Arnold Kling  

Ricardo's Difficult Idea Eludes Wonks

PRINT
Immigration Reform... Surveys and Happiness...

Alex Tabarrok has a timely post that links to another Paul Krugman classic on the gulf between economists and noneconomists on the theory of international trade. Krugman writes,


it is not obvious to non-economists that wages are endogenous. Someone like Goldsmith looks at Vietnam and asks, "what would happen if people who work for such low wages manage to achieve Western productivity?" The economist's answer is, "if they achieve Western productivity, they will be paid Western wages" -- as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor plausible.

Today, I went to a media event sponsored by the New America Foundation. The first topic was the state of the economy, and the topic of international trade came up. Numerous audience participants and panelists displayed ignorance. Michael Lind, a panelist, talked about the "need to create comparative advantage." You cannot understand the term "comparative advantage" and still talk about a need to create it. He also talked about low wages as a source of comparative advantage. Once again, that is an abuse of economic language.

Of course, Lind is not exactly new to fallacious economic reasoning. The Krugman piece refers to a 1994 article by Lind. Krugman writes,


The question here is not why Lind got these numbers wrong. It takes considerable experience to know where to look and what to worry about in economic statistics, and one should not expect someone who does not work in the field to be able to get it right without some guidance. The question is, instead, why Mr. Lind felt that it was a good idea to make sweeping pronouncements about this subject, when he clearly was unwilling to invest time and energy in actually understanding it.

At today's event, Lind was on the same panel with Martin Baily, a former Chairman of the Council of Economic Advisers under President Clinton. Baily got the economics of outsourcing exactly right, pointing out that full employment is a macroeconomic issue rather than a trade issue, and pointing out that our economy as a whole benefits from outsourcing but that in his opinion policies are needed to ease the adjustment problem for workers who have to switch occupations.

But Lind was given equal billing with Baily. I know that Baily is a qualified economist and that Lind is a charlatan. But my guess is that the media attendees did not know that, and they probably found Lind easier to follow.

For Discussion. How would you explain to a layman the theory of comparative advantage so that the layman would not make the mistake of calling low wages a source of comparative advantage?


Comments and Sharing


CATEGORIES: International Trade



COMMENTS (23 to date)
Eric Krieg writes:

>>The economist's answer is, "if they achieve Western productivity, they will be paid Western wages"

Is this a good assumption under current conditions?

I am thinking about China, a place with a huge pool of unskilled labor. In many cases, Chinese companies are combining this cheap labor with advanced machine tools. The huge supply of labor itself keeps wages down, even as the machine tools keeps productivity up.

Stephen Richards writes:

I'm a layperson, but I was thinking that 1, the supply of labor had gone up with the availability of say chinese labor, 2, the price would go down to some kind of equilibrium due to the cheaper labor and the additional costs of outsourcing/culture translation/ language translation and also the avialibility of other work.
So which wins: western productivity will give western wages vs supply and demand with a vast new pool of supply?

Thanks for any explanation
Stephen

Arnold Kling writes:

I'll write a longer article on this, but in equilibrium the wage rate equals the marginal product. The marginal product of labor in China is much lower than ours, which is why the wage rate is so much lower.

It will take generations for both productivity and wages to catch up to the U.S. That will be good for us, not bad for us.

Your ability to earn a good living in the U.S. depends on your productivity. Yes, world competition is getting tougher, for both U.S. businesses and U.S. workers. So, if your productivity stays constant, your relative economic standing will decline. Only continued increases in productivity will raise the standard of living--either for an individual or for a country as a whole.

TL writes:

Arnold,

I'm obviously a layman. My understanding is that comparative advantage is an internal, not external, comparison. Comparitive advantage measures internal opportunity costs.

Assume it costs country #1 the same amount of resources to produce either 7 loaves of bread or 1 widget and country #2 can produce a widget with the resources required to produce only 3 loaves of bread Country #2 has a comparative advantage in the production of widgets because a widget costs only 3 loaves of bread versus country #1's cost of 7 loaves per widget. Country #1 has a comparative advantage in the production of bread because it can produce 7 loaves of bread at the cost of only 1 widget versus country #2's cost of 2 widgets for 7 loaves of bread.

