Tim Worstall

Misunderstanding Ricardo.

Armed Liberal over at Winds of Change is arguing about the hollowing out of the US manufacturing system, the decline of the middle class and so on. He quotes a piece of Neal Stephenson to make his point:

When it gets down to it–talking trade balances here–once we’ve
brain-drained all our technology to other countries, once things have
evened out, they’re making cars in Bolivia and microwave ovens in
Tadzhikistan and selling them here, once our edge in natural resources
has been made irrelevant by giant Hong Kong ships and dirigibles that
can ship North Dakota all the way to New Zealand for a nickel, once the
Invisible Hand has taken all those historical inequities and smeared
them out into a broad global layer of what a Pakistani brickmaker would
call prosperity–y’know what? There’s only four things we do better
than anybody else: music/movies/microcode (software)/high-speed pizza
delivery.

The unfortunate thing here is the misunderstanding of comparative advantage. We, or anyone else, do not need to be "better" than others to benefit from trade. We most certainly do not need to be "best" at anything. That is confusing competetive advantage, absolute advantage and comparative.

For trade to work, for us all to get richer by it, we do indeed need to do what we do best, but that comparison is not with others. Far from it, the "comparative" refers to what we ourselves can do, the comparison being to all of the different things we could apply our talents to and which of those do we do least badly, at which of these are we "best"?

This logic is so strong that even if someone else, everyone else, were better at producing everything than us it would still make us richer for us to concentrate on those things that we do least badly and then trade the results.

Don’t get me wrong, absolute and competetive advantages are nice things to have but the logic of trade and globalization do not depend upon them, only upon comparative. Which is why one Nobel winner for Economics (Paul Solow I think?) said that Ricardo on trade is the only non-obvious non-trivial result in economics (and I would extend that to most of the social sciences actually, but that’s pure prejudice).

In

15 responses

  1. Rob Read Avatar
    Rob Read

    You’d think that just about the only theorem in Economics would be more widely known?
    Perhaps it doesn’t fit with certain educational institutions and broadcasters stereotypes?

    Reply
  2. james C Avatar
    james C

    His point is nothing to do with comparative advantage.
    He is arguing that the US has suffered a loss by transferring know-how.

    Reply
  3. rjw Avatar
    rjw

    You are quite right on the confusion about comparative advantage. You don’t need to be absolutely best at anything to benefit. That is the central point of trade theory that is consistently misunderstood the world over. An analogy is the office division of labour. Why doesn’t the boss do his secretaries job ? Because by delegating tasks to the secretary he is freed up to do more valuable things at the margin, like extracting more surplus value from his workers. (Of course – my assumption that the boss could do the secretay’s job is a heroically convenient one made just for purposes of the argument)
    Before we get carried away though it’s worth recalling that actual policy discussions on trade have another angle. The winners and losers from changes to trade rules are not usually the same people. Trade liberalisation may, under certain key assumptions, make us better off in aggregate. But clearly that is not the same thing as saying everyone benefits. This matters an awful lot (for both good and bad) in practice.
    I think you mean’t Paul Samuelson by the way. Robert Solow also got one (a Nobel), but that remark was probably Samuelson as trade theory was his big thing.

    Reply
  4. AJE Avatar
    AJE

    Tim – I think the reason that many people misunderstand comparative advantage is the way in which it’s taught: the two country, two good, numerical example.
    Instead, all we need to say is that for any individual, where time is scarce, has a choice between a. producing something themselves or b. specializing in something else, and then trasding for it.
    As you rightly say, you don’t have to be better than someone else in order to benefit, but it’s not even “differences” that matter: the only thing that makes trade mutually beneficial is the scarcity of time.
    http://thefilter.blogs.com/thefilter/2005/02/comparative_adv.html
    ps I think it was Paul Samuelson

    Reply
  5. Marc Danziger Avatar
    Marc Danziger

    Tim, I’m not silly enough to argue against comparative advantage, nor to believe that the trends we’re seeing are (or should be) reversible.
    In fact, the hope at t he end of this process is that the marginal economies of the world ignite, leading to significant improvements in living standards everywhere.
    This presents a social and political problem to the United States, though, as our supersized lifestyles need scale down toward (not necessarily to) those of our competition.
    That domestic problem is the one that needs addressing.
    A.L.

    Reply
  6. Tim Harford Avatar
    Tim Harford

    Samuelson.

