Comparative advantage is a theory evidenced by using economic models. I should stop there; anyone who has taken more than one class in Economics will tell you that an "economic model" relies on the idea of ceteris paribus: "all other things equal." In theory, this is the only way we can interpret the world around us. If we hold other things constant, then the relationship between X and Y will become more clear.
Economics as a discipline is more concerned today with the field of econometrics. The basis of econometrics itself rejects ceteris paribus, because regression analysis is only as accurate as the multiple variables being accounted for. Things are not being held constant in regression analysis. It is the duty of an econometric analyst to be fair, detail-oriented, and comprehensive. In excluding variables, he or she erodes the integrity of the regression analysis. In contrast, economics is concerned with rejecting all such variables.
Now, it is not sufficient to say that because of economic modeling techniques, that the science is a farce; quite the contrary. Economics can be used to "prove" what may seem common sense, or what may not seem common sense. It is an ingenious way of looking at incentives, unintended consequences, and policy decisions. Economics has value as a partial explanation. It can often be a necessary component in understanding. However, it is often not sufficient in its power. This is very much the case here.
Country Butter Guns
Albanon 8 12
Belania 6 4
In this example, we avoid the problems of perfectly mirroring supply curves which do not exist in real life, and which provide no useful information in terms of international trade. In this instance, we can see that Belania perhaps has better infrastructure than Albanon, more capital investment, or a more skilled workforce, and thus can produce goods at a better rate in both goods.
The way this is utilized is by understanding that for maximizing output, given a total of 40 labor hours, Belania could produce 4 units of butter and 4 units of guns if it desires to maximize consumption of each. In contrast, Albanon can produce 2 units of guns and 2 units of butter. The world economy is now 6 units of butter and 6 units of guns.
However, if Belania instead focused on producing primarily guns and Albanon focused on producing primarily butter, we see an increase of the total goods of the world. To get this number, we graph a line depicting a production frontier of butter versus guns for both nations. In 40 hours, Albanon can produce 5 units of butter, and Belania can produce 7 units of guns and 2 units of butter. By trading with one another, the world economy is now richer 1 unit of guns and 1 unit of butter.
How this works is quite simple. The opportunity cost Albanon faces by producing every unit of guns is 1.25 units of butter, meaning that if it focused on producing butter with the understanding it could trade with Belania, it can increases its overall consumption because it has chosen the production with least opportunity cost. Belania also benefits because it too can focus on its comparative advantage in guns than producing butter, which it has no comparative advantage.
Another perspective comes from our previous explanation as to why comparative advantage happens. If we believe a priori that this is a net benefit for all involved, we may explain away this issue by citing Brazil as being ideal for ranching because of its poor soil quality, while places with rich soil quality such as France are, of course, better for producing agricultural goods.
However, Dosi et al. (1988) found that in the realm of manufactured goods, differences in production capabilities are largely driven by technological infrastructure, not some innate quality within the country's borders. In a similar vein separate to this study, if we look at professional services as a good, it is a function of human capital, something that is not innate and largely dependent on migration patterns.
This is compounded by previously stated empirical evidence showing that manufactured goods are a function of technology. If this is the case, then a nation like Albanon which is less developed will likely stay less developed, while Belania will see greater capital investment thanks to its booming industry.
Second, and related to the previous point, the production of guns and butter have two very different demands in terms of infrastructure. If we make the assumption that guns and butter are both valued at $1, then nations may have no preference initially for one over another and will actually see their economy grow in the short term.
However, we also understand producing certain goods gives a nation an advantage tangible only in geopolitics. If Belania produced guns both guns and butter, and Albanon produced only butter, as with our previous example, Belania could afford to intimidate Albanon to sell butter for less money, or they will impose sanctions and stop trading guns. This would disadvantage Albanon greatly, and if they reverted to an autarky, they would begin to contract, which is the beginning of an economic death spiral.
Belania also has an advantage by producing a good that requires greater capital investment. By producing guns, Belania will be able to support a city population over a rural one because it can provide factory jobs. Albanon is limited to its own acreage, and even if butter is produced on a large scale and in industrial settings, it is a short vertical supply chain from milk to butter. Belania relies on a very advanced vertical chain of iron to steel production, lead processing, and plastic molding, which all enamor it to have a more industrial society. This means it likely trades with more nations for their iron, steel, plastics, lead, copper, and other goods. This too gives more leverage over Albanon, as its industrial and global economy make it more valued by other nations as they export more to Belania, meaning they are more likely to side with Belania in the event the two nations have a dispute.
Third, an obvious caveat, is that guns are far more useful and essential than butter to a nation's existence. If Albanon is invaded, it cannot use its cow ranches and butter production facilities to stimulate a war economy. Very obviously, Belania's gun factories can easily transition into a wartime economy.