Lets say country #1 trades 5 loaves of bread to country #2 for 1 widget. Country #1 gets a widget for 2 loaves of bread less than it would cost to produce the widget domestically and country #2 gets 5 loaves of bread for a widget that cost it only 3 loaves of bread to produce. Both countries are net winners.

The above comparisons express opportunity costs in terms of economic goods and are independent of the wages or living standards in either country #1 or #2.

Luke Lea writes:

I made a serious study of modern neoclassical trade theory (HO theory) in preparation for an article I wrote on the subject for Challenge magazine in the early 1990's. (I especially remember the classic text World Trade and Payments, which was a simply beautiful piece of expository writing. Anyway, that book certainly supported the idea of comparative advantgage from low wages when caused by unequal factor endowments, which is what I think most laymen have in mind. The conclusion (and this is standard theory) was that most workers in a capital rich society like the U.S. would be made worse off under free trade with undeveloped countries like China, UNLESS steps were taken to redistribute income from capital holders to low skilled workers in the rich country? Is this not the whole point of Samuelson's classic paper on wages and protectionism, that caused such a stir back in the 1940's? Luke Lea (e-mail to luke@lukelea.com

David Thomson writes:

"Only continued increases in productivity will raise the standard of living--either for an individual or for a country as a whole."

This is why we must not surrender to the protectionists. We must allow the destruction of jobs which have outlived their reason for existence.

John Thacker writes:

The conclusion (and this is standard theory) was that most workers in a capital rich society like the U.S. would be made worse off under free trade with undeveloped countries like China, UNLESS steps were taken to redistribute income from capital holders to low skilled workers in the rich country.

As Professor Krugman's essay mentions, while it is hypothetically possible that under free trade the productivity of a nation will increase yet the fate of laborers grow worse (although unlikely, since again wage rates tend towards marginal product), there is strong evidence that this has not occurred in the United States, since the proportion of income going to labor has remained stable. This of course does not rule out there being individual winners and losers, of course.

Dave Sheridan writes:

Arnold,

How about the old Econ 101 question: Assume that I am both the best lawyer and the best typist in the world. Do I do my own typing? Explaining why I will hire an inferior typist, at a wage lower than what I can earn as a lawyer, introduces is the notion of opportunity cost. When extrapolated to an entire economy trading in a world market, says that low wages may confer an absolute advantage vis a vis higher-wage producers of similar goods, but they do not dictate the best uses of low-wage labor among all possible uses.

Mcwop writes:

Of course, if the Fed and State government in the U.S. would make reforms that lower the cost of labor here, then maybe that will help during this long global transition. Payroll taxes, onerous regulation compliance, workers comp, etc... all add to fully loaded labor costs.

Boonton writes:

The lawyer/typist analogy is excellent. Obviously if the lawyer can get $150 an hour, he is better off hiring an inferior typist for $25 an hour even if it takes the typist two hours to type what he could do in one hour.

One major fallacy that people fall into is the 'lump of jobs' fallacy. The economy does not produce, export or import jobs. It produces goods and services. Jobs are an input to produce goods and services.

The analogy I used is a cake factory. You have bakers, flours, eggs, sugar, butter etc. You try to bake as many cakes as possible with those inputs. If some magic fairy gives you an extra two tons of flour per week, it isn't a diaster for your economy. You can now increae the amounts of cake you can bake because you are able to buy more of all the other types of inputs.

Eric Krieg writes:

>>The marginal product of labor in China is much lower than ours, which is why the wage rate is so much lower.

What evidence is there of this? What are the actual productivity numbers coming out of China for these new factories?

I don't think that it should be taken on blind faith that it will take the Chinese decades to reach Western standards of productivity. Over time, nations have industrialized at a faster and faster rate. Britain took longer than the US, who took longer than Germany, who took longer than the Japanese, who took longer than the Koreans.

We should expect the Chinese to industrialize very rapidly. It is very possible that, with the latest machine tools that they are importing, that they ARE at Western productivity levels in some factories. Yet the supply of labor ensures that wages may take decades to reach Western levels.

