It’s election time again, so we’re about to hear a lot of economic feel-good nonsense. One of the most important economic theories is that of comparative advantage. It’s a counterintuitive theory that describes the benefits of free trade.
Absolute Advantage is an easier concept. One country can be absolutely better at producing something, but that does not mean it can produce everything. Workers are not an infinite resource. This is key to understanding free trade.
One of the better essays I’ve read on this topic is Paul Krugman’s Ricardo’s Difficult Idea:
The idea of comparative advantage — with its implication that trade between two nations normally raises the real incomes of both — is, like evolution via natural selection, a concept that seems simple and compelling to those who understand it. Yet anyone who becomes involved in discussions of international trade beyond the narrow circle of academic economists quickly realizes that it must be, in some sense, a very difficult concept indeed.
The difficulty comes in separating Comparative Advantage and Absolute Advantage.
Comparative Advantage is about “mutually beneficial specialization” which maximizes possible production.
In short, it’s better than America outsource it’s low end manufacturing jobs to countries like Mexico, so that Americans can get better jobs in the tech industry. This is true even if Americans have an absolute advantage in manufacturing.
So here’s a simple example. Say there are 500 US and 500 Mexican workers. The Americans have absolute advantages in producing computers and shoes but are better at making computers than shoes compared to Mexicans.
The average US worker produces 10 computers a month or 50 shoes. The average Mexican produces 2 computers a month or 40 shoes.
If each country produced independently, they would have to divide their laborers between both businesses. This keeps shoe manufacturing jobs in America.
200 American produce computers, and 300 produce shoes
Output: 2000 computers, 15,000
200 Mexicans produce computers, and 300 produce shoes
Output: 400, 12,000
Total output: 2,400 computers, 17,000 shoes.
If the Americans and Mexicans utilize their comparative advantages and specialize in what they are best with and trade the surpluses with one another, they will produce far more than they could indepedently.
If they specialize and trade, 500 Americans produce computers and 500 Mexicans produce shoes,
Total Output? 5000 computers, 20,000 shoes.
And it really is that simple.
Actually it gets more complex from there, but this gets the point across. Comparative Advantage grows more powerful from here on. As countries specialize, they get even better at producing their goods. Wages will increase and imported consumer goods will decline in price. It’s win-win. Comparative advantage increases world-wide production.
Low-end Manufacturing jobs are a major gain for poorer countries. Back to Krugman: Cheap labor jobs are a major step up the ladder for impovished society. Their workers are advancing from even more impoverished agricultural economies. By eliminating textile manufacturing, wealthier countries free up their workers to work in advanced technology industries and help make the world’s poorest wealthier than before.
Whereas, economic autarky and protectionism makes everyone poorer.
Keep this in mind when Politicians claim they want to keep “jobs” in America. Workers are not infinite in number. If you want Americans to make cheap sneakers and t-shirts, you have to pull them out of more productive economic sectors. It’s better to specialize in some industries and import other goods from foreign nations. This leads to greater benefits for everyone.
So why the hostility?
At the deepest level, opposition to comparative advantage — like opposition to the theory of evolution — reflects the aversion of many intellectuals to an essentially mathematical way of understanding the world. Both comparative advantage and natural selection are ideas grounded, at base, in mathematical models — simple models that can be stated without actually writing down any equations, but mathematical models all the same. The hostility that both evolutionary theorists and economists encounter from humanists arises from the fact that both fields lie on the front line of the war between C.P. Snow’s two cultures: territory that humanists feel is rightfully theirs, but which has been invaded by aliens armed with equations and computers.
Humanity is nothing more than mathematical formulas. And we’re figuring them out. Get used to it.