Arnold Kling  

Roll Over, Ricardo

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Bond Market... Government vs. Private Debt...

That was the title I wanted for this essay on comparative advantage, which pulls together several ideas that I first trotted out on this blog. The essay is lengthy. Here is a short excerpt:


To see why trade balance is an equilibrium condition, imagine a barter economy. In a barter situation, in order to pay for Indian software programmers, we would have to provide goods or services to India in exchange.

For Discussion. Does moving from a barter economy to an economy where money is a medium of exchange alter the status of balanced trade as an equilibrium condition?


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CATEGORIES: International Trade



COMMENTS (14 to date)
mcwop writes:

Arnold, in the article on Comp Advantage it states:

Equilibrium Conditions
In his Atlantic article, Michael Lind's thesis is that unless the government steps in, the middle class will disappear as businesses increase productivity through outsourcing and the use of technology.

What about government mandated costs that employers in the US must pay (payroll taxes, workers comp, etc...)? Is this factored into equilibrium conditions when comparisons to other countries are made? Maybe this is an area where the government may need to step out of the way, making fully loaded wages more competitive.

Eric Krieg writes:

Moreover, I can state with complete confidence that Michael Lind, Paul Craig Roberts, Senator Arnold sez: "Charles Schumer and other math-challenged pundits could never in a million years show how their thinking about trade could be made consistent with equilibrium conditions. Giving such commentators credence in discussions of economic policy is like trusting your open-heart surgery to someone who has never so much as dissected a cat."

This is the argument that Steve Antler ("The Econopundit") makes to guys like Paul Krugman all the time. He challenges everyone to take their economic prescriptions, put them into the FAIR econometric model, and see if the outcomes are what they say that they are.

I have yet to see Krugman take Steve up on his offer. I wonder why? Maybe Krugman isn't such a math genius after all.

Don Lloyd writes:

Arnold,

From your article --

"...In physics, a rock that is lying on the ground can be in equilibrium. A rock that is suspended in midair with nothing holding it up is not in equilibrium...."

This is true, but the transition from disequilibrium to equilibrium is by no means instaneous, nor without consequences, as you may well appreciate if you stand under the rock.

The real world is never in equilibrium, and never will be until life disappears from the universe and all that is left are the remnants of burned out stars radiating away their residual energy in the infrared spectrum.

Your arguments are all correct, but incomplete. The really interesting parts of economics are the trajectories taken towards equilibrium, but nearly always interrupted before arriving.

Equilibrium economics is a static economics without any need for actual economic actors. It is a map with no journeys taken.

Regards, Don

Andrew writes:

Don -- You are correct that most of the interesting and difficult questions are about non-equilibrium states. The point is that many commentators are getting the boring and easy questions wrong!

Tom Dougherty writes:

To bolster Andrew’s point, I would say that people like Michael Lind don’t even understand the tendency towards equilibrium. Wages will tend to equal the marginal product of labor. If for example, entrepreneurs in the Indian software industry are earning positive economic profits due to paying software programmers less than their marginal product, then that will entice other entrepreneurs to enter the field so they too can earn positive economic profits.

For the new entrepreneurs to bid away the software programmers from their current employment, they offer a higher wage. If the old entrepreneurs were making 10% above “normal” profits or zero economic profits, the new entrepreneurs may say that they are willing to bid up the wage of the software programmer in order to make 7% above “normal” profits. Other entrepreneurs do not want to be left out, so they bid up the wage to where they are left with 5% above normal profits. The old entrepreneurs don’t want to lose their workers so they bid up the wage. This bidding process will go on until profits are bid down to where there is zero economic profits and wages are bid up to where they equal the marginal product.

This process is not instantaneous, nor does it run as smoothly as my example. Too many entrepreneur may enter the software industry and end up bidding profits below zero economic profits causing submarginal businesses to drop out of the industry.

Arnold’s article is right on. More people should read it, especially Michael Lind.

Eric Krieg writes:

Anyone who doubts that prices and/ or wages will tend towards equilibrium, even in India, should take a look at the Chinese auto industry.

The market for new vehicles in China used to have limited entry, with VW, Jeep, and Buick making obscene profits there.

Lately, entry to the industry has been expanded, and every fly by night company over there has entered the industry. Prices are falling a few % per year despite very strong demand among the new Chinese urban middle class for vehicles.

It is to the point where, if you project current capacity growth rates to the near future, there will be OVERCAPACITY in the Chinese domestic auto industry in a year or two.

Which goes to show Krieg's First Law: the ability to expand industrial capacity is order of magnitudes easier than building demand for that capacity. This is why there is global overcapacity for EVERY industrial and consumer product on the planet.

Which is also why guys like Brad DeLong need to be slapped down. The US budget deficit is one of the few things that is/ will juice up global demand for goods. It also puts pressure on the dollar, which in turn forces the Europeans and Japanese to lower their interest rates, which in turn helps juice up global demand.

dsquared writes:

I must say I thought that this was an excellent article (not just because I got cited in it?!) In fact, Arnold's point here about balanced trade is even stronger than an equilibrium condition; it's an adding up condition. The only way trade can be "unbalanced" in this sense is if one side is getting something for nothing.

The general point about wage competition is also a good one. I've been pretty savage about globalisation rhetoric on my own weblog over time, but I must admit that there is something not a little patronising and nasty about the kind of antiglobo who claims that developed world workers must be protected from evil little brown people who are prepared to work for nothing. It's a nasty part of the history of the trade union movement and one we'd be better off without.

