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April 03, 2009

Comments

Diversity

Yes but also read Krugman on trade. There are big trade gains from simply having a wider variety of goods and services on the two markets.

Planeshift

"imagine two countries"

Shame there are around 200 then.

Mike Woodhouse

"India is already better at high-end technology than the West"

Source for that? What would the argument look like if that were not true?

Cityunslicker

Plus add in that as india's economy grows so the market for the UK goods increases.

An agreement to 'do' DOHA would have been the best thing by a country mile for the G20 to do.

Sadly, few people seems to understand ricardo even after all this time and all the evidence available.

Matt

If people understood Ricardo then every country would instantly drop all of its import tariffs (unilateral free trade). So yeah, sadly they do not.

ad

Matt, is this really true? The cost of taxing a transaction is presumably borne by the trading parties. Usually, both of these parties will be your fellow countrymen.

But a tariff taxes transactions in which one of the parties is a foreigner. So a tariff allows a government to tax foreigners, as well as its own subjects. Perhaps that is why they are so popular.

charlieman

Employment in Indian T-shirt manufacture: cotton planters, cotton pickers, mill workers and managers, garment machinists, packers.

Employment in Indian electronics gadget manufacture: component import managers, electronic assembly workers and managers, ditto in plastics, gadget assembly, packers.

Few well paying skills are transferrable. The low end roles are easily filled by subsistence farmers switching to industry (but we should assume that they will keep their land rights?). Most of the jobs that require manual dexterity will be performed by women workers. Packing is for the boys.

But India can still manufacture T-shirts at the same rate because the country's workforce is still under-employed.

Matt

"But a tariff taxes transactions in which one of the parties is a foreigner. So a tariff allows a government to tax foreigners, as well as its own subjects. Perhaps that is why they are so popular."

It is true that it allows the government to pass part of the tax on to foreigners. However, this effect is only noticeable if your country is large relative to the size of the world market. If you are in a small economy then the import tax will be borne entirely by your own public. My feeling is that even for the US most tariffs are borne by domestic consumers.And the true cost of the taxation (deadweight loss) will of course be far higher than simply taxing all goods at the same rate as it will cause more distortions in behaviour.

Footnote: as an extreme example of tariffs being passed on to foreigners, imagine two countries, one Muslim and one Christian. The Muslim country produces liquor but does not consume it. The Christian country consumes liquor but has forgotten how to produce it. The supply cost is low; it costs 0 for Muslims to produce. The demand curve is a step function; Christians will pay P for it up to some Q and 0 thereafter. The price paid for the liquor is P, the quantity sold is Q and the total profit to the Muslim nation is PQ. Now the Christian nation attaches an import tariff of P/2 per unit of liquor. The AFTER-TARIFF price paid is STILL P and the quantity sold is STILL Q. PQ/2 goes to the Christian government, PQ/2 to Muslim suppliers.

Matt

By the way, if the reasoning behind import tariffs was simply passing taxation on to others then you might wonder why more countries don't charge an export tariff. By the same reasoning as previously, an export tariff causes some of the tax to be paid by the foreign consumers of your goods. In a two-country trade arrangement the fact that it's country A placing a tax wedge between consumers and producers doesn't make a difference as far as changes in prices and behaviour goes. It could just as easily be country B placing the tax wedge. The only difference is whether A or B's government gets to keep the taxes so raised.

john cramer

If the education system is not up to teaching how to make things but only how to go on the welfare - will this not , sooner or later , make a difference?

Tim  Worstall

More on the same argument here.

http://adamsmith.org/blog/international/mindboggling-200904043249/

Bob B

Tim is absolutely correct.

If I may say so here, IMO there are more accessible ways of illustrating the essentials of the principle of comparative advantage for non-economists. Consider two countries, A and B. In A, in the absence of trading links, say a car exchanges for 20,000 TV sets, while in B, a car exchanges for 25,000 TV sets.

Ricardo's insight was that a trader in A could export a car to B and sell it there to buy 25,000 TV sets which could be imported back to country A where 20,000 of the sets could be sold to buy another car for export to B. This would earn a profit equivalent to 5,000 TV sets, less transport and transactions costs.

Country A has a comparative advantage in producing cars, and country B in making TV sets.

The logic of comparative advantage is timeless and holds true with reference to the benefits of trade arising from differences in relative prices. The principle does not imply that trade isn't also motivated by differences in absolute prices.

Trade may also be motivated by what is dubbed "reciprocal dumping" where verging on monopolies in their respective home markets export into other country markets and under-cut the incumbent monopolies by dumping - in which case, good for dumping.

JS Mill, a committed advocate of free-trade, nevertheless agreed that there are two valid departures:

- the infant-industry argument for protection while a new industry starts and grows to the point where economies of scale and scope enable it to compete against rivals based abroad

- the optimum tariff argument where the imports or exports of a country are sufficiently large in relation to global markets to affect their international prices.

Of course, for those who insist on rejecting the economic recipes of the mainstream, there is always Friedrich List on: The National Syetm of Political Economy
http://en.wikipedia.org/wiki/Friedrich_List

Conrad Barwa

Aren't you assuming certain things for Ricarod's theory to hold true here? Firstly that countries are operating at pretty much the outer limit of the production frontier and that labour productivity is the same in sectors across both countries? I would assume that it is a lot lower, coneqeuntly wages lower in India than in the UK - even for low wage sectors.