Boonton writes:

But it would take a long while before *all* of China achieves Western productivity. Yes you may have one factory at Western levels but that doesn't counter the fact that the rest of the country is still backwards. However, that one great factory will be able to hire the best workers and its owners will make excellent profits. That will boost wages for everyone else somewhat and also induce more factories to modernize. Soon the extraordinary profits will be gone and wages will be at Western levels...if China really achieves Western productivity.

Eric Krieg writes:

>>Soon the extraordinary profits will be gone and wages will be at Western levels

Well, the former is already happening. There are so many new car factories in China that car prices are falling, even though demand is very strong.

I still think that the ability of China to reach Western productivity levels is being underestimated. The Chinese ARE concentrating on infrastructure. They have a new and fast growing highway system, for example (and something that the Koreans didn't have at this stage of their development).

For things like communications, the Chinese have a huge advantage in that they can simply skip building a landline system and go right to wireless!

Bernard Yomtov writes:

I think Eric and Boonton are onto something here. The benefits of free trade are obtained in equilibrium. But suppose it takes a long time to reach the new equilibrium. Then what happens along the way matters, and is often what people are aware of.

This is a real problem, but it is also one of perception, one of several such that affect most people's views of trade.

ABC Corp moves production to China and you read about 500 employees being let go in your town. You don't see 500 people being hired in lots of other places, or the benefit of the lower prices for ABC's products.

I think Krugman makes some excellent points in his essay about why trade is not understood. But I think he overlooks this aspect.

Lawrance George Lux writes:

How would you explain to a layman the theory of comparative advantage so that the layman would not make the mistake of calling low wages a source of comparative advantage?

A very difficult task, because there is artificial comparative advantage to low wages, when there is Government action to forestall equilibrium. Failure to reach this equilibrium will stop Wages from equaling marginal productivity. The greatest inhibitation of this equilibrium comes in restriction of foreign imports into the nation, while producing for export. Other inpediments are restriction of foreign product use by extreme taxation of complementary Goods, like fuel or electricity. There are also geographical restriction placements, which keep Workers in low provision areas.

Discussion of the problem of global equilibrium of Wages based on marginal productivity must enter into the exact conditions causing lower Wages, which are not tied exclusively to marginal productivity. Business can maintain artificialy low or high labor enrollment, restrict capital equipment for preset levels of productivity, over or under subscribe labor costs. Union contracts, Stock Options, Government regulations, etc., all create bubbles in Wages which will be disturbed when approaching equilibrium. All these elements can equally force continued inequilibrium.

Claim there is no comparative advantage to low wages can only be vindicated, in the abscense of these inpediments to equilibrium. Otherwise, there can be comparative advantage to low wages. lgl

Eric Krieg writes:

The bottom line is that we need to figure out ways to be more competitive. Tariffs don't do that.

How could we become more competitive? Privatize Socialist Insecurity. Make individuals responsible for their own health care, rather than businesses or government. Transform the educational system with vouchers. Implement the English System of tort law.

None of this is ever going to happen, because it is easier to demonize than to actually fix problems.

spork writes:

in public choice theory, it is the determined minority (e.g. those whose jobs will be axed or "farmers" who benefit from subsidies) who work the hardest (i.e. lobby) to get their special interest legislation, regulations and protections through.

this is almost always to the detriment of the wider public, who individually don't notice it much and thus are not motivated as much to block said lobbying. when costs are dispersed and the benefits concentrated, there will always be abuse.

until people get wise to this game (become enlightened) special interests (and the congress people in whose pockets they belong) will continue to vote for the needs of the few which, only in washington, outweigh the needs of the many.

Bob Dobalina writes:

I know it's crazy for me to have gona and used this internet thing, but the first Google result for "comparative advantage" looks like a good start. It taught me a couple of things that I didn't know.

Michael Fortson writes:

I'm an economic layman trying to get a grasp on the justification for different policies, and the Ricardian model of free trade is certainly compelling, but it I can't see how it can be complete unless it takes serveral additional effects into account. I would be surprised if such work hasn't already been done, and would apprieciate it if someone could give me a few pointers to relevant authors or papers.

