Quarrels With Comparative Advantage  

Posted by T. Greer in

Today's "intriguing passage of the week" takes issue with the economic theorems of David Ricardo. One of the founding fathers of modern macroeconomics, Mr. Ricardo published his opus, On the Principles of Political Economy and Taxation, more than two centuries ago. Despite its age On the Principles of Political Economy is a treatise with few parallels. This is probably because On the Principles of Political Economy is where David Ricardo first formulated the law of comparative advantage.

The law of comparative advantage is one of the most important ideas to come out of economic theory. Its implications are so far ranging (I have seen it dragged into discussions concerning everything from the arms trade to illegal immigration) that no man should claim the title of informed citizen without first having a frim grasp on the law's implications. Unfortunately, it is not only one of the most important ideas to come out of economic theory -- it is also one of the most counter-intuitive.

Luckily, I do not need to explain the law here. Those who tread this path before me have left a trail any person can follow. Perhaps the most accessible introduction to the law of comparative advantage can be found at the Library of Economics and Liberty. Even better is the entertaining Ricardo's Desert Island Game, one of the cleverer mixes of coconuts, mathematics, and animated graphics to be found online.

Most criticisms of comparative advantage (and the policies that naturally follow from it) are little more than populist gobbly-gook. The law of comparative advantage is as mathematically solid as Newton's laws of motion. It cannot be attacked without questioning the aims and methods of economics as a whole.

This is exactly what the following passage attempts to do. Writes Nassim Nicholas Taleb in the insert to the 2nd edition of his most famous book:

Mother Nature likes redundancies, three different types of redundancies. The first, the simplest to understand, is defensive redundancy, the insurance type of redundancy that allows you to survive under adversity, thanks to the availability of spare parts. Look at the human body. We have two eyes, two lungs, two kidneys, even two brains (with the possible exception of corporate executives)—and each has more capacity than needed in ordinary circumstances. So redundancy equals insurance, and the apparent inefficiencies are associated with the costs of maintaining these spare parts and the energy needed to keep them around in spite of their idleness.
The exact opposite of redundancy is naïve optimization. I tell everyone to avoid attending (orthodox) economics classes and say that economics will fail us and blow us up (and, as we will see, we have proofs that it failed us; but, as I kept saying in the original text, we did not need them; all we needed was to look at the lack of scientific rigor—and of ethics). The reason is the following: It is largely based on notions of naïve optimization, mathematized (poorly) by Paul Samuelson—and this mathematics contributed massively to the construction of an error-prone society. An economist would find it inefficient to maintain two lungs and two kidneys: consider the costs involved in transporting these heavy items across the savannah. Such optimization would, eventually, kill you, after the first accident, the first “outlier.” Also, consider that if we gave Mother Nature to economists, it would dispense with individual kidneys: since we do not need them all the time, it would be more “efficient” if we sold ours and used a central kidney on a time-share basis. You could also lend your eyes at night since you do not need them to dream.
...take the notion of comparative advantage supposedly discovered by Ricardo and behind the wheels of globalization. The idea is that countries should focus, as a consultant would say, on “what they do best” (more exactly, on where they are missing the smallest number of opportunities); so one country should specialize in wine and the other in clothes, although one of them might be better at both. But do some perturbations and alternative scenarios: consider what would happen to the country specializing in wine if the price of wine fluctuated. Just a simple perturbation around this assumption (say, considering that the price of wine is random, and can experience Extremistan-style variations) makes one reach a conclusion the opposite of Ricardo’s. Mother Nature does not like overspecialization, as it limits evolution and weakens the animals.

This also explains why I found current ideas on globalization (such as those promoted by the journalist Thomas Friedman) one step too naïve, and too dangerous for society—unless one takes into account side effects. Globalization might give the appearance of efficiency, but the operating leverage and the degrees of interaction between parts will cause small cracks in one spot to percolate through the entire system. The result would be like a brain experiencing an epileptic seizure from too many cells firing at the same time. Consider that our brain, a well-functioning complex system, is not “globalized,” or, at least, not naïvely “globalized.”
– Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable (2nd ed). (New York: Random House Books). 2010. pp. 312-313.

Mr. Taleb argues that a smaller, "flatter" Earth is a more vulnerable one. Is he right? Is the globalized world safer from system disruptions or more prone to them? Have we been searching for gains in economic efficiency where we should have been seeking gains in economic resilience? Does free trade and comparative advantage leave humanity with (metaphorically speaking) but one kidney?

Above average comment thread, for those interested.




H/T to the proprietor the blog Macroeconomic Resilience, who pointed me towards Taleb's essay via private correspondence. 




ADDENDUM (8/8/2010): Joseph Fouche has written a superb response to this post over at the Committee of Public Safety:

Svechin-Ricardo Punchout: Does Svechin’s Giant Forehead Provide a Comparative Advantage?
"Joseph Fouche". Committee of Public Safety. 7 August 2010.



This entry was posted on 06 August, 2010 at 10:16 PM and is filed under . You can follow any responses to this entry through the comments feed .

4 comments

Taleb is my favorite author whom I would not care to dine with. I was inspired by The Black Swan when it came out. I literally made several changes in my life on its suggestion and think it contributes many important pieces to modern philosophy and economics.

