Comparative advantage?

All economists are always in support of “free trade” all of the time, right? Some interestings conversations are happening in the econo-blogs about international trade theory and reality. First, I love how Dani Rodrick is challenges the conventional wisdom on international trade:

One of my favorite stylized facts about development is contained in the graph below, which comes from a paper by Imbs and Wacziarg. What it shows is that as countries grow out of poverty, their economies become less specialized and more diversified. This seems to be true both across countries, and within countries over time.

What’s the big deal, you might say. Well, it is a big deal if you have been brought up on the idea that the key to economic growth for poor countries lies in specialization according to comparative advantage. If that simple recipe were true, countries that are getting richer would be producing a narrower range of goods, not a broader range. It takes a lot of mental gymnastics to square this stylized fact with the standard comparative advantage arguments. A far simpler interpretation is that the key to growth is the acquisition of production capabilities in an increasing range of goods, in a way that is often in tension with what comparative advantage would dictate. Here is a paper that tries to make these ideas more precise.

Next, Paul Krugman, in “Divided over Trade” (relayed by Mark Thoma), looks at winners and losers:

… Fears that low-wage competition is driving down U.S. wages have a real basis in both theory and fact. When we import labor-intensive manufactured goods…, the result is reduced demand for less-educated American workers, which leads … to lower wages… And no, cheap consumer goods at Wal-Mart aren’t adequate compensation.

So imports from the third world, although they make the United States as a whole richer, make tens of millions of Americans poorer. How much poorer? In the mid-1990s … economists, myself included, crunched the numbers and concluded that the … effects … on the wages of less-educated Americans were modest, not more than a few percent.

But… We’re buying a lot more from third-world countries today… Trade still isn’t the main source of rising economic inequality, but it’s a bigger factor than it was. So there is a dark side to globalization.

Krugman follows up his NY Times piece with some more detail here:

Many people think that Economics 101 says that trade is good for everyone. Alas, it isn’t so. Way back in 1941 Paul Samuelson and Wolfgang Stolper pointed out that even the most conventional economic analysis suggests that some group within a country – and possibly a large group – actually loses from trade. It’s even in Wikipedia.

Intuitively, here’s the logic. Imagine that America exports stuff that is produced mainly by college-educated workers, while those industries that compete with imports mainly employ less-educated workers. Now suppose the price of imports falls. Then in order for import-competing industries to cope, the wages of less-educated workers have to fall — in fact, they have to fall more than the price of imports, because other costs of import-competing production, namely the wages of highly educated workers, will actually rise. So if import prices fall, say, 10 percent, wages of less-educated workers will fall, say, 15 percent.

But don’t these workers gain from cheaper imports? Yes, but not enough. Imports are only part of what people consume, so while wages fall more than import prices, the overall cost of living falls less than import prices — say, 15 percent fall in wages, only 5 percent fall in the cost of living. Trade reduces the real wages of low-education workers.

So why did people like me say in the ’90s that globalization wasn’t a big problem for U.S. workers? Because the numbers didn’t look big enough. Bill Cline of the Institute for International Economics posted a pretty good overview of that discussion here.

Since then (Cline’s numbers ran through 1993), however, the numbers have grown. You can get a sense of the changes from the World Trade Organization data. U.S. imports from China, Mexico and the “six Asian traders” went from about 3 percent of G.D.P. in 1995 to almost 5 percent in 2005. What’s more, the center of gravity of those imports has shifted to the lower wage countries. Estimates of labor costs are calculated by the Bureau of Labor Statistics, Table 1 and p. 5 for China.

The growth of China’s exports, in particular, has undermined one of the arguments I and others (including Cline) made for not worrying too much: we thought the low-wage manufacturing exporters would, as their own education levels increased, place less pressure on low-education workers here. Well, the original group of exporters did move “upscale” — but along came China (and to a lesser extent Mexico), taking their place and then some. The overall wage rate of U.S. trading partners relative to the U.S., calculated in that B.L.S. report, rose through 1990, but it has stagnated since then — and the index doesn’t include China. Add that in, and our trade is increasingly with low-wage countries. So the problem has gotten bigger.

As I said in the article, however, the big problem is what to do about it. And a return to protectionism would just have too many negative effects.

11 comments

  • One great idea for understanding economic life is to delete anything you ever heard about comparative advantage, like a sort of partial lobotomy. “Comparative advantage? I don’t know what that is.”

    When I read parts of Ricardo’s Book that came out in 1817 in which this idea, comparative advantage, was set out, I wound up going over it again and again like a compulsive repeating his count of the pickets in a white picket fence. Was it really so, did it really say, that, how could he say that.

