What happened to comparative advantage?

February 23, 2006 9:03 PM

What ever happened to comparative advantage and why is everyone obsessed with global competition? Looking for econ books / articles...

The theory of comparative advantage says that even if it's uniformly more expensive to do everything in country A than country B, it could still be to their mutual benefit to trade if the relative costs of various activities were different (see the extended Ricardian example on the wikipedia page).

Notwithstanding this, everybody, everybody, everybody is talking about global competition. Maybe it's no surprise that non-economists are concerned with "offshoring" of manufacturing jobs, but even people like Robert Reich who are ostensibly familiar with the issues are talking like nation-states are competing "teams" who are trying to beat one another rather than trading to mutual advantage.

So my question is: what's up with that? Has the theory of comparative advantage been generally discredited and/or have conditions changed since its original exposition? Are countries struggling to reduce its effects to conform to some ideal of competition that they can win? It seems to me that countries would almost inherently use different ratios of resources to produce various things and moreover that there would be no reason to try and change this situation since, under comparative advantage, you just maximize your strengths and trade for what you need.

I don't expect a quick answer in an AskMe post, but if anyone's familiar with some books or articles (I can access any economics journal, just provide a citation) that address this, I'd be interested in hearing about them.

posted by rkent to society & culture (11 comments total)

This book (The Undercover Economist) took a pretty good look at the issues involved without getting too complicated - not sure if that's what you're looking for. It's not as focused on the "freakonomics"-type stuff as reviews would have you believe, and a good half of the book deals with comparative advantage, globalization, game theory and the such. It is written for a lay audience though.
posted by loquax at 9:19 PM on February 23, 2006

The index for economics articles is called "The Journal of Economic Literature." The JEL comes out quarterly in paper/on CD and would be part of any university's journal collection.

There is an online version of the JEL called "Econlit." Access your university's library and it's online databases. You can search Econlit and get citations which can then be looked up in either hard copy journals or online journals. Any university library should have "free" access for students to all the major (and many minor) online journals.

Note that the most prestigoius journals (like the American Economic Review (AER) -- which publishes the JEL) have a lag period before they will allow online access to recent issues. These volumes would have to be viewed in paper.

Here are the major classifications in the JEL to give you some idea what to search for.

JEL Classification Sytem

Happy hunting.
posted by bim at 9:54 PM on February 23, 2006

It's true that comparative advantage means we (that is, the US) will benefit if we stop doing things that other countries do better than us and focus on things that we do better than anyone else.

Unfortunately we already have a whole lot of people in this country doing things other countries do better than us -- for example, manufacturing. If we let other people do that work a lot of people will be out of jobs. Some of them can't be retrained and of those that are retrainable, what exactly are we supposed to retrain them for? We don't know what they'll be doing yet. Furthermore, many of them are in unions and have contracts that mean there is a large cost to cutting their jobs. Also, people hate losing their jobs because it causes an upheaval in their lives, especially if they are supporting a family, so they will naturally fight anything that they think threatens their job. And those people vote, especially for politicians they see as being on their side, so there is a lot of political capital in protecting their jobs. It is true that in the long run everyone would benefit if we let comparative advantage drive things, but the "long run" could be longer than your working life. In the long run, goes the aphorism, we are all dead anyway. People want their own lives to be good, not their grandchildren's. (Well, they do want good lives for their grandchildren as well, but they don't think they can have it if their own life doesn't get measurably better.)

So in the real world we don't let comparative advantage run its course -- what we've let go so far are a bunch of non-unionized manufacturing jobs, where the cost advantage of offshoring is simply so vast that if you were a manufacturer it would be stupid to pay American workers to do the job (especially since there's no union to stop you from laying them off), customer service jobs that can be easily moved back to the US if customers complain (so there is little risk), and IT jobs where American workers arrogantly believe they are much smarter than everyone else, which means that they don't see Indians as an actual threat yet (maybe to their co-workers but not to THEM) and thus don't need to unionize since they can easily beat the Indians (again, their co-workers might need to unionize, those guys are a bunch of no-talent assclowns after all -- and every one of them, even the no-talent assclown in the next cube, is thinking exactly the same thing...).

