Comparative Advantage and Competition
William R. Hawkins
Thursday, March 04, 2004Gregory Mankiw, Chairman of the Council of Economic Advisers, triggered a political firestorm when he told the Joint Economic Committee of Congress (JEC) on February 10 that outsourcing jobs is “just a new way of doing international trade.” Yet, he was correct in his assessment. It was his total lack of concern about the consequences that provoked even the Republican Speaker of the U.S. House, Dennis Hastert of Illinois, to respond, “I understand that Mr. Mankiw is a brilliant economic theorist, but his theory fails a basic test of real economics.”
It is this conflict between theory and reality that has always driven debates over international trade. This discussion has often been sliced between economists on the one hand, and historians and political scientists on the other. Economics is a social science, not a hard science, despite all the attempts to disguise this fact with graphs, equations, and computer models. Economics is filled with contrasting philosophical views of how the world should work.
Mankiw´s idealism is evident from other things he said during his JEC testimony. Consider the following: “International cooperation is essential to realizing the potential gains from trade. Trade agreements have reduced barriers to international commerce, and contributed to the gains from trade. A system through which countries can resolve disputes can play an important role in realizing these gains.”
This statement reflects the theory of comparative advantage in its most simplistic form. Countries are to specialize in particular fields and then trade with those who have specialized in complementary fields. The emphasis is on cooperation, not competition. Each trading state recognizes and accepts its place in the integrated global economy. Indeed, the increasing use of the terms “integration” and “global” in place of “competition” and “international” reflect the philosophical bent of 19th century classical liberalism for harmony over rivalry.
There is, however, very little in the history of international trade to support this concept. David Ricardo conceived his comparative advantage model at a time when even his native England was not yet a fully industrial nation. He thus drew heavily on pre-industrial concepts based on a “natural” division of labor and specialization based on climate, raw materials and local artisan skills. One of the more famous examples of this approach is Adam Smith=s observation about the difficulty of growing bananas in Scotland.
Today, it is possible to manufacture products almost anywhere because technology is not limited by soil or climate like agriculture; transportation costs have dropped; capital is fluid; and there are smart, skilled people everywhere. Related to this “unnatural” state is another critical fact that free trade theory does not take into account: In a large and complex world, multiple nations can have a comparative advantage in the same field. They thus become rivals in the attempt to gain as large a share of world markets as possible.
The United Nations Conference on Trade and Development (UNCTAD) puts out measurements of “revealed” comparative advantage based on an index that compares the share of a given sector in national exports to the share of the sector in world exports (known as the Balassa formula). According to this measurement, the United States, China, Germany and Japan all have a comparative advantage in miscellaneous manufacturing; the U.S., China, Japan and Singapore have comparative advantages in electronic components; the U.S., Germany and Japan have advantages in transportation equipment (mainly cars and trucks) and in non-electrical machinery; the United States and Germany have an edge in chemicals; China and Germany both have comparative advantages in basic manufacturing, while Japan has just lost it advantage. In information technology and consumer electronics, China, Japan, and Singapore are rivals, with the United States having lost ground but still close enough to recover its advantage with a little effort. Comparative advantage is a dynamic function, subject to change over time as rivals actively compete, trying to better their position and knock out the others.
Ambitious nations are never satisfied with their “assigned” place in the system. The American colonies revolted against a British Empire that did not want them to develop industry but simply maintain their comparative advantage in the production of raw materials. Ricardo=s own classic “wine and cloth” example was meant to show that Portugal should accept its role as a traditional supplier of wine and let England move ahead with the new industrial process of cloth production. This example was denounced as “free trade imperialism” by all nations which understood that developing new technology and manufacturing capacity was the path to both prosperity and power. The current impasse at the Doha Round trade talks reflects this historic rivalry between developed and developing nations.
China is not going to accept the U.S.-Japanese-German edge in automobile production and import vehicles. It will build its own auto industry, along with industries in aerospace, chemicals and steel. Beijing will use American transnational corporations to aid in its development efforts, since these firms do not care where they produce. China will also push forward with its shipbuilding industry, even though South Korea, Japan and the European Union are currently more advanced. What moves international commerce is the same motive that moves business in general: cutthroat competition and a relentless desire to expand into new fields. The key difference between domestic and international competition is that the latter also affects national capabilities, which in turn can shift the world balance of power and with consequences far greater than those experienced by domestic companies in their more circumscribed competition.
