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Taking Comparative Advantage Seriously

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by Pierre Lemieux

berries.jpg
Some geographical conditions can be changed by human entrepreneurship or government intervention. If hothouses have been built with a government subsidy and their cost is sunk, don't they now represent a comparative advantage?

A recent Wall Street Journal story reports that the longer growing season of Mexican farmers is seen as a cause of dumping and that a renegotiated North American Free Trade Agreement may have to compensate for this comparative advantage of Mexico:

American farmers, however, complain that their Mexican rivals enjoy unfair advantages, including low-cost farm labor, state subsidies and a year-round growing season that lets them dump cheap berries on the U.S. market when the two countries' growing seasons overlap in the late spring.

Perhaps the reporter's or editor's interpretation was a bit loose (the reporter did not respond to my inquiry regarding whom exactly he was citing). But note how, in a similar way, French farmers complain against the unfair weather advantage of their Spanish competitors:

French farmers and winegrowers dumped some two tons of peaches and nectarines in front of the Spanish consulate ... in order to denounce Spanish competition, deemed "unfair." ... For [a fruit growers' spokesman], "a European solution is needed."

It is difficult to believe if you haven't seen it with your own eyes, but economic savvy is even less common in France than in America. This is a bit distressing nearly two centuries after French economist Frédéric Bastiat wrote his petition of candle makers disadvantaged by the competition of the sun. "If an orange from Lisbon sells for half the price of an orange from Paris, it is because the natural heat of the sun," Bastiat noted.

In The Wealth of Nations, Adam Smith defended the importation of wine even if "[b]y means of glasses, hotbeds, and hot walls, very good grapes can be raised in Scotland, and very good wine too can be made of them." As he explained, domestic production would cost "about thirty times the expence for which at least equally good can be brought from foreign countries." Or, to borrow an example from William Taussig, very good pineapples could be grown in Maine with similar means.

Geography, weather, and other natural conditions create justifiable comparative advantage in trade. Except if one is an ascetic, it is not rational to produce by oneself what somebody else can produce more cheaply in another climate.

However - and here is a little challenge - the distinction between "natural" and "artificial" conditions is not as neat as one might think. Some geographical conditions can be changed by human entrepreneurship or government intervention. If hothouses have been built with a government subsidy and their cost is sunk, don't they now represent a comparative advantage? Ski resorts can be built and artificial snow made, possibly with government subsidies. Ignorant people can be instructed, even in government schools. Moreover, some phenomena straddle the distinction between the natural and the artificial, that is, phenomena like language, culture, and morals (see chapter 1 of Friedrich Hayek's vol. 1 of Law, Legislation and Liberty).

The question is which features of the world count in comparative advantage? Swiss producers' strong work ethic and Canadians' use of English help determine their comparative advantage. Economies of scale benefit producers who have come to serve a larger market. Market institutions and a political system favorable to enterprise also help determine comparative advantage. But don't the Chinese government's subsidies and other assistance to Chinese businesses also help determine the latter's comparative advantage? Similarly, aren't the subsidies that aircraft maker Bombardier got from the Canadian and Québec governments now part of the company's comparative advantage?

Such interrogations are related to an important argument made by Paul Krugman in an article later published in the Journal of Economic Literature ("What Should Trade Negotiators Negotiate About?" 35-3: 113-120). Krugman argued that government regulations and taxes are part of the comparative advantage landscape; they do change relative prices, but trade proceeds - and should be left to proceed - from that point on.

This comprehensive concept of comparative advantage does not invalidate arguments against inefficient or immoral regulations, taxes, or subsidies. We may wish (often contra Krugman) that these measures do not exist in our own country, and try to persuade foreigners that they should not be subjected to them either. But they do not extinguish comparative advantage and negate all benefits from trade.

Except perhaps in extreme cases (for example, trading in stolen goods, such as goods made with slave labor), foreign governments' interventions do not justify another government prohibiting its own residents from trading with the regulated or subsidized foreigners. One can wish that one's trading partners were freer and thus more productive and wealthy, but it remains beneficial to trade with them, even if not as much as it would be in an ideal world where everybody were perfectly free.