In other words, we haven't even really begun to outsource everything that we could, so comparative advantage isn't really driving things as much as it could. And it won't, it's just politically unfeasible. Therefore we must compete somehow on actual skill against people who are better and/or cheaper than we are. This puts us in a bind. Our auto workers, for example, need to be much better than Toyota's to be worth what they're paid. But one look at GM tells us they're not. Actually, Toyota is so good that IMHO the best GM could ever be is as good as Toyota, but then they are still hobbled by expensive labor, pensions, medical benefits, etc. Since we won't let GM's workers go (the Federal government will probably bail them out like they did Chrysler) and retrain them to do other work that we can do better than the Japanese, comparative advantage doesn't apply. Of course GM's workers are still fucked in the long run, because eventually GM will change radically or cease to exist, but most of them are hoping they'll be retired before it really affects them.

As an aside, Toyota employs Americans now to make its cars, they just do it less expensively than GM because they're not unionized. So we have a foreign company using American workers to outcompete an American company also using American workers. So what exactly is Japan's comparative advantage in this case? Perhaps Japan's advantage is management, process, and negotiation -- in which case maybe we should let Japanese executives run our businesses! Somehow, though, managers never seem to consider themselves subject to outsourcing. So, comparative advantage won't come into play there either.

I've rambled on a bit but hopefully I've shed a little light on why comparative advantage doesn't really work except in a pure free market economy, and the one we find ourselves in is far from such. Thus we find ourselves continually forced to compete directly, when if we collectively had the will to accept some short-term pain we could probably avoid much of the need for it. I don't see things swinging that direction anytime soon, but eventually we'll fail at direct competition (again, see GM) and the longer we put off the inevitable reckoning, the more painful it will be.
posted by kindall at 10:46 PM on February 23, 2006

To shorten kindall's answer; comparative advantage makes sense when some of the basic factors of production (land, labor, capital) are in short supply and need to be rationed most efficiently. Note that the example given in Wikipedia (wine versus cloth production) turns on the question, "How best should a country use its limited land?"

Most countries these days - at least the ones wealthy enough to sustain a debate about global competition - aren't seriously constrained by shortages of the factors of production. Rather, surfeits of labor are a serious problem nearly everywhere, and markets are artificially manipulated to ensure jobs at home.
posted by ikkyu2 at 11:22 PM on February 23, 2006

comparative advantage makes sense when some of the basic factors of production (land, labor, capital) are in short supply and need to be rationed most efficiently

I don't think this is true; unless I grossly misunderstood Comparative Advantage, this is the most common misunderstanding about the topic. Why would a lack of scarcity make a difference?
posted by yerfatma at 4:13 AM on February 24, 2006

Response to kindall and (somewhat) ikkyu2: read the Ricardo example again; in that situation, England takes more resources to produce both wool and wine than Portugal does, it's just that the ratio between them within each country is different. My own numbers, just to exacerbate the difference: say England takes 5 units of (whatever; say land) to produce 1 unit of wine and 3 units of land to produce 1 unit of wool, and Portugal takes 1 unit of land for a unit of wine and 2 units of land for a unit of wool. If Portugal wants 1 unit each of wool and wine, they can produce both themselves -- after all they're cheaper than England -- or they can produce 2 more units of wine with that land, which are worth 3.3 units of wool in trade with England. Bam! Increased consumption due to trade, even though Portugal is "better" at everything. Vice versa to increase England's consumption of wine (the sots!).

Now, in theory, there's no reason it doesn't work with labor, capital, whatever instead of land. But I do take your point, kindall, about the inelasticity of labor, though my response would be that it seems everyone would be better off if we addressed that problem rather than imposing protectionist trade barriers.
posted by rkent at 6:06 AM on February 24, 2006

Two comments:

1)Rkent asked, "Has the theory of comparative advantage been generally discredited and/or have conditions changed since its original exposition?"

Conditions have changed. Comparative advantage assumes the immobility of factors of production. That is most definitely not the case in today's world.

2)In my opinion, economic theories and mathematical models of what we supposedly should do to maximize whatever are all well and good. But when you are the one whose family has been decimated by a lost job and such, theories become a litle less interesting and appealing. As one of my professors long ago said of the esteemed economist Milton Friedman (Mr. Free Market), "He made the mistake of believing his theories."

Reality bites. :)
posted by bim at 6:50 AM on February 24, 2006

There are some big imbalances in wages, consumption, and wealth, which aren't based on anything that will necessarily endure. Its the slow transition towards some more balanced distribution of these things that's causing some problems. It's unlcear how it will work out in the end.