The term “trade war” is far more applicable to the world trading system than most people want to admit. Political science professor William R. Thompson, from a career spent looking at the international system, has reached this conclusion: “Unlike the pattern in warfare in which ascending states fight their way up through their regional neighborhoods before taking on the system=s most powerful state, commercial challenges are aimed immediately at the leading commercial power.” Today, that target is the United States.
In this global competition, the United States is losing. There is no field in which its domestic producers are without rivals, which means that if national leaders adopt the attitude that it doesn´t matter who wins, America will be defeated by those who do care about winning. A $549 billion trade deficit in goods, and increasing penetration of foreign firms into key sectors of the domestic American economy, indicate how rivals are running up the score.
Professor Mankiw does not apparently think in these terms. The critical question is whether the man who appointed Mankiw, President George W. Bush, understands the larger issues at stake. So far, there is no evidence that he does.
William R. Hawkins is Senior Fellow for National Security Studies at the U.S. Business and Industry Council.
You want another Great Depression, don't you Willie?
Suppose the mercantilist model--that centuries-old paradigm of planned, coordinated, "balanced" protectionism now resurrected by William R. Hawkins to create a stronger America--were a viable policy alternative in August 1945, at the end of World War II. And let us take this supposition as an opportunity to assess the U.S. trade record, to see where it has been, economically and politically, and perhaps to see where it is heading. After all this, we may better see just what Hawkins has in mind.
With the end of the Second World War, America, then by far the greatest military and economic power on earth, faced an extraordinary challenge: What kind of postwar world should America nurture? Broadly it had two options.
First, should the United States retreat to its mercantilist, isolationist, divisive, protectionist, and inadvertently contentious stance of the twenties and thirties?
Consider the history behind this question. Congress, which refused to ratify the Treaty of Versailles, rejected U.S. membership in the League of Nations. In 1922, Congress adopted the Fordney-McCumber Tariff, which led to a 44 percent average tariff on dutiable imports. That percentage was boosted to nearly 60 percent by the more widely imposed Smoot-Hawley Tariff of 1930, a record tariff that touched off retaliatory protectionism and divisiveness around the world. It also exacerbated the Great Depression (economist Jude Wanniski says Smoot-Hawley caused it) and contributed to the frictions that led to the Second World War.
Under newly installed President Harry S. Truman, America in 1945 carried forward the flag of leadership earned by military victories in war-ravaged Europe and Asia. Therefore, should America seek a united, not a divided, globe, an international fraternity of nations predicated on, to borrow the slogan of IBM, "World Peace through World Trade," an international fraternity wherein nations are free to exchange goods and services, ideas and technology, capital and tourists, for the benefit of all concerned?
Wisely, I think, America chose the second option, though it still clung to a number of mercantilistic ideas advocated in the accompanying article by William Hawkins. America fostered the United Nations, headquartered in New York, and the General Agreement on Tariffs and Trade (GATT), headquartered in Geneva.
GATT, which celebrated its fortieth anniversary in 1987, seeks to promote free trade by requiring member nations signatory to any tariff ... (3100 of 19478 Characters) Read Full Article
This sums up well where we are today and why free trade theory and comparative advantage have always been poorly thought concepts whose last bastion of relevance only lives on in Ivy Tower Land.
The models, case studies, theorems of comparative advantage, are a static, simplistic, closed-end ball of assumptions that portends to relate to a dynamic, chaotic, violent world of Nations each seeking short, intermediate and long-term strategic advantages over other nations. The notion of nations willing to abide by some sort of managed cooperative trading, and specialization of industries as William Hawkins points out is naïve and flies in the face of history.
Not really.
The truth is only prosperous nations can afford to import more goods than they export, and those times when America's had the lowest trade deficits have been when we were in economic recession.
In addition, more jobs are outsourced to America, than America outsources to other countries.
Do you think that this guy paid for his house and car with cash, or did he run up his own "trade deficit"?