal relationships. In these relationships you get to know each other, so that you can better trust each other. A party that makes a sacrifice today sees this in the long-term perspective of the future benefits arising from the relationship. Furthermore mutual affection is built up, as well as a joint identity and culture. This commits the partners to each other’s interests. Exactly the non-exchangeability of the cooperating partners has intrinsic value for the stakeholders. The form of governance of such relationships can be found in companies, networks and clusters.

… yet free trade makes building appropriate relationships more difficult

Free trade and the related interchangeability can make sustainable commitment to complex collaborative relationships more difficult, with higher transaction costs as a result. After all, the stronger party can more easily escape from the relationship by having the good or service in question produced in another country. In that respect international competition can make the relationship between partners less balanced rather than more. The growing imbalance between interests makes it more difficult to build trust that all interests in a complex partnership are adequately secured. Think for example of opportunistic hedge funds that break down unwritten agreements that are part of corporate cultures. The short-term gain for the shareholders is at the expense of other stakeholders. This opportunistic behavior undermines trust in agreements that align interests, thereby hurting the long-term earning power of the economy. Another example of uprooting as a result of free trade is the far-reaching flexibilisation of the labor market. A weaker position of workers undermines the incentive to invest in company-specific skills. The greater uncertainty for workers results in alienation. That too harms people’s well-being.

Regulating labor and capital markets

To prevent free trade from undermining valuable domestic relations by an unequal balance of power, countries and regions should retain sufficient instruments to regulate markets for labor and capital and to protect relatively weak parties or goals (13). This requires sufficient space for forms of governance that enable cooperation partners to commit to relationships. Such institutions counterbalance the market, which is based more on interchangeability and liquidity. A broader view of man corrects the tendency of economists to choose for interchangeability and liquidity at the expense of mutual anchoring in personal, sustainable relationships. On the labor market durable employee-employer relationships should be less disadvantaged compared to other contract forms, for example as a result of tax arrangements. The same applies in the capital market for equity financing compared to less relational financing forms, such as debt.

Creative destruction requires sound social security and education (development 3)

Broad distribution of the benefits of free trade…

International competition is accompanied by creative destruction, the third challenging development that is inherent in the expansion of global free trade. The importance of innovation and service for the public interest comes at the expense of some private interests, for example those of laborers working for companies that go out of business due to international competition. In a democracy in which all interests count, the legitimacy of international competition depends on social insurance for those who are hurt by international competition. Only then are the benefits of international trade widely shared within a country. Especially small open economies that expose their companies to international competition tend to have extensive social insurances. This is to protect employees who lose their job through creative destruction. Social security and the associated solidarity are thus complementary to free trade. A well-known proposition from economic theory is that free trade strengthens (weakens) the position of relatively abundant (scarce) production factors in a country. In poor countries unskilled labor from the underclass is usually the abundant production factor, but in the rich countries this is typically the skilled labor from the upper class. While free trade in poor countries this tends to strengthen the position of weak groups, thereby reducing inequality, in rich countries it deteriorates the already weak position of the middle class. That poses a challenge to the rich countries to ensure that also the lower middle class benefits from international trade in order to protect the legitimacy of international competition.

…through activating social security and good foundational education everybody

Solidarity with those who experience the disadvantages of free trade can take different forms. Social security is about finding a balance between protecting people against a drop of income on the one hand, and encouraging people to develop their talents for the benefit of others. Equal opportunities for young people in basic education are essential for an economy that benefits all. The growing complexity and interconnectedness of the society further increases the importance of education. While simple skills are being automated, the work that remains requires skills that cannot be codified: entrepreneurship, creativity and mutual service. More is being asked of citizens in terms of self-regulation and social skills. Both families and the basic education should therefore teach young people to govern themselves and to work together. An equal distribution of opportunities in a services economy requires a balanced distribution of non-cognitive skills and asks for early education in the virtues of citizenship (14). The win-win principle at the macro level of society requires that citizens are able to apply this principle of mutual benefit also at the micro level in their own lives.

Conclusions

We cannot separate international trade from a broader, relational view of mankind and the associated forms of governance – such as personal relationships and communities with shared norms and values, based on a common identity. Prosperity and peace require both (a) complex cooperation in durable, personal relationships within regional communities, companies and families and (b) superficial forms of cooperation with anonymous strangers far away – for example in the form international trade. Both deep and broad forms of cooperation are essential for human flourishing and should keep each other in balance.