As Krugman suggests, this wide view of comparative advantage reconciles free trade and political decentralization at the world level. It is beneficial and possible to have both. On the one hand, political decentralization is necessary to preserve liberty and experimentation, as opposed to a world government. Different peoples can have different sets of regulations, including less regulation. There is no need to impose standards or regulatory harmonization in "free trade" agreements. On the other hand, the benefits of free trade are preserved because comparative advantage continues to exist under intervention, although with some distortions. The distortions introduced by a world government monopoly would certainly be worse.

This line of argument supports the idea that unilateral free trade is beneficial: it is in the interest of (most of) a country's residents to be free to import at will whatever obstacles other national governments impose on their own citizens or subjects.



Pierre Lemieux is an economist affiliated with the Department of Management Sciences of the Université du Québec en Outaouais. His forthcoming book, to be published by the Mercatus Center at George Mason University, will aim at answering common objections to free trade. Email: PL@pierrelemieux.com.


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CATEGORIES: International Trade




COMMENTS (14 to date)
Thaomas writes:

Lemieux seems to be missing the point of "comparative advantage." The "comparative" of comparative advantage refers to comparing one activity to another (growing wine or wheat in Ricardo's example) not comparing countries (Portugal and England). The warmer sun in Portugal may explain why the cost of producing wine is relatively cheaper in Portugal than producing wheat [or maybe it's something else, who knows and who should care?], but what drives trade is different relative prices between countries in the no trade situation. The sun does not give "Portugal" a comparative advantage, indeed unless one has something like a labor theory of value the very idea of a comparative advantage of one economy over another makes no sense.

Thaomas writes:

Concerning trade agreements, these are best thought of as political vehicles to overcome the "Olsen" problem. The benefits of reducing import restrictions are thinly spread among consumers and exporters while the costs are concentrated among import substituting sectors leading to a collective action problem (similar to dispersed harm of CO2 emissions versus the concentrate benefits). Trade agreements negotiations mobilize exporters and consumers to offset the political weight of producers of import substituting goods. [This is especially tricky in the US where import substituting sectors have been concentrated in "swing" states and the exporters and more of the consumers are in states that both political parties can take for granted/for lost.]

Don Boudreaux writes:

Thaomas: Your first point is pedantic. It's clear that Pierre understands that countries, as such, have no comparative advantage or disadvantage but, rather, that comparative advantage and disadvantage exist at the level of the individual producer. The fact that we use as a shorthand a comment such as "Portugal has a comparative advantage in the production of wine" is just that: a shorthand. Its use does not imply that those who use it believe that comparative advantage exists at the country level.

Warren Platts writes:

Don, you and Thaomas are both committing a fallacy of reduction. You have a peculiar metaphysics: on the one hand you guys talk about collective action problems, yet on the other you deny that collective actions have collective consequences.

Consider China. At the level of the national government, they have not only the willingness, but the ability--via paid hackers working for the People's Liberation Army--to conduct worldwide industrial espionage, to steal IP, that they then distribute to Chinese firms. How is that not a comparative advantage at the national level? Firms get lots of high technology, without having to pay for the R&D, but they would not be able to get that IP were it not for action at the national level.

Similarly, consider the mere size of a nation's economy. The size of a national economy is a property of the economy as a whole; it is not the property of individual firms. Yet, standard tariff theory tells us that large countries can extract terms-of-trade gains at the expense of the ROW--if they can solve the collective action problem and choose to exercise that power.

Warren Platts writes:

I very much enjoyed Pierre's insightful article on how the distinction between natural and artificially induced comparative advantage is itself an artificial distinction.

Unfortunately, he does not follow this insight to its logical conclusion: he admits that government action can improve a nation's comparative advantage at both the national and firm level--artificial though it may be; yet he still cleaves to the doctrine that the USA should limit itself to its "natural" comparative advantages. But why should that be the case?

Consider US natural gas prices. I just ate a fine tomato. I figured it was from Mexico, but it turned out it was from Canada. I'll bet cheap energy had something to do with it. Cheap natural gas also gives North American manufacturers a comparative advantage. Yet you free traders last Wednesday were cheerleading LNG exports; while on Monday you were extolling the virtues of trade deficits and how exports make us poorer.

What will LNG exports do to the US comparative advantage in cheap energy? A: it's going to eliminate it. It will raise US prices somewhat; meanwhile, the world price will decline dramatically until we are all paying $5/MCF. Thus, if we were to take Pierre's article to heart, the smart thing to do is obviously impose a fat export tariff on LNG exports: this would have the dual effect of keeping energy prices low for US consumers and producers, thus boosting manufacturing exports, and it would raise billions of $$$ of revenue to help reduce the fiscal deficit. Of course this will never happen, because we seem to be incapable of smart collective action.

