The Myth of Comparative Advantage

The economic/economists' argument for globalization (economic and financial at least - political will have to wait) rests on the idea of comparative advantage. But I am now beginning to wonder just how accurate this framework is for thinking about globalization.

Several recent articles by Tom Friedman have me thinking and worrying about this. Today's op-ed in the Times argues that Europeans are helplessly caught in the past and about to be run over (which pisses off David Sirota to no end). Of course, Friedman, like all Times columnists, being a committed free-trader, ends his column with the tag -- we all have to work harder and try harder if we want to compete and we will all be better off.

This strikes me as a rather empoverished view of economics. We have to remember that there are lots of goods that are not tradable and lots of markets that don't exist. As long as this is the case, it's hard to argue that the person who works 80 hours a week and drives a Mercedes is better off than the person who works 40 hours a week and drives a Ford. (And that's about more than just the difficulty of making interpersonal comparisons of utility - for you economists out there) If we are all working 80 hour weeks (state A) but have a few more goods it is entirely possible that we would be collectively better off if we had less and worked less too (state B). Getting to the second state could be a serious collective action problem, however. For one thing, you would need an enforcement mechanism to make sure no one goes off and cheats and works 80 hours. And for another you will need a way of compensating those who prefer the first, hard work state for not being able to live in that state. Doing the compensation is going to be impossible since you will never be able to learn who really needs the compensation. The obvious incentive is to lie and say you need to be compensated, even if you are a lazy state B sod like me.

An added worry on top of this though is that it may be based on a false premise we have accepted from economics for a long time. The idea of comparative advantage is that it makes sense if you are good at farming and your neighbor is good at baking for the baker to sell you his land so you can do all the farming and for the baker to do the baking. You buy the baked goods using the money made from the farm items you raise while the baker makes money selling baked goods to buy other essentials. This seems like a strong argument in the context of a small town. How many people will be good at baking or good at smithing or good at farming? We are all better off in this context if we can specialize. More bread gets baked, more crops get raised, etc...

In the international context the argument is supposed to apply because we treat nations like individuals. We ask, what should each country specialize in? With an N under 200 in the international context it seems unlikely that each country can't find something it excels at. This has been the basis of the theoretical argument for globalization for a long time. In the context of earlier debates, such as the one over NAFTA, the argument goes something like the one above. If America concentrates on what it does best, it can do more of that than it now does and buy what others can do better for less than what we currently pay our own workers. We end up better off and the countries that sell us their goods, like China and Mexico get better off too. Comparative advantage and specialization. The problem is that production workers in this country have been told they are likely to lose their jobs to foreign workers who will work for less and they will need to get retrained, better skilled and join the ranks of us elite, educated workers. This way we can all enjoy the brave new world. Implicit in these arguments is a vision of an America consisting of lots of high skilled workers producing value and everyone else in the service sector servicing the population. But the country needs to keep producing value to maintain its standard of living.

But it rests on the idea that, like people, each country can do one thing best and should do that. But what if countries are not like people? Some may be if they are small and endowed with limited (or like the Mideast, abundant) natural resources. But what about the large nations? I say this because increasingly it is becoming clear that China, India, Singapore and other places are not going to compete with us just in the area of unskilled labor. As Friedman shows in a NYT Magazine piece, they will compete with us in almost everything. This means that countries, unlike people, might be able to do a lot of different things at once. In fact, as globalization increases apace, and technology shrinks distances further, it seems clear that some countries like India will be able to do everything we can do. Soon, there will be almost nothing that we do in this country that cannot be done in India for less. The reason outsourcing has become such a hot political issue is that all those skilled workers have suddenly found out that being educated and skilled in the global economy is no protection if someone can do your job for $10 an hour while you require $80. The old saw that we all need to up our skills and training may offer us no help if there is no profession to which we can upgrade because all the jobs can be done in India for less. Pretty soon our exportable industries will be movies and capital. And who is to say that India can't make movies better and more cheaply for a mostly yellow, brown and black world? What professions that are productive will be left for Americans? Remember that most American jobs are in the service sector -- even academia, law and medicine.

A good friend works for one of those Indian outsourcing companies, a rival of Infosys, sent me the Friedman NYT Magazine piece It's a Flat World After All -- having seen it first hand. I sent him this reply:

It used to be that the free traders comforted us with the notion that unskilled labor ought to go overseas so we could focus on our comparative advantage -- skilled creative work. What this means for the unskilled is they essentially have to go into service jobs to service the skilled, usually at a lower standard of living -- if they themselves can't get skilled. What India shows us is that now all labor can shift over seas. That there really isn't all that much that a Westerner can do that a person living in a less developed country can't also do for a whole lot less money.

Perhaps Marx was right after all. Soon, the only advantage we will have over other countries will be our financial capital and that will be concentrated in a few hands. America will become the place where all the money is (of course, before too long, if the current account deficit persists, we won't be - China will). America will be where the owners are and everyone everywhere, even here, will work for the owners, the capitalists, at paltry but equalized wages set to the lowest common denominator. If that doesn't sound like a race to the bottom I don't know what is. If that doesn't make you protectionist I don't know what will. Countries are not likely to be able to specialize, but people are. And unless you choose to specialize in something that few elsewhere can do, your wages will be whatever the cheapest source of that same labor is likely to be. So what will Friedman and Co. tell those Americans who fear further economic integration? How will they compete if there is nothing that could even begin to make them competitive? Any honest macro-economist will tell you that the notion that free trade represents a pareto improvement in which all are made better off is a fiction.