Do not underestimate the importance of free trade…

International free trade is not unimportant, but it is also not a panacea. Two dangers are present. One is to underestimate the importance of free trade in disciplining limited rational and limited moral people. International trade is a cornerstone of institutional structures that balance different goals and interests. It does so by imposing limitations on dominant interests that threaten to overshadow other interests and goals. International competition limits those in power in their opportunities to serve their own interests at the expense of others. Disciplining people to take the interests of others into accounts serves peace and prosperity. Free trade also contributes to a process of civilization. We learn to trust and appreciate strangers. We also teach ourselves to impose restrictions on ourselves in the interest of the parties we cooperate with. .

… but also do not underestimate the importance of the rule of law,

The second, opposite danger is to underestimate the importance of institutions others than the market. For disciplining people with limited morality to take the interests of strangers into account, the impersonal institutions of the market and the rule of law are mutually dependent. Other key domestic institutions are personal relationships, families, companies, labor market institutions, activating social security and good basic education for everyone. Good citizenship is also important to make all these partnerships flourish.

…relationships,

To guarantee subsidiarity it is necessary that countries and regions maintain sufficient discretion in their public policies regulating factor markets, such as the labor market and the capital market. With their own local institutions, regions can further develop their unique individuality. Globalization then goes hand in hand with localization; free trade not only uses geographical diversity, it also develops it further. A broader view of man corrects the tendency of economists to opt for interchangeability and liquidity at the expense of mutual anchoring in personal, durable relationships.

…and shared norms and values

A broader, relational view of man argues that shared values and norms are an essential building block for the management of international trade. The scope of shared values and norms determines the size of a common market in complex products and services. The importance of a shared moral basis increases with the complexity and interconnectedness of a network economy. Reconciling the tension between national policy sovereignty and diversity on the one hand and international cooperation on the other requires a shared human identity alongside other, more regional identities. Monotheistic religions can contribute to a shared identity between peoples on which economic cooperation in the form of international trade can be based. After all, these religions teach that all people are created by the same God who gives each person – even if not all of them belong to the same group – a unique dignity.

Merchant and reverend

Because of its location on the open sea our country, the Netherlands, has a rich free trade tradition. Merchant and reverend keep each other in balance. The Jewish-Christian tradition recognizes the dignity of every person – even a stranger. This moral basis reconciles the impersonal institutions of international trade, competition and the rule of law with spiritual freedom and regional diversity. Based on these century old values the Netherlands can play a pioneering role in the challenge that the world is currently facing: reconciling regional diversity and identity, as well as personal freedom, with international cooperation whose fruits are broadly shared by all. Free trade creates unity in diversity, but also requires this as a foundation. Ultimately, a shared culture and the associated moral values and norms governs international trade and its scope.

Notes

  1. Daniel Kahneman, Thinking, fast and slow. New York: Farrar, Straus and Giroux, 2011.
  2. Samuel Bowles, The moral economy.Why good incentives are no substitute for good citizens. New Haven: Yale University Press, 2016.
  3. Dan Ariely, The (honest) truth about dishonesty. How we lie to everyone –especially ourselves. New York: Harper-Collins, 2012.
  4. George A. Akerlof and Rachel E. Kranton, Identity economics. How our identities shape our work, wages, and well-being. Princeton: Princeton University Press, 2010.
  5. Ernst Fehr and Urs Fischbacher, ‘Why social preferences matter. The impact of non-selfish motives on competition, cooperation, and incentives’, The Economic Journal 112 (2002), C1-C33.
  6. Eric van Damme, ‘Liefde en economie’, Economisch Statistische Berichten 100 (2015), pp. 724-726.
  7. Ariely 2012.
  8. Johan Graafland, ‘Do markets crowd out virtues? An Aristotelian framework’, Journal of Business Ethics 91 (2009), nr. 1, pp. 1-19.
  9. Adam Smith, Lectures on jurisprudence (edited by Ronald L. Meek, David D. Raphael and Peter G. Stein). Oxford: Oxford University Press, 1976.
  10. Joseph Henrich, Robert Boyd, Samuel Bowles, Colin Camerer, Ernst Fehr, Herbert Gintis and Richard McElreath, ‘Cooperation, reciprocity and punishment in fifteen small-scale societies’, American Economics Review 91 (2001), pp. 73-78.
  11. Daron Acemoglu and James A. Robinson, Why nations fail. The origins of power, prosperity, and poverty. New York: Crown, 2012.
  12. Dani Rodrik, The globalization paradox. Democracy and the future of the world economy. New York/Londen: W.W. Norton, 2011.
  13. George A. Akerlof and Robert J. Shiller, Phishing for phools. The economics of manipulation and deception. Princeton: Princeton University Press, 2015.
  14. James Heckman, ‘Policies to foster human capital’, Research in Economics 54 (2000), nr. 1, pp. 3-56.

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