    Ricardo’s idea is exprssed in a small paragraph on one page of a 300 page book. It is abstract and not accompanied by any graph or table, indeed it is entirely an imaginary exercise and nowhere in his book are any real life instances of the idea set out. This idea, which illustrates the difference between absolute and comparative advantage in national output on the basis of labor time as the measure of value, can be turned into a table. When you do that you find there are instances where the relative labor time of Portugal is less than England in the production of cloth. Could not happen with the power loom in place in England.
    ]You learn that Ricardo is working on a basis unlike the working of an economy within the territory of a state, since he says no advantage persists in any industry within an economy since if there is one the competition of capitals wipes it out pretty soon. Of course Portugal is a different state. Could not happen since English capital was well established in the Portugese wine trade and dominated 70%of it half a century before Ricardo wrote. In the case of wine, English caital did not stay home, it went over to Portugal and took over the gathering and marketing of wine through Oporto (hence “port”).
    And this was all due to a treaty the English made about 1703 by which the Portugese promised to get all their cloth from England and in trade they would take Portugese wine at a favoroble price for Portugal.
    In other words the “:circumstances” of the wine trade had damm all to do with comparative advantage, but with military, historical, and chance events.
    Ricardo’s idea, which students of economics love to “explain” to the unwashed, never did work. Nobody even tried to make it work from 1817 to 1954 and then it was shown it did not work. Leontieff proved that again and the economists rewarded him by calling his study the “Leontieff paradox”.

  • garhane, you prompted me to pull out my copy of The Worldly Philosopers for Robert Heilbroner’s summary of Ricardo’s thought. He argues that Ricardo saw a rising population leading to higher food prices, which on the one hand brought more marginal land into production, but also gave a free ride to the owners of land where cheaper production was to be had.

    Ricardo argued for free trade because it would bring cheap grain into England, something that landlords fought against for three decades.

    Ricardo was interested in distribution and argued that different classes made out quite differently when left to the “natural order” of things. And that this outcome was unjust and miserable for some groups while others got that free ride. This is quite the opposite conclusion to Smith’s invisible hand.

  • I don’t see the contradiction. Both Smith and Ricardo saw that special interests would favour restrictions on trade, and that that everyone would be better off if they were removed.

    I’ve been following Dani Rodrik’s bolg pretty closely (and several of his papers before that), and I don’t see any lessons there for Canada. The vast majority of our trade is with rich countries.

  • Oh. To be more precise, replace ‘would be’ by ‘could be’. The real challenge is to make sure that workers displaced from declining secors can find work in expanding sectors. In Canada, that has been the case: employment rates continued to increase, and the effect of the sectoral shifts on average wages has been positive. Small, but positive.

  • Stephen I’ll have to look up the facts later, but I’ll bet that Canada – Asian NIC trade is higher as a % of GDP than the figures Krugman cites as a factor behind depressed wages – we are actually more exposed than the US to low wage competition in that we are negligible producers of consumer goods and domestic production for the domestic manaufacturing market is at a lower level than the US. Of course, the physical location of our resources does protect us to some degree compared to the US. We shoudl also think about onock on effects on Canada of growing US trade exposure to the NICs

  • My sense is that comparative advantage clearly applies to resource industries, which depend on each country’s natural endowment, but is problematic with respect to manufacturing and service industries, which are entirely man-made.

    In many cases, the theory of comparative advantage is more justificatory than explanatory. As China quickly moves up the value chain, it is said to have a “comparative advantage” in whatever it is exporting at the moment. Compared with any number of other countries, what inherent advantage does South Korea have in producing automobiles?

    Conservative economists argue (reasonably enough) that Canada’s increasing focus on resource extraction is a rational response to high global commodity prices. However, they are strangely reluctant to conclude that Canada’s comparative advantage is the extraction of nonrenewable resources. The suggestion is always that Canada’s comparative advantage will lie in some new and undefined high-value, tradable services.

  • As a puzzle comparative advantage applies everywhere. Curiously trade within a nation is ruled by the law of absolute advatage. Why is that?

  • It isn’t. Comparative advantage works there, as well.

  • Conservative economists argue (reasonably enough) that Canada’s increasing focus on resource extraction is a rational response to high global commodity prices. However, they are strangely reluctant to conclude that Canada’s comparative advantage is the extraction of nonrenewable resources. The suggestion is always that Canada’s comparative advantage will lie in some new and undefined high-value, tradable services.

    Conservative economists? Who are they?

    Anyway, the statements

    ‘Canada has a comparative advantage in the extraction of non-renewable resources’

    and

    ‘Shifting productive resources to the extraction of non-renewable resources will increase total income in Canada’

    are equivalent statements. So are

    ‘Canada no longer has a comparative advantage in the extraction of non-renewable resources’

    and

    ‘Shifting productive resources away from the extraction of non-renewable resources will increase total income in Canada’

  • Sorry that should have read comparative and absolute ‘cost’ not ‘advantage.’ Free trade theory depends on the exchange rate mechanism working so as to make all regions equally competitive. For a full presentation of this argument and a better model of free trade see:

    http://homepage.newschool.edu/~AShaikh/globalizationmyths.pdf

    Especially pp. 9-11

  • S.Gordon asks Weir

    “Conservative economists? Who are they?”

    I think you just answered your own question.

    But if it makes you feel any better (that is if it gives you a higher subjective self valuation), more properly, I would suggest that you are a liberal economist (in the non American sense of the word). I should think there are some good courses at Laval which could clarify this philosophical tradition for you.

    See, and you just thought you were trained as an economist. 🙂

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