Fourth, if world demand for either good declines, there is no mechanism for either country to switch to a good with higher demand. Albanon, in order to produce 5 units of butter, needs to structure its economy to support this production by utilizing its arable land effectively and to its maximum potential. Belania, to produce its 7 units of guns, must be an industrialized nation with factories, mining operations, and power plants. If guns were suddenly no longer a good in demand, Belania would have to spend an inordinate amount of time transferring to butter production, which means retrofitting factories and tilling new topsoil. The reverse is perhaps were for Albanon, as it has no capital investment for producing factories or industrial networks easily.
There are many other problems that I could go over, including how the velocity of money would benefit Belania more as it produces a greater number of units of goods and how unemployment would effect Albanon worse than Belania, but for the purposes of this blog, we can safely say that comparative advantage has flaws and it is not a model of which we can make accurate assessments of the world with.
Of course, one will easily find examples of international trade benefiting individual nations. India, for example, halved its poverty rates since the early 2000s by becoming the world's face of customer service, and China became the shining example of the Tiger Economy by producing cheap commodities and electronics.
The costs of the global economy, however, fall in line all too well with the problems outlined above with comparative advantage. India's workforce is pigeonholed into an industry rapidly being automated, and skills developed in customer service and telemarketing do not translate well into other industries. China too imposes great externalities on its own environment, inspiring literal quadrillion-dollar cleanup projects for the Yangtze River and having a workforce with among the highest suicide rates in the world, developed or not.
The price of a global economy and a global society are enslaving nations like Albanon for the benefit of Belania. We must ask ourselves, as economists: are there more valuable things than production? Are their more valuable things than money?
Economics as a discipline is more concerned today with the field of econometrics. The basis of econometrics itself rejects ceteris paribus, because regression analysis is only as accurate as the multiple variables being accounted for. Things are not being held constant in regression analysis. It is the duty of an econometric analyst to be fair, detail-oriented, and comprehensive. In excluding variables, he or she erodes the integrity of the regression analysis. In contrast, economics is concerned with rejecting all such variables.
Now, it is not sufficient to say that because of economic modeling techniques, that the science is a farce; quite the contrary. Economics can be used to "prove" what may seem common sense, or what may not seem common sense. It is an ingenious way of looking at incentives, unintended consequences, and policy decisions. Economics has value as a partial explanation. It can often be a necessary component in understanding. However, it is often not sufficient in its power. This is very much the case here.
Explanation
Comparative advantage begins with a model like the one below, using the fictional Mediterranean countries of Albanon and Belania. This model grades their ability to produce the classic economic tradeoff of butter versus guns. The numbers represent labor hours to produce a single unit of either good.Country Butter Guns
Albanon 8 12
Belania 6 4
In this example, we avoid the problems of perfectly mirroring supply curves which do not exist in real life, and which provide no useful information in terms of international trade. In this instance, we can see that Belania perhaps has better infrastructure than Albanon, more capital investment, or a more skilled workforce, and thus can produce goods at a better rate in both goods.
The way this is utilized is by understanding that for maximizing output, given a total of 40 labor hours, Belania could produce 4 units of butter and 4 units of guns if it desires to maximize consumption of each. In contrast, Albanon can produce 2 units of guns and 2 units of butter. The world economy is now 6 units of butter and 6 units of guns.
However, if Belania instead focused on producing primarily guns and Albanon focused on producing primarily butter, we see an increase of the total goods of the world. To get this number, we graph a line depicting a production frontier of butter versus guns for both nations. In 40 hours, Albanon can produce 5 units of butter, and Belania can produce 7 units of guns and 2 units of butter. By trading with one another, the world economy is now richer 1 unit of guns and 1 unit of butter.
How this works is quite simple. The opportunity cost Albanon faces by producing every unit of guns is 1.25 units of butter, meaning that if it focused on producing butter with the understanding it could trade with Belania, it can increases its overall consumption because it has chosen the production with least opportunity cost. Belania also benefits because it too can focus on its comparative advantage in guns than producing butter, which it has no comparative advantage.
Empirical Refutation
We have few examples of a so-called autarky, or self-sustaining economy, suddenly opening its trade. The prime example and perhaps on the largest scale is 19th-century Japan, which Bernhofen and Brown (2004) found had a real price increase of exported goods of about 100%, and the price of imported goods declined up to 75% at most. This makes sense ex post facto, as we understand intuitively that as demand goes up, so do prices. In our example of Belania and Albanon, we were maximizing world GDP in a way. This hurts the consumer using the same logic that benefits the supplier.Another perspective comes from our previous explanation as to why comparative advantage happens. If we believe a priori that this is a net benefit for all involved, we may explain away this issue by citing Brazil as being ideal for ranching because of its poor soil quality, while places with rich soil quality such as France are, of course, better for producing agricultural goods.