You might want to read Stephen Roach on "global labor arbitrage". Some of the numbers from 2003 are a bit out of date now, but I think the basic situation hasn't changed much since then.
posted by sfenders at 6:58 AM on February 24, 2006

A lot of good information in the responses, but some are misleading:

1) Comparative Advantage Theory (CAT) DOES indeed assume limited factors. However, it is not a "shortage", but it is also not unlimited. Therefore, there is a capacity issue. So, the question that the comparative advantage theory answers is what the best use of those limited factors are. If there wasn't an upper limit on how much of one factor you can use, the trade-off question wouldn't be there; you would use as much land as you want for cotton, and also for wine and wouldn't worry about which one is more efficient. There would not be an opportunity cost of committing your factors of production on producing one product vs. the other. Therefore, factors need to be limited in supply, but there doesn't need to be a "shortage".

2) CAT does assume immobility of factors across borders. Therefore, the fact that labor or technology can indeed cross-borders will complicate matters significantly. By technology transfer, or by importing skilled labor, you can change the factors in play.

3) CAT also assumes free markets for trade. Through protectionist policies, many countries have trade barriers in place to protect certain industries. Agricultural subsidies paid by the government is one of the sole reasons why agricultural production in the U.S. and EU can still continue (there are exceptions, such as cotton production where U.S. has technological advantages). When there are trade barriers in place, these barriers distort the gains that could be achieved via trade due to CAT.

Of course, a lot of the trade barriers are put into place by governments due to several factors highlighted in this thread, including unemployment concerns, re-trainability of employees in these industries, populist policies by politicians, etc.

4) CAT also assumes away the cost of logistics. Even with CAT in play, it is still difficult to produce all cars or steel in a single country and ship it out to the rest of the world, since the cost of transportation as well as the time it would take negates most of the benefits that CAT provides.

5) Finally, despite all of these, CAT is still one of the primary theories explaining th existence of international trade and continues to be well respected and heavily utilized. And in real life, you continue to see its effects. For example, that's why there is very little manufacturing of TVs, VCRs, or low-tech computer components in the U.S.
posted by tuxster at 11:05 AM on February 24, 2006

Comparative advantage assumes the immobility of factors of production.

It does? I thought the only real assumption was a finite amount of time.

But when you are the one whose family has been decimated by a lost job and such, theories become a litle less interesting and appealing.

The powerful appeal of empirical cases is exactly why cold, rational, nasty theories are extracted, so we can see more clearly whether we're being screwed directly or if everyone's getting rodgered on a random basis.
posted by yerfatma at 12:04 PM on February 24, 2006

It does? I thought the only real assumption was a finite amount of time.

Yes, it does. Here are two references to this point.

"David Ricardo (1772–1823) probably discovered the law of comparative advantage around the first two weeks of October 1816. The date itself is not important, but his letters at the time reveal how Ricardo's mind worked when he discovered the law. If my hypothesis is correct, the letters show that his mind ranged over much of the terrain of trade theory—from factor price equalization conditions to the Ricardian model. I also conjecture that the hard part of his discovery was coming up with the key assumption of factor immobility." ~ Roy Ruffin

And the Brookings Institution has posted a transcript of a roundtable that they held. There are some good explanations around pages 8 to 10. And the economist on the panel also addresses the immobility of factors of production.

"What we're asking is, whether the conditions specified in trade theory for free trade to be mutually beneficial to the trading partners, where those conditions hold, when factors of production are as mobile as traded goods. That's the question. The case for free trade, since the time of Ricardo, rests on the principle of comparative advantage. And the principle of comparative advantage, in turn, rests on the immobility of factors of production. This is in all the textbooks, it's in the literature. I have a recent piece from a trade theorist, Roy Ruffin, it's basically addressing Ricardo's theory of comparative advantage and why he has the claim to it. And he says, the key assumption of trade theory is the inability of factors to move from a country where productivity is low to another where productivity is higher." ~ Paul Craig Roberts (p.9)

*****

The powerful appeal of empirical cases is exactly why cold, rational, nasty theories are extracted, so we can see more clearly whether we're being screwed directly or if everyone's getting rodgered on a random basis.


Hmmm...for some reason the phrase that comes to mind here is: The operation was a success but the patient died. LOL. This probably a whole new thread in itself, so I'll pass for now. :)
posted by bim at 7:35 PM on February 24, 2006