Wednesday, April 14, 2004

Outsourcing our understanding of economics

Recently, in the comments to one of Mr. Bruno’s posts, Orlando tried to advance his belief in the evils of allowing certain people to trade goods and services (specifically, free-trade). After I tried to explain the standard text-book argument for free-trade, Orlando accused me of drinking the kool-aid. First, read up on the actual theory of comparative advantage. Now, let’s discuss:

No seriously, please read this. The meat and potatoes part is in the example in the second section. It’s really basic.

Ok, so Orlando misunderstands the process of comparative advantage. He thinks that he has a awesome counter-example “what happens when the US produces neither T-shirts nor software cheaper than India?”. Well, it’s not a counterexample. In fact, the law of comparative advantage is so impressive because it states that even in this “Awsome efficient India” world, free-trade is to society’s advantage.

Let’s state this again: What Orlando thinks is a counter-example is in fact the whole point and the reason why the theory of comparative advantage is so powerful.

I won’t walk you through the “Awsome efficient India” example because they go through it here. Orlando should keep in mind that the “efficiency” of production here is not effected by how cheap labor is. Assuming that India is better at computers and t-shirts means assuming that it actually takes fewer man hours than in America. The worker wages reflect their productivity on the world market which is why Indian workers get paid less: They aren’t as good at computers as we are.

Let’s go through his “points”:

1) “In the first place, some investment is individual but much of it is corporate.”

Orlando must be blessed with a very special ass. Answers don’t come out of my ass, but Orlando is different. He’s gifted. He lives in a magical world where the stock market doesn’t exist and where corporations in non-growth sectors needlessly plow all their money into R&D, vainly wasting money that they admit would probably be better spent researching something else. In Orlando’s world, non-growth corporations don’t pay dividends to their stock-holders for them to invest, in fact, in Orlando’s world apparently, no appreciable amount of money ever gets invested in new sectors at all. How did India get to be a software giant in the first place? Why didn’t they just keep spending money on new and better basmati rices? Tell us oh great and wonderful owner of the almighty ass!

2) “world demand for T-shirts is nothing like adequate to guarantee full-employment to India's one billion plus workers”

Which world demand is Orlando referring to? Could it be the current world demand? Or could it be the world demand after millions of Indians have enough money to buy multiple t-shirts for the first time in their lives? If Orlando’s supply-side blinders were on as tightly as his demand-side ones, he would be taking about how wonderful it would be that new consumers were being created around the world. Does Orlando really imagine a world where Indians produce goods at the level of Americans without consuming on the level of Americans? Does he think Indians are particularly ascetic or something? He would have felt right at home with those complaining about how cheap Korean labor was putting Americans out of business. Of course, those people aren’t around anymore, not since Koreas wages shot up… predictably.

3) “[India] is perfectly situated to become the T-shirt AND software maker to the world”

What, did I just step into a time warp? This is the same misunderstanding of the theory of comparative advantage that we saw earlier. Only now it’s wearing those funny glasses with a fake nose and mustache. Yes, the theory is usually only presented with two markets for convenience. But economics text-books (apparently, the kind which if you read is equivalent to “drinking the kool-aid”) present multiple industry models with the same results. Countries end up specializing in industries they are more efficient at than other industries. Wages are dictated by how over-all efficient a country’s companies are: efficiency measured in how many man-hours to produce a dollar of goods.

Orlando seems to suspect that America’s relative advantage lies in making T-shirts, which is how is closes his post. Most economists think that it actually lies in other more favorable fields. But let’s for a moment, imagine that it does. Let’s imagine that for every hour I work at my computer programming job, I produce less “goods” than if I worked at a T-shirt factory. Let’s say, $1 worth of completed programs vs. $2 of T-shirts. What kind of idiot would waste his time programming computers when he could be living the high-life with his own T-shirt company? Apparently, Orlando.

Update: Fixed now-annoying misspellings of “kool-aid”. I want to say that this shouldn’t devolve into a fight over who can come up with a better put-down. I like to write in an animated style and Orlando’s lack of familiarity with the theory of comparative advantage was very good grist for the mill. Orlando should be commended for standing up for what he believes in, regardless of whether we agree. Certainly he is much better than the protectionists (and free-traders) who don’t want to learn more about the subject and don’t want to argue. Lastly, I do want to underscore that Free-trade is not a magical cure-all for society’s ills, but I will go into the downsides of free-trade at another time. It suffices to say that the good points can easily be made to outweigh the bad ones with the appropriate government policies.

posted by Tommaso Sciortino at 9:43 PM

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