Bruce Cleaver writes:

Yes, Don/Andrew have hit the weak point in the comparative advantage discussions. A point is taken at t = 0, and the outcome as t = infinity (rather, t >> 0) is trotted out. The ensuing transient is ignored, possibly because the effects are very hard to calculate. The discussions remind me of the massless beams, frictionless planes, and inviscid/incompressible flows that dot the physics and engineering pedagogy: very useful to a point, and wildly inaccurate past that point.

Is it worth the disruption if it takes 2 years to regain the lost ground? How about 5 years? A generation? I suggest that part of the Ricardian resistance comes from the realization that benefits are diffuse and future-based, while costs are concentrated in space and time.

Tom Dougherty writes:

“Yes, Don/Andrew have hit the weak point in the comparative advantage discussions.”

Don/Andrew didn’t find a weak point in comparative advantage, rather they were talking about how economies in disequilibrium move toward (if never actually reaching) equilibrium. It takes time for prices and wages to adjust toward an equilibrium condition. It takes time for entrepreneurs to spot profitable opportunities. It takes time for labor and capital to flow from one area of the economy to another. It takes time for employees to train and acquire human capital. None of this is a weak point in comparative advantage.

Ricardo’s comparative advantage is a specific case applied to international trade of a more general law of association. The law of association says that cooperating with my fellow man will raise my standard of living. Even if I produce everything more efficiently than my neighbor, it will benefit both of us to exchange with each other. If I produce what I have a comparative advantage producing and he produces what he has a comparative advantage producing relative to me, then total output is increased and both of us will be better off through exchange.

The fact is that time is a factor in all endeavors, whether one chooses to cooperate or if one chooses to have an autarkic existence.

Bruce Cleaver writes:

"... None of this is a weak point in comparative advantage."

Sure it is, if you want to persuade somebody of the value of comparative advantage - my original (perhaps ill-defined) point.

Lawrance George Lux writes:

' Does moving from a barter economy to an economy where money is a medium of exchange alter the status of balanced trade as an equilibrium condition?"

Yes, it does! You enter into a double-loop equilibrium, where the supply of Funds in both Curriencies affect the caparative equilibrium of Product production. Ease of Currencies will lead to lower production costs, while diffculty of operational capital will affect Labor Wages.

Arnold,
I liked your argument, but it tends to be a little unbalanced. Ricardian Economists refuse to see Trade links the Wage scales of both Nations, and affects both independently of marginal productivity. An example of this could be the Software Programers which as so discussed. A Nation, in isolation, has a set Labor complement of Programers. Their marginal productivity varies from Job to Job, and their Wages are set by the need to hire Programers: so that the marginal productivity of Programmers is averaged over the entire range of Programming activity.

Now enters the Trade Issue: One Nation has a limited Programmer labor force having high Wages, based upon a high average marginal productivity. The other Nation has an immense number of Programmers, but limited amounts of work. Hiring Programmers modifies to lower Wage, which is not equal to marginal productivity, or even average national marginal productivity. Enter the Trade pattern, the Wage schedule for Programmers will be linked through ease of production location.

The nation with many Programmers will not even reach national average marginal productivity until significant numbers of Programmers are employed. Their Wage level for Programmers will still be much lower than the high-Wage paying Nation. Trade links the Wage schedules of both Nations for Programmers. The actual Wage levels paid (as total National remuneration) will fall drastically in the high-Wage paying Nation, until the point where the low-Wage paying Nation reaches average national marginal productivity for Programmers. The average marginal productivity governing Programmer wages in the low-Wage nation will still undercut the Programmer wages of the high-wage Nation, until the marginal productivity is averaged for both Nations.

Sorry for the long tirade, Arnold.
lgl

Stefano writes:

In his Atlantic article, Michael Lind's thesis is that unless the government steps in, the middle class will disappear as businesses increase productivity through outsourcing and the use of technology.

Lind's thesis is even stronger than that: he claims that the middle class would not even exist without government intervention, since it was created by the homestead act and FDR's pro-labor policies.

It's true that trade models predict (and data confirm) that countries become wealthier because of trade, but models don't consider distributive issues: that new created wealth could end up to few upper-class individuals, leaving the middle class (and the poor) worse off.

That is how things went when Russia opened to trade: a few people became very rich, while the general population was no richer, and in many cases poorer than before.

My question is: does the market by itself (abstaining government intervention) favor the middle class, or tends to dissolve it by increasing the gap between the super-rich and the others ?

Robert Monical writes:

I think several people have hit on the issue for Americans: equilibrium will take a long time to achieve because there is a lot of available labor to soak up in Asia. Long term, this will be a very, very good thing but the next couple of decades may be a little rough for American programmers.

Because Asian economies are propping up the dollar, this leads me to believe that Ricardo already applies to manufacturing even at $.47 or $.18 per hour.

Back to programming: there are barriers to out-sourcing critical applications. One is protection of intellectual property: a country that does not respect intellectual property rights is not an attractive place to develop intellectual property. I guess India is OK here, but I'm less worried about the armies of Chinese programmers.

Another is criticality. I recently resurrected my security clearance and obtained a contract with Lockheed Martin. In part, this is to be outsourcing proof. In part it was because, since 9/11, I was not particularly inspired by what I was doing.

TeamCanada writes:

"General equilibrium implies that you can have low wages with low productivity or high wages with high productivity, "but never low wages with high productivity""

Really. That's even assuming that produtivity isn't a factor, because with market capitlization who need productivity?--or for that matter, what would you measure it against? DeBeer would be a good example.

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