    Reply
  7. dsquared Avatar
    dsquared

    Paul Samuelson or Bob Solow, choose one.
    In unrelated news, while it’s nothing to do with trade policy, this apocalyptic scenario in which vast chunks of the human capital of the USA were destroyed, leaving the economy unable to produce any manufactured goods at all at a competitive cost, would probably be a bad thing if it happened. Limitingly unlikely, but bad if it happened.
    Tim adds: It’s PS. Tim Harford kindly sent me the original quote from the WB site. And if there was such a destruction of human capital, yes, of course it would be abad thing. Depends on how fast it happens really, the move away from manufacturing in hte US> Over a generation or two there would be no such destruction. Tomorrow? Indeed, a problem.

    Reply
  8. Atanu Dey Avatar
    Atanu Dey

    To most bright people, the lessons of economics appear obvious and trivially true. The mathematician Stanislaw Ulam once asked Samuelson if there was anything in economics that was both non-obvious and true. Samuelson took several years to arrive at the answer that it was the theory of “comparative advantage.” He said, “That it is logically true need not be argued before a mathematician; that is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.” {from here.}

    Reply
  9. Remittance Man Avatar
    Remittance Man

    So, if this dumb mining engineer’s got it right, the whole thing about comparative advantage boils down to “Do what you’re best at because that’s how you will benefit the most”.
    In other words I shouldn’t give up my day job and try and become an actor (or an economist for that matter).
    It’s amazing that whole forests have been sacrificed to produce books to say that and still people don’t grasp the concept (or have I grabbed the stupid end of the stick again?).
    RM
    Tim adds: Absolutely the right end of the stick. I, in order to keep it clear in my mind, don’t use “best” as that gets some people thinking that they must be better than others in order for it to work. I like to say “Do what you are least bad at and swap the results”. And that’s it. The whole idea in a nutshell. And billions still don’t get it.

    Reply
  10. dsquared Avatar
    dsquared

    No, it’s “do what you’re least worst at”. If it turns out that there’s a country overseas that produces mining engineers for tuppence ha’penny and loves plays, then you *should* become an actor.

    Reply
  11. Remittance Man Avatar
    Remittance Man

    Now I am getting confused. Isn’t “my least worst” the same as “my best”? Are we talking abilities or are we talking situations here?
    Since no one would pay me a farthing for my acting I’d better pray my bosses never hear about those tuppence ha’penny mining engineers.
    RM

    Reply
  12. dsquared Avatar
    dsquared

    [Are we talking abilities or are we talking situations here?]
    situations. If you’re a really good mining engineer but you want a living wage, then from the POV of economics you’re a worse engineer than someone who’ll engineer mines for a bowl of porridge. When you read all those stories in the Guardian about brain surgeons from Lithuania working in London as waiters, then what’s going on there is not something completely unlike comparative advantage (not least because many of them, however good they are at brain surgery, are really quite dreadful waiters).

    Reply
  13. m Avatar
    m

    I think you may have overlooked an important point: “once our edge in natural resources has been made irrelevant” is stated in the passage you quote.
    Comparative advantage will not create benefit when there are not enough resources. Since the United States has 5% of the world population, yet consumes 20% of the energy, I am not convinced that comparative advantage will prevail in the United States. Since increases in the price of energy disproportionately affects the poor, they will suffer the most.
    e.g., China and India are competing more for oil. Hence the price of oil is going up. Supply will not keep up with demand (I belieive this is true now, but inevitably it will be true). That is causing the poor in the United States to suffer a lot more than the rich (see also Example 1 of “Comparative Advantage” at Wikipedia).

    Reply
  14. m Avatar
    m

    I think you may have overlooked an important point: “once our edge in natural resources has been made irrelevant” is stated in the passage you quote.
    Comparative advantage will not create benefit when there are not enough resources. Since the United States has 5% of the world population, yet consumes 20% of the energy, I am not convinced that comparative advantage will prevail in the United States. Since increases in the price of energy disproportionately affects the poor, they will suffer the most.
    e.g., China and India are competing more for oil. Hence the price of oil is going up. Supply will not keep up with demand (I belieive this is true now, but inevitably it will be true). That is causing the poor in the United States to suffer a lot more than the rich (see also Example 1 of “Comparative Advantage” at Wikipedia).

    Reply
  15. Remittance Man Avatar
    Remittance Man

    Thanks Dsquared. A rare ray of sunshine penetrates the murk of my understanding of economics.
    Now lurching back into the gloom. If these tuppence ha’penny mining engineers really exist then I’ll need to rely on my competitive advantage (and hope I’m better at engineering mines than them and thus worth more). If I can’t then the theatre going public may have to suffer my interpretation of Henry V.
    RM

    Reply

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