But his misanthropy and demonization of whole fields of inquiry becomes very tedious. Because Comparative Advantage could be taken to an unhealthy extreme, Taleb ridicules it.

Most of us should probably eat more vegetables and drink more water. But I say these nutritionists are morons! If you drink a thousand gallons of water and eat 900 carrots -- you'll die!

The trouble with CA is its counter-intuitiveness. Hundreds of forces are arrayed against it, yet Ricardian Economics is the one demonstrable theory that argues in favor of trade and specialization. Taleb -- brilliant though he surely is -- is wrong to discredit it based on an unlikely overuse.

August 7, 2010 at 9:21 AM

@JK-

Fair enough, but where lies this "unhealthy extreme"? Taleb argues - unless I am reading him wrong - that globalization itself is an unhealthy extreme. Mr. Ricardo says it is better for the trade barriers to go down. Have England make cloth whilst Portugal makes wine - economies of scale will make matters cheaper for them both.

In contrast, Taleb sees economy of scale as part of the problem itself: better for Portugal and England to keep their markets as separate as possible. Though it will be more expensive to them both, maintaining separate (and consequently smaller) production bases and consumer markets ensures that a problem with one part of the market will not bring the entire system crashing down.

It is a trade off worth contemplating. Specialization makes things more efficient at what they are designed to do. The cost of specialization is that these things must be designed to do less. A 1/4 inch socket wrench is the best thing in the world for removing 1/4 inch bolts. But how does it fare with a 3/4 inch nut?

At some point gains in comparative advantage result in general disadvantage everywhere else. But how do we find this point? How do we know if we are at the unhealthy extreme?

August 7, 2010 at 10:54 PM
Anonymous  

Comparative advantage is a sound principle, but sometimes people derive unsound ideas from it.

The executive hires the secretary through comparative advantage. Now suppose there was a nation 1 of highly educated executives and a nation 2 of (relatively) poorly educated secretaries.

2 scenarios:
nation 1 hires nation 2's population, forever.

Nation 2 refuses to be hired and the secretaries start their own businesses. They open their own schools. They get more educated. And suddenly, they are no longer a nation of secretaries.

Apply this to food production or manufacturing. America would never have become a world power if it did not impose heavy taxes (or ban altogether) goods produced from British manufacturing. Its because of these tariffs and bans that America grew manufacturing centers and infrastructure.

I used to oppose government regulation of international trade...high school economics and further study of the histories of various nations taught me the value of it. But this only applies in situations where severe gaps in infrastructure are the root causes of inequality, and it only applies to poorer nations. With regards to natural resources, or, on a more personal level, different aptitudes, comparative advantage still holds true.

The executives can do without the secretaries. They are only hiring them so they can focus on bigger tasks.

But the secretaries cannot become independent of the the executives until they have the education and infrastructure to become executives themselves. In the long run its better for the nation of secretaries to improve itself rather than sell away its resources.

August 8, 2010 at 2:02 PM

Dear Mr. Greer,

If you will indulge me, I will quote an extract from my book, Political Economy of Globalization, that is germane to your discussion of comparative advantage. Here is part of Thesis 30:

The static model of globalization derived from a completed extrapolation of production geographically distributed according to comparative advantage and lowest opportunity cost is inherently unsustainable and would collapse spectacularly if it could be brought into being. But precisely because it is so vulnerable, it would never come to pass. Were such a failure possible, however, it would force a reversal in the global integration process—global disintegration—which, as noted in Thesis 28, is contrary to the processes of modernization, industrialization, and globalization, given the difficulty of their reversal. If market liberalization creates socio-economic dislocation and popular discontent, a failure to continue with a program of liberalization, or an attempt to reverse liberalization and return to closed markets, protectionism, and self-sufficiency, is likely to be much more painful yet.

While catastrophic global economic failure is unlikely, the uneven pattern of global development suggests that lesser shocks will have regional consequences almost as severe as catastrophic global economic collapse, entailing a reversion to proto-economic activity. The reduction of economic activity to proto-economic activity is likely to cause severe disruption that is no longer merely economic dislocation, because subsistence agriculture, not to mention a hunter-gatherer economy, is not likely to be able to sustain the changed needs (or, more to the point, the changed wants) of an industrialized populace.

The absolute numbers of contemporary populations are important in this connection because if an economic system fails and population numbers are sufficiently low, people can abandon their formal economy in favor of subsistence through proto-economic activity. However, once a certain population threshold has been passed, there simply isn’t room for the population to scatter from urban concentrations to resume a pastoral existence on the land. When there are more people than subsistence methods can support (even if the same number of persons can be comfortably supported by industrialized methods when the latter are fully functional), competition for scarce subsistence resources would lead to instability and violence. But after violence and starvation had reduced the absolute numbers, the survivors could return to subsistence once all the bodies had been buried. Needless to say, this approach to economic self-sufficiency is not one envied among either nations or peoples.

End of extract

In my book I explain in more detail how lesser shocks to the international trading system will prevent a catastrophic scenario from unfolding.

Best wishes,

Nick

August 10, 2010 at 10:19 AM

Post a Comment