Ricardian Comparative Advantage

I think everyone should take a course or two in microeconomics. Children should be taught the notion of opportunity cost early on. Models of supply and demand should be shown in high school at the latest, along Smith’s pin factory and some notion of how to read macroeconomic news. And, of course, there should be a discussion of Ricardo’s comparative advantage model. To paraphrase the link (and deviating from the whole Britain/Portugal Wheat/Wine thing to use the more contemporary Gilligan/Skipper metaphor, which is apparently all the rage in econ 101 quizes):

Suppose Gilligan can gather 10 coconuts an hour, or catch 10 fish an hour, while the Skipper can gather 20 coconuts/hour or catch 15 fish/hour. The Skipper is absolutely better at both gathering coconuts and catching fish that Gilligan; the Skipper also has a comparative advantage at coconut gathering, since he can gather 1-1/3 coconuts for every fish he catches, whereas Gilligan gathers 1 coconut for every fish he catches. Conversely, Gilligan has a comparative advantage in fish catching. As an aside, note that Gilligan, if coconuts and fish were converted to currency, would have absolutely lower wages than the Skipper (this is pretty much tautological in this simple model, as the Skipper is absolutely more productive at both tasks).

If Gilligan and the Skipper have a spat and move to opposite sides of the island, how do they spend their day? If they each spend 4 hours in each activity, Gilligan winds up with 40 coconuts and 40 fish, while Skipper has 80 coconuts and 60 fish. The total production for the island would then be 120 coconuts and 100 fish. We can vary the distribution of activities to get other numbers, but that’s the basic picture. Now, suppose Gilligan and Skipper make up and decide to trade. Gilligan specializes in fish catching, his comparative advantage, and spends 8 hours doing that, catching 80 fish. The Skipper can spend 6 hours gathering coconuts, and 2 hours fishing, yielding the same 120 coconuts, and 30 fish. Total island production is now 120 coconuts and 110 fish, and the ten surplus fish can be divided up in some way between Gilligan and the Skipper. So, specialization, even partial specialization in the case of the Skipper, has yielded extra production compared to autarky. Consumption choices can of course be changed, but you still get more stuff at the end of the day when there’s specialization: Skipper can spend all his time gathering coconuts, resulting in a total island output of 160 coconuts and 80 fish. The island inhabitants may want to sacrifice 20 fish for 40 coconuts. Or, the Skipper can devote some time to catching fish as in the above example, if there’s a greater demand for fish relative to coconuts; his fish catching productivity will be used to fill in for the supply shortfall from Gilligan.

That’s the basic Ricardian model. In this description, we’ve ignored real-world effects, such as costs of trade, externalities, market power, etc.; these elaborations of the basic idea are explored in detail in the trade theory literature for those interested. Note also that the Britain/Portugal metaphor Ricardo originally used focuses comparative advantage to trade amonst nations. The Gilligan/Skipper metaphor hints a bit more about the benefits of specializing in your comparative advantage to smaller scales, such as two people working on a desktop publishing project (one person is comparatively better at writing while the other is better at page layout), or a bank outsourcing its janitorial needs. It’s a little more concrete and everyday.

Krugman has an interesting take on why there’s resistance to, say, Ricardian trade theory by non-economists, be they journalists, politicians or other lay people, even though these people are generally smart and intellectual. He notes that the theory of comparative advantage gets rejected because:

  • Some intellectuals want to intellectually fashionable and heterodox; Ricardian theory is old and orthodox among economists.
  • Ricardian theory is harder than it looks, and explaining it well requires a set of concepts familiar to economists, but perhaps unusual to lay people.
  • There may be an aversion to a mathematical way of thinking about the world. Krugman invokes C.P. Snow’s notion of there being two cultures. Modern economic thinking at its base is mathematical thinking, imaging the world as a set of logical models. There’s story-telling, but the stories are driven by the model. Krugman basically says that a lot of people want to tell stories that aren’t based on models, and may not like the stories with a more rigorous framework. This touches Feynman’s statement about the relationship between math and the world, which I’m taking from a recent Economist science article:

    mathematics is a deep way of describing nature, and any attempt to express nature in philosophical principles, or in seat-of-the-pants mechanical feelings, is not an efficient way.

  • Perhaps the more literary economic stories are told to confirm or describe a particular moral point of view? For the basic economic models are fundamentally objective and amoral, and cannot be ignored; they do not leave room for good intentions, which may not be to the taste of everyone. In any case, the lack of understanding about how comparative advantage works and how it will help developing nations in the long term tends to lead to, say, anti-WTO protests and the like. Currently, we have the whole outsourcing thing becoming a campaign issue this year, even if this is more or less a special case of Ricardian theory.

    DeLong has a recent piece that reiterates the notion that trade and outsourcing don’t affect employment level in the US — the Fed has more influence than anything else, following by national macro policy — but instead affects the composition of jobs in the country. Industries shift to conform to comparative advantage (textile manufacturing in the US?), producers use to the cheapest providers of raw materials or necessary services (call centers), workers shift from the old factories to new ones, and as a whole the country is better off. Note also that technological change is far more influential in the Schumpeterian uprooting of old industries and the creation of new ones; Bhagwati points this out in a recent NYT editorial. Of course, this is painful to the workers that have been uprooted, regardless whether the industrial restructuring is because of trade (international or domestic) or technical change. As white-collar industries are now being affected, people may not understand that the time and money they’ve invested in their education may no longer matter (what did the buggy whip makers feel at the dawn of the automobile age?). Arguably, this is why we need better education on economics, and a big push to strengthen such things as Trade Adjustment Assistance, and expand it into a general program for worker retraining, to help ease the transition from old industries into new ones, regardless of what happened. America is the land of reinvention, after all.

    Update: Daniel Drezner has an article on EU outsourcing to the US. For example, Nokia has a contract with IBM to handle IT help desk functions and desktop environment. The EU apparently understands the notion of liberal world economy (even though it doesn’t practice it particularly well with regard to agricultural subsidies). There’s also a note about the relative rise in “insourced” US jobs compared to outsourced ones. As noted, the main effect of trade is the composition of US jobs, not the quantity.

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