And now, another few stupid questions for economists, continuing on from last week
. The subject of this week's stupid questions:
To summarize briefly, comparative advantage is the idea that the
world economy as a whole is best off when each country does what that
country is best at doing, even if some other country could do it better.
And furthermore, that this situation naturally comes about by free trade.
This notion was first put forward by David Ricardo, who came up with a
numeric toy example of an economy with two goods and two countries: Portugal
can produce either wine or wheat more efficiently than England, but the
productivities differ. The details are like this:
|Cost (Man-hours per unit)||Total man-hours available|
And we also make a few assumptions, just to keep the math easy:
- There are no transport costs or tariffs.
- All wheat and all wine are interchangeable.
- The costs are static -- there is no progress in production, nor economies
And so forth. From there, a little simple arithmetic
that if the countries don't trade, the economy as a whole produces 17 units of
wheat and 11 of wine. But if England specializes exclusively in wheat, and
buys wine from Portugal, the total output is 18 units of wheat, and 12 of
wine. So even though Portugal can produce wheat more efficiently than England,
it's still better off specializing in wine, and buying its wheat from the less
productive English countryside.
And so, the argument goes, specialization in the good with the
greatest comparative advantage is good for everybody. Even the
toilers in English vineyards, who, according to the argument, should
be just as happy to work on a wheat farm. (Part of the implicit
background of economic arguments in this era -- or sometimes not
so implicit -- is that market forces will act to keep workers'
wages uniform and low. People who repeat the same arguments without
qualification now, are arguing in effect that in the modern era,
workers with IT jobs should take it with simple equanimity if
they find that the Market, in its wisdom, has reallocated their labor
Regardless, the effect on the scale of industries is clear: for comparative
advantage to yield its benefits, the English vineyards, and Portugese wheat
farms, have to get wiped out. And the operation of the market provides for
that to happen. In Portugal, investing in vineyards yields greater returns
than investing in wheat farms -- so that's where the money will go. In
England, it's the reverse. (This happens through fluctuations in prices
once goods start to travel; details here).
Or, to change the example slightly, suppose that Portugal is renamed
"Nigeria", and its comparative advantage is now in oil. Once again, investing
money in drilling oil wells will yield higher returns than just about anything
else you could do with that money in Nigeria. With the result that oil
drilling (or other extractive industries) would be seen to drive out
investment in other kinds of industries in less-developed countries where it
was found. As is found to occur -- a triumph for economic theory! Or is it?
Well, it's empirically true that oil-exporting third-world states
are peculiarly slow to industrialize. There's even a name for the
phenomenon -- the "oil curse". But, to judge from the economic
literature, the cause is something of a mystery, and quite a few
papers have been published searching for explanations. Here are
pointers, for instance, to a few
papers which attribute it to institutional factors -- the oil
industry, for instance, is said to foster corruption. (One problem
with that, as I pointed out here,
is that China, the major current success story for ongoing third-world
industrialization, is spectacularly corrupt, and industrialization
there is going strong). These economists are puzzled, and I am puzzled by
their puzzlement -- which brings me to my first stupid question for
the week: Isn't the "oil curse" just comparative advantage at work?
More generally, let's consider the implications of this for a third-world
"developing" economy which doesn't have any natural resources. In
the absence of trade barriers, what should that country produce? The
principle of comparative advantage would say that it should be whatever
that country is best at producing. Or perhaps, in cases like this, it's more
appropriate to say that the country's capital should go to whatever economic activity is
the least comparatively disadvantaged, since countries like this
don't do anything well. Either way, we can ask, what's that going to be?
Well, what do people there know how to do? They're able to do farming --
they have traditions in that going back millenia. And it doesn't necessarily
require a whole lot of infrastructure beyond the ground itself, nor training;
doesn't require workers to keep exact shift schedules; and so forth. If, on the
other hand, you plop a factory in the middle of a country like that, you also
need other facilities for that factory to succeed -- power and transportation
infrastructure, and a trained work force -- which simply don't exist in the
country, and which the factory is not likely to pay for on its own. So, our
impoverished country has a very hard time making good use of a factory -- but
it is able to get agricultural products out of a patch of dirt. Now, it may
not do either of these things well, but it seems likely that its comparative
advantage is going to be with agriculture.
