One of the places I look for blog material is the Post Everything section at the Washington Post, and one of the regular contributors is Jared Bernstein, who bills himself as “former chief economist to Vice President Biden,” which doesn’t sound like the kind of employment you’d want to brag about.
Anyway, Bernstein has a post about the Trans-Pacific Partnership (TPP) trade agreement that is currently winding up negotiations, and which will soon be up for ratification by Congress. He criticizes supporters of the agreement for being too simplistic (emphasis mine):
Supporters of the Trans-Pacific Partnership (TPP), a trade agreement under negotiation between the United States and 11 other countries, make this case: Trade between countries is always good, and more trade with more countries is even better. Harvard economist Greg Mankiw goes further in a recent New York Times piece, arguing that anyone opposed to trade deals does not understand elementary economics.
Note the highlighted phrase. Because two paragraphs later, he writes this (emphasis mine again):
In the simple models of introductory textbooks, countries improve their respective economic outcomes by specializing in their “comparative advantage” — the goods they produce more efficiently than their trade partners — thereby increasing the supply of goods and lowering prices.
Actually, that’s not what comparative advantage is. In fact, it’s a common misunderstanding of comparative advantage. If Bernstein was an Economics 101 student, I think he’d lose a bunch of points for giving that definition in an exam.
Consider a pair of dentists, Alice and Bob, who make all of their money filling cavities and doing root canals. Patients needing a filling are willing to pay $100, and patients needing a root canal are willing to pay $200, and they arrive with equal probability.
Alice has years of experience and is very fast at everything. She can fill a cavity in 20 minutes and do a root canal in 30. Thus, in an 8-hour day she can serve an average of 9.6 patients of each type, earning an average of $960 for doing fillings and $1920 for doing root canals, for a total of $2880 per day.
Bob is a new dentist, and he’s a lot slower. It takes him 30 minutes to fill a cavity and 90 minutes to do a root canal. At that rate, he can only see an average of 4 patients of each type per 8-hour day, earning an average of $400 for doing fillings and $800 for doing root canals, for a total of $1200 per day.
Now suppose Alice and Bob combine their offices and share all their patients, splitting the work as efficiently as possible. In that case, Alice will do 16 straight root canals in each 8-hour day to earn $3200 per day, and Bob will do 16 straight fillings in each 8-hour day to earn $1600 per day.
Note that both Alice and Bob make more money by splitting the work. And note that it’s worth it for Alice to let Bob do some of the work even though she is better at everything than he is.
We can see why this works by looking at their respective opportunity costs for each procedure.
- Alice earns $300/hour doing fillings and $400/hour doing root canal procedures, so she makes more money by doing root canal procedures. Looked at another way, every hour she has to spend filling cavities instead of doing root canals will cost her $100. Alice therefore prefers to do root canals.
- Bob earns $200/hour doing fillings and $133/hour doing root canal procedures, so he actually makes more doing fillings. Looked at the other way, every hour he spends doing root canals instead of filling cavities will cost him $67. Bob therefore prefers to fill cavities.
Thus, even though Alice as an absolute advantage over Bob in everything, she’s still better off by letting him fill all the cavities so she can do all the root canal procedures because she has a comparative advantage in root canals and he has a comparative advantage in fillings.
Of course, Alice and Bob don’t have to merge offices to do this. They can simply refer patients to each other. It’s still better for both of them that way. And if Alice and Bob are in separate countries, then whenever Alice refers a patient to Bob, that would count as an import from Bob’s country to Alice’s country, and vice versa.
(I probably should have picked an example with transportable goods instead of services — maybe bakeries where one is more efficient at making cakes and the other is more efficient at making pies — but it works out the same. When you buy services from outside your country, such as staying overnight in a hotel as a tourist, it counts as an import in the national accounts, the same as if you’d imported a physical good.)
That’s comparative advantage. Bernstein defined it as applying to “the goods they produce more efficiently than their trade partners,” but even if a country doesn’t produce anything more efficiently than its trading partners, it will still make economic sense to concentrate on the things it does best and outsource production of the rest to other countries. Thus there’s always something for everyone to do, no matter how inefficiently they do it.
It doesn’t really make much of a difference in the rest of Bernstein’s article — he goes on to make a good point about the lack of transparency in TPP negotiations and a dubious point about currency manipulation — but if you’re going to argue that academic economists are using a theory that is too simplistic, it helps if you state the theory correctly.