However, Dosi et al. (1988) found that in the realm of manufactured goods, differences in production capabilities are largely driven by technological infrastructure, not some innate quality within the country's borders. In a similar vein separate to this study, if we look at professional services as a good, it is a function of human capital, something that is not innate and largely dependent on migration patterns.
The Failures of Ceteris Paribus
Now we can examine some of the ways comparative advantage cannot work in reality. First, while the world GDP increases when nations focus on what they are best at producing, this does not mean local economies do not suffer. This is most evident if we assign prices to butter and guns. If 1 unit of guns is worth $5 and 1 unit of butter is worth $1, Albanon would never agree to produce only butter, as its economy shrinks from $12 to $5 given the same labor hours. This hurts local incomes and affects their ability to buy goods from other countries.This is compounded by previously stated empirical evidence showing that manufactured goods are a function of technology. If this is the case, then a nation like Albanon which is less developed will likely stay less developed, while Belania will see greater capital investment thanks to its booming industry.
Second, and related to the previous point, the production of guns and butter have two very different demands in terms of infrastructure. If we make the assumption that guns and butter are both valued at $1, then nations may have no preference initially for one over another and will actually see their economy grow in the short term.
However, we also understand producing certain goods gives a nation an advantage tangible only in geopolitics. If Belania produced guns both guns and butter, and Albanon produced only butter, as with our previous example, Belania could afford to intimidate Albanon to sell butter for less money, or they will impose sanctions and stop trading guns. This would disadvantage Albanon greatly, and if they reverted to an autarky, they would begin to contract, which is the beginning of an economic death spiral.
Belania also has an advantage by producing a good that requires greater capital investment. By producing guns, Belania will be able to support a city population over a rural one because it can provide factory jobs. Albanon is limited to its own acreage, and even if butter is produced on a large scale and in industrial settings, it is a short vertical supply chain from milk to butter. Belania relies on a very advanced vertical chain of iron to steel production, lead processing, and plastic molding, which all enamor it to have a more industrial society. This means it likely trades with more nations for their iron, steel, plastics, lead, copper, and other goods. This too gives more leverage over Albanon, as its industrial and global economy make it more valued by other nations as they export more to Belania, meaning they are more likely to side with Belania in the event the two nations have a dispute.
Third, an obvious caveat, is that guns are far more useful and essential than butter to a nation's existence. If Albanon is invaded, it cannot use its cow ranches and butter production facilities to stimulate a war economy. Very obviously, Belania's gun factories can easily transition into a wartime economy.
Fourth, if world demand for either good declines, there is no mechanism for either country to switch to a good with higher demand. Albanon, in order to produce 5 units of butter, needs to structure its economy to support this production by utilizing its arable land effectively and to its maximum potential. Belania, to produce its 7 units of guns, must be an industrialized nation with factories, mining operations, and power plants. If guns were suddenly no longer a good in demand, Belania would have to spend an inordinate amount of time transferring to butter production, which means retrofitting factories and tilling new topsoil. The reverse is perhaps were for Albanon, as it has no capital investment for producing factories or industrial networks easily.
There are many other problems that I could go over, including how the velocity of money would benefit Belania more as it produces a greater number of units of goods and how unemployment would effect Albanon worse than Belania, but for the purposes of this blog, we can safely say that comparative advantage has flaws and it is not a model of which we can make accurate assessments of the world with.
The Slave Economy
Unfortunately, many proponents of globalism use this model as the basis for their beliefs that a world united through trade can eventually inspire peace due to international interdependence, enrich poorer nations by means of specializing production and foreign investment, and overall build a much more productive world economy.Of course, one will easily find examples of international trade benefiting individual nations. India, for example, halved its poverty rates since the early 2000s by becoming the world's face of customer service, and China became the shining example of the Tiger Economy by producing cheap commodities and electronics.
The costs of the global economy, however, fall in line all too well with the problems outlined above with comparative advantage. India's workforce is pigeonholed into an industry rapidly being automated, and skills developed in customer service and telemarketing do not translate well into other industries. China too imposes great externalities on its own environment, inspiring literal quadrillion-dollar cleanup projects for the Yangtze River and having a workforce with among the highest suicide rates in the world, developed or not.
The price of a global economy and a global society are enslaving nations like Albanon for the benefit of Belania. We must ask ourselves, as economists: are there more valuable things than production? Are their more valuable things than money?
Comments
Post a Comment