And, in fact, you can see particular countries where things seem to be
playing out just like that. All over Africa, for instance, people are
dressing themselves in the cast-off
T-shirts of Americans. In fact, Nigeria (where we'd expect things to be
particularly skewed with the oil money) is now trying to ban imports of used
clothing altogether, in order to preserve some kind of a local textile
industry. Which might be a completely vain pursuit in the world of
Comparative Advantage, just like the preservation of Ricardo's English
vineyards, if the comparative advantage lies elsewhere.
What applies to textiles -- hardly high tech these days -- applies just
as much to any other industry. African local industry is being starved out by
first-world castoffs in everything from computers
to mattresses to trucks. And the logic is the same in each case: the
theory of comparative advantage seems to me to say that in the absence of trade barriers,
industrialization cannot occur in a country if its comparative
advantage lies in oil drilling or agriculture, because the lack of
infrastructure dicates that you'll make more money running a farm in those
countries, than putting up a factory there. And that's a good thing, because
total world economic output is maximized by dedicating the continent to dirt
farming -- in perpetuity.
The tricky words there are "in perpetuity". One of the assumptions of
Ricardo's theory, as I mentioned above, is that the cost matrix stays the same
-- that neither economies of scale, nor synergy, nor anything else is going to
change it. It's a static theory. But an integral part of industrialization
is doing things -- training the work force, building up transportation and
energy delivery infrastructure -- which make it possible for a factory owner
to get more bang for the buck. And these things take time. Longer than a
decade. Longer than investors in the modern world are generally willing to
To put it another way, a great deal comparative advantage in industrial
goods comes from having a lot of industry, and the support structure for it,
already in place. So, for countries that don't, what is to be done?
Well, one possibility is to put up trade barriers to force
local people to invest in creating industries which would otherwise
make no economic sense -- and in their share of a support
structure which makes it cheaper to build the next factory.
The idea here isn't that trade barriers are a positive good, to be
maintained in perpetuity -- but rather, that for developing economies,
they are a necessary evil, to be dropped when local industry can stand
on its own. It's not a fairy tale to suppose that can happen.
That's what South Korea
did, for example, last century, pursuing mercantilist policies
while building up its industry in the 1960s and 70s, and progressively
lowering trade barriers after that. For that matter, it's more or
less what the U.S. did in the nineteenth century. And it's what
Mauritius, one of the few bright lights in the dismal African economic
picture is doing
right now. But this flies in the face of conventional "Washington
consensus" advice to developing governments -- which is to drop all
trade barriers immediately, and keep them down.
Another possibility is to have the government itself create
and provide some of the support structure. To have it create
electrical, water, and sewer systems, so that private industry doesn't
have to shoulder that burden. But that again flies in the face of
"Washington consensus" advice, which is to privatize, on the theory
that "the competitive market" can provide more economical service. In
practice, unfortunately, "privatization" all too often takes the form
of first-world conglomerates getting monopolies, as in the case of Bolivian water
utilities. The rationale was that the first-world monopolist,
Bechtel, would serve more efficiently than the old public utility --
but in fact, it took advantage of its monopoly and the lack
of competition to raise rates to levels that were literally killing
To recap: starting from a perfectly orthodox statement of the principle of
comparative advantage, I've got the very heterodox position that in
conditions of pure free trade, it's going to be extremely difficult for
developing countries to industrialize. All of which goes way, way against
economic conventional wisdom. So, the remaining dumb questions for the week:
where are the countries where conventional wisdom has worked, and
what's wrong with this argument?
Well, aside from the garbled version of the wine-and-wheat
example that was originally posted up top. Repeat ten times: proofreading cannot
be omitted. Proofreading cannot be omitted. Proofreading...