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- From: rob@KAMAN.COM (Rob Vienneau)
- Newsgroups: sci.econ
- Subject: Free Trade or Comparative Advantage
- Message-ID: <9208140247.AA13878@lenny.kaman.com>
- Date: 14 Aug 92 02:47:25 GMT
- Sender: daemon@ucbvax.BERKELEY.EDU
- Lines: 134
-
- In this forum, a Stanford economist recently began a discussion by
- stating, in the usual authoritarian and obscurantist manner typical of
- the higher learning, that the theory of comparative advantage shows
- that the employment impact of the new free trade agreement is nothing
- to worry about. Although the theories of international trade and
- development are not my specialty, insofar as an amateur can be said to
- have a speciality, I'll offer some comments here. Apparently these
- theories aren't known at Stanford either. I'll ignore all
- methodological questions, other than to point out one ought to wonder
- how an "ought" can be derived from a theory that normally is presented
- as an "is." Instead, I'll examine the theory of comparative advantage
- on its own grounds.
-
- David Ricardo originated the theory of comparative advantage to explain
- why relative labor values do not regulate the price of goods traded
- internationally. Although the labor theory of value was rejected by
- academics after the Neoclassical revolution, Ricardo's theory of
- international trade was retained almost unchanged in a completely
- different setting.
-
- Here is a rational reconstruction of Ricardo's example. Suppose both
- England and Portugal consume only two goods, cloth and wine. Suppose
- cloth and wine are both produced with only one factor of production,
- labor. Furthermore, suppose the given technology exhibits constant
- returns to scale such that:
-
- In England, 100 men are needed per square yard of cloth produced
- 120 men are needed per barrel wine produced
-
- In Portugal, 90 men are needed per square yard of cloth produced
- 80 men are needed per barrel of wine produced.
-
- Suppose the level of employment is given in both countries. Note that
- for any level employment, Portugal can produce more of any basket of
- goods (x square yards of cloth, y barrels of wine). That is, Portugal
- has an absolute advantage in both goods. Nevertheless, both countries
- gain, assuming they are interested in maximizing consumption for their
- given levels of employment, if they engage in trade in consumer goods.
- For a certain range of prices, England should produce only cloth, and
- Portugal should specialize in wine. Note that it does not matter to
- this argument how much or how little workers in England are paid
- compared to those in Portugal. (I suppose, then, those who
- misunderstand what's been demonstrated think the UAW need not fear cheap
- Mexican labor.)
-
- The nonprofessional economists who do not see how both parties benefit
- from trade need not worry. The great Chicago economist thought that
- Ricardo was more likely to drive the average person to drink than to
- convince him that free trade in wine was a good idea.
-
- This argument can be generalized to many countries, many goods, many
- factors, and more flexible production conditions. What cannot be
- removed, as far as I know, are the assumptions that factors (e.g.
- finance capital and labor) are immobile between countries, that the
- level of employment is given, and that changes in technology are
- exogeneous.
-
- An argument that takes the level of employment as given cannot be said
- to show that free trade has no effect on the level of employment.
- Suppose this assumption is relaxed to state that long run tendencies
- towards full employment exist. This still does not mean that a sudden
- removal or decrease in tariff barriers will not cause problems. An
- adjustment process must occur in which a country's whole structure of
- production is transformed for specialization in the production of a
- different set of goods. Economists set themselves too easy a task if
- they confine themselves to demonstrating that the sea is calm after the
- storm has passed. These transitional problems remain. Capital goods
- are not ectoplasm that can be instantly and costlessly transformed from
- being appropriate to producing one set of goods to being appropriate for
- another. Nor can one casually assume the ultimate direction in which
- the economy is headed is independent of the route it travels to get
- there.
-
- Another problem with this model is the theory of exchange rates lying
- behind it. With continuous production functions, the theory derives an
- equilibrium set of exchange rates between different currencies. But, as
- far as I know, the volume of transactions on currency markets is much
- larger than that needed to clear accounts between those engaged in
- international trade. The dominant influence is speculation -
- individuals trying to guess what the future will bring. In a market in
- which prices move in response to the participants' beliefs about what
- others will believe tomorrow about future movements, it's hard to accept
- the Neoclassical argument that prices tend towards realizing some
- physical constraint. See Chapter 12 of Keynes' _General_Theory_ and
- almost any commentary on it by G. K. S. Shackle.
-
- A glance at what is traded also reveals large deficiencies in the
- theory. Some countries specialize in raw materials. Some trade in
- semifinished goods. And, as required by the theory, consumer goods are
- traded. The roles of immigration, movements in finance, and
- multinationals are also of interest. In short, the assumptions that
- factors of production are relatively immobile between countries and that
- consumer goods dominate trade are rarely met in practice. Also, one is
- hard pressed to believe that a country should be indifferent to whether
- it specializes in bananas, oil, steel, autos, or consumer electronics.
- Obviously, changes in the technology available to a country are affected
- by what it produces. Both Adam Smith and Friedrich List knew this, but
- academic economists cannot accept it without rejecting the whole of
- Neoclassical economics.
-
- As a final empirical point, the theory of comparative advantage has been
- falsified. After WW II, Europe lay in ruins. Presumably, the U.S. had
- a relative advantage in capital intensive goods. But the Nobel laureate
- Leontief found that in that period the U.S. imported capital-intensive
- goods, whatever that means, and exported labor-intensive goods.
- Neoclassicals added a few epicylces to their theory, labelled this the
- Leontief Paradox, and continued on their way in ignorant bliss.
-
- And for a final theoretical point. A whole alternative theory sprang up
- from Keynesian Macroeconomics. Suppose consumption increases in a
- country, but much of it is spent on imported goods. Then the multiplier
- effect, which increases the GNP and employment, is considerably
- lessened. On the other hand, countries who export the goods now being
- consumed by the first country might increase their demands for imports
- from that country, with consequent improvements in that country's
- employment. Then, of course, one might want to consider how different
- monetary policies in different countries affect this process.
- Obviously, there's room for the development of lots of theory here, and
- a lot was developed.
-
- I hope this note has made it clear that a competent analysis of free
- trade and employment must consider much more than the theory of
- comparative advantage, either in introductory or advanced forms. And
- I only considered a selected subset of issues here.
-
- Robert Vienneau I sit in one of the dives
- rob@kaman.com On Fifty-Second Street
- Uncertain and afraid
- P.S. Has anyone read As the clever hopes expire
- this far? Of a low dishonest decade:
- Waves of anger and fear
- Circulate over the bright
- And darkened lands of the earth,...
- W.H. Auden
-