Jon Murphy writes:

Except perhaps in extreme cases (for example, trading in stolen goods, such as goods made with slave labor), a foreign governments' interventions do not justify another government prohibiting its own residents from trading with the regulated or subsidized foreigners.

I'm really glad you made this point. So often I hear the claim that the argument for free trade relies on both countries having free trade. But, as we see here, that simply is not true. Nothing about Ricardo or Smith depends on free trade on both sides.

The problem, like in almost every discussion about comparative advantage, seems to reside in the distinct definitions of the term.

Ricardo's notion of comparative advantage is different than the one in current economic textbooks, as it is explained in this paper: https://www.academia.edu/32214661/Ricardo_s_Numerical_Example_Versus_Ricardian_Trade_Model_A_Comparison_of_Two_Distinct_Notions_of_Comparative_Advantage

Hazel Meade writes:

The "unfair" comparative advantages created by government subsidies and regulations are not unfair to the foreign consumer, they are unfair to the domestic taxpayer and consumer. Even if other countries subsidize their producers in a way that is unfair to your countries producers, it is canceled out by the benefit to your countries consumers who can not buy the subsidized product at a discount - and the subsidies are paid for by foreign taxpayers. Thus its actually a moot point - it doesn't matter why the comparative advantage exists, its always beneficial to buy the most cost effective product from the foreign country, even if the cost effectivness is created at foreign taxpayers expense.

Hazel Meade writes:

What will LNG exports do to the US comparative advantage in cheap energy? A: it's going to eliminate it. It will raise US prices somewhat; meanwhile, the world price will decline dramatically until we are all paying $5/MCF. Thus, if we were to take Pierre's article to heart, the smart thing to do is obviously impose a fat export tariff on LNG exports: this would have the dual effect of keeping energy prices low for US consumers and producers, thus boosting manufacturing exports

... while keeping prices of imports artificially high. How is this good for US consumers? We sell them cheap LNG, and we get cheaper imports back. Cant see how net productivity would not by higher if we allow LNG to find its way to the most efficient uses.

Jon Murphy writes:

@Warren Platts:

Yet you free traders last Wednesday were cheerleading LNG exports; while on Monday you were extolling the virtues of trade deficits and how exports make us poorer.

Incorrect. Exports only make a nation's people poorer insofar as they do not facilitate increased imports. Remember: imports are a benefit and exports are a cost. If your costs increase and your benefits do not, then you are made worse off (you're getting the same, or fewer, benefits for higher costs).

In this specific case, the US has a comparative advantage in producing natural gas, and thus we have an "excess supply" of natural gas. By exporting such excess supply, the US can import more than it could otherwise; more lower-cost goods, services, etc. This is a subtle, but important, point.

Warren Platts writes:

"The "unfair" comparative advantages created by government subsidies ... are unfair to the domestic taxpayer and consumer."

Not at all. Ask any Chinese factory worker: those export subsidies are a big reason China has created over 100 million manufacturing jobs. The resulting paychecks have lifted hundreds of millions of people out of abject poverty. When the team does well, the players do well.

jj writes:

The risk in allowing free trade of government-subsidized goods is that a foreign government may act erratically by increasing or removing subsidies, in the process harming your local producers or consumers. In a competitive marketplace there are natural price swings to which economies and trade flows need to adjust, but perhaps government-induced price swings would be larger.

That said, my observation is that governments tend to stabilize prices beyond all reason. As a consumer I'll gladly take any subsidy that foreigners want to offer me, and as a worker I'll just stay in unsubsidized sectors.

Jon Murphy writes:

@Warren Platts

those export subsidies are a big reason China has created over 100 million manufacturing jobs.

Citation needed. Specifically, you need to show that the jobs were created because of the subsidies (in other words, for your claim to stand, you need to show the number of jobs created would have been lower than they otherwise would have been, and same with the level of wealth).

When the team does well, the players do well.

You've reversed the causality here.

Hazel Meade writes:

Ask any Chinese factory worker: those export subsidies are a big reason China has created over 100 million manufacturing jobs.

Note that I said "taxpayer and consumer".
Those subsidies had to be funded by someone. Those those jobs cost someone money to create.
How many jobs would have been created had those people been free to spend that money on something else?

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