1. Overspecialization -- Comparative advantage rests of nations specializing in those things they do well and trading for things they do less well. It also says that as market conditions change and demand for labor moves elsewhere, aggregate labor conditions change to reflect this. However, to what extent can specialization prevent a population from being adaptive? Can specialization, in the extreme be nonadaptive? Suppose that a "rate of adaptation" could be determined for a labor market. Does that suggest a trade off between free trade and protectionism? Are there clear mathematical relations between these tradeoffs?

2. Economic considerations of "skill", and "transferable skills" -- Simplified econimic reasoning typically treats labor as a commodidy, as if one, having offered labor services to an automotive company on Tuesday, can on Friday offer additiona labor services to a bio-tech company. It is well understood that skill takes considerable time to develop, and that even with the motivation to acquire skill, there are many barriers to entry, some of which are not necesarily "economic" in character, such as a VERY deep resistence to changing ones career after having spend a long time doing something, and also including historical, traditional, and cultural barriers to rapid labor "migration". Is it possible to make measurements of labor flexibility? That is, given a nation and current allocation of labor to industries, can one determine an aggregate responsiveness? Are particular strategies suggested?


Anyhow, I am looking for answers to these two problems in particular because using the theory of comparative advantage to advance policies of unrestricted trade and specialization seem irresponsble without further investigation. Also, my personal intuition and experience suggests that overspecialization is extremely dangerous.

Eric Krieg writes:

Did anyone else wonder who the hell Micheal Lind is?

http://www.nationalreview.com/goldberg/goldberg121001.shtml

Hi, Michael (Fortson).

Your thoughtful comment contained many interesting questions. Here are some thoughts on just one:

>Can specialization, in the extreme be nonadaptive?
>Suppose that a "rate of adaptation" could be
>determined for a labor market. Does that suggest a
>trade off between free trade and protectionism?

It is absolutely reasonable and likely that specialization entails investment in particular skills. And, for those particular individuals who invest (laborers, business owners, and the producers of machines, software, and other capital goods for that industry), those investments may not be quickly adaptable to changes in circumstances.

But that doesn't mean that free trade is improved on by protectionism, however hard the adaptation process may be.

The long-run goals have to be weighed against the short-run goals. If the long run ultimately means full adaptation, then somehow or other the people in that industry ultimately are going to have to adapt. Protectionism often makes things worse by putting off the inevitable.

Let's suppose, as you suggest, that a "rate of adaptation" has been identified. Even if protections would soften the blow to some people in the short run, protections would slow the rate of adaptation that ultimately has to take place in the long run.

Protections make it harder for newcomers to realize that this protected field is not a viable one for the future, enticing them into the industry by offering unrealistically high prices. Laborers are more likely to be misinformed---or resistant, as you describe!---than business owners by this, I'd argue. How would a newcomer figure out to not go into a protected industry? Protected prices remain unrealistically high; businesses in the protected industry continue to offer jobs. But what if the long run is that the industry is doomed by its not having a comparative advantage?

Is there a way to help those who make unfortunate skill investments only to be overwhelmed by unexpected worldwide changes that put their industry at risk, yet without harming future generations' choices about skill investments? Protectionism by its very nature disrupts many economic decision margins. If the goal is to help people who made unfortunate decisions, then direct income subsidies are perhaps a better route on economic grounds.

You also ask, quite reasonably, for some documentation. I don't have everything you ask for offhand, but let me suggest starting with the first few (thoughtful and easily readable) chapters of _Some Aspects of the Tariff Question_ by Frank Taussig, Harvard University Press, online at:

http://www.econlib.org/library/Taussig/tsgSTQtoc.html

Although Taussig's research was directed toward the protecting so-called "infant industries," many of the arguments he discusses are directly relevant to your general questions. In particular, he detailed how well-intended temporary protectionism tends to permanently disrupt economic decisions, including those made by labor.

Lauren Landsburg

Bernard Yomtov writes:

An additional thought on this topic: Part of understanding comparative advantage is understanding the idea of relative prices - an apple costs two oranges, etc. If you understand this, comparative advantage falls in your lap. In Country A apples cost three oranges, in B they only cost one, regardless of whether A or B has better overall conditions for growing fruit. So let B grow apples and A grow oranges. Not hard.

But if you don't grasp the relative price idea this becomes more difficult.

Comments for this entry have been closed
Return to top