Conrad Barwa

Well there are loads of valid departures really, including things that have been cited in the original post such as factor immbility, increasing returns, and some that haven't such as exchange rates, labour productivity differences, class etc.

As my old economics teacher used to say according to Ricardian theory, if you are some peasant economy producing bananas and importing everything else, then you should remain like that. Of course you only need to look at the welfare and working conditions of many primary producers in such countries to realise why this is unattractive. Few countries have grown rich or improved the human welfare of their populations by simply relying on leaving their labour force trapped in agriculture. None of the East Asian countries would have done so; heck Germany and the US probably wouldn't have done so if they hadn't ignored Comparative advantage and imposed trade barriers, ignored intellectual property rights and had some sort of industrial policy.

Planeshift

"If people understood Ricardo then every country would instantly drop all of its import tariffs (unilateral free trade). So yeah, sadly they do not."

So why don't they?

Is it lack of knowledge of economics in the leaderships of states, leading to irrational policies? Or something else?

ad

"By the way, if the reasoning behind import tariffs was simply passing taxation on to others then you might wonder why more countries don't charge an export tariff."

Matt, neither you, me, nor anyone else make decisions based on the truth. We make decisions based on what we believe to be true.

And most people believe it to be obviously true that a £10 tax paid by X, costs X £10, and costs nobody else anything.

Voters are even more rationaly ignorant than shareholders - and the banking sector has just shown us how ignorant shareholders think it rational to be.

Bob B

A repost because something went wrong:

Comparative advantage does NOT need to assume factor mobility or countries being on production possibility frontiers or some countries having cheap labour.

What the principle of comparative advantage shows is that the residents of countries can benefit (profit) from trading if RELATIVE prices differ in different countries.

They may also be motivated to trade because of differences in absolute prices at prevailing exchange rates.

If all (or most of) the products in one country are cheaper than in its trading partners that means the exchange rate of its currency is out of equilibrium - undervalued currencies are a real possibility in the real world and undervaluation can continue for long periods of time. Hence the (frequent) allegations made about a government "manipulating its currency" to maintain an undervalued exchange rate for its currency in order to boost its exporting industries.

Most of the criticism directed at the principle of comparative advantage simply demonstrates that the critics don't understand it.

ad

"As my old economics teacher used to say according to Ricardian theory, if you are some peasant economy producing bananas and importing everything else, then you should remain like that."

How does it predict that?

I should think that it predicts that if your country is poor, and labour costs low, you should concentrate your capital on labour-intensive industries, rather than capital intensive ones.

Call centers, perhaps.

I might point out than raising yields in agriculture might well be capital intensive (draining fields, irrigating fields, improving transport links with remote parts of the country etc).

Bob B

Ricardo's principle of comparative advantage (by itself) said nothing about how a country came to have a comparative advantage in particular products nor about developing/acquiring comparative advantages in different products.

Hecksher-Ohlin theory offered an explanation of the sources of comparative advantage - namely, in simple terms, that countries relatively well-endowed with (say) labour would tend to have a comparative advantage in producing products that required much labour relative to other factors in their production functions.

One of the troubles with that is that some products may intensively use one factor at one set of factor-price ratios and intensively use other factors at different factor price ratios - hence products may not always be (say) labour intensive in production.

There is also (notoriously) the Resource Curse of countries well-endowed with natural resources :
http://en.wikipedia.org/wiki/Resource_curse

Bob B

Raymond Vernon's product life-cycle was another and illuminating stab at a narrative to explain how and why a country's comparative advantage could change through time - and even evaporate:
http://www.provenmodels.com/583/international-product-life-cycle/vernon

On the benefits of trade liberalisation to developing countries, see the analysis in this IMF paper:
http://www.imf.org/external/np/exr/ib/2001/110801.htm#i

Conrad Barwa

Comparative advantage does NOT need to assume factor mobility or countries being on production possibility frontiers or some countries having cheap labour.

Well actually it kind of does, because you are assuming that factors of production that go into making some goods (like unskilled labour for bananas) can be easily moved into making other goods (like skilled labour for mobile phones) but anyway the point about PPFs etc. isn't that it invalidates Comparative advantage - of course it doesn't. Comparative advantage as a theoretical construct is perfectly valid; but what we are talking about here and what most of use are interested in, is what kind of policy/outcome ensures the best possible outcome in terms of increased welfare for those involved. Therefore comparative advantage doesn't exist in a vacuum but can be set alongside other approaches and all have policy implications - after all Ricardo wasn't just prpounding this theory so it could look sexy in economic treatises and textbooks but because he felt that it clearly supported certain policy frameworks - ie free trade over that of others.


"I should think that it predicts that if your country is poor, and labour costs low, you should concentrate your capital on labour-intensive industries, rather than capital intensive ones.

Call centers, perhaps."


Wow, that is great mate, all we need to is move those peasants out of producing bananas into being semi-skilled urban workers who can staff call centres!!! I think you missed my point; which was Ricardian theory here advocates that you should concentrate on producing that which you have a comparative advantage in; and if this is something that requires backbreaking, low wage, low productivity agriculture so be it. It doesn't offer you a roadmap about how to move out of that into an economy that resembles something like what most advanced countries have. This might be attractive to those who don't have to work in such economies but obviously may not be the choice of those that do.

Conrad Barwa

Quoting an IMF paper to support trade liberalisation, oh dear, never mind.

Matt

"Is it lack of knowledge of economics in the leaderships of states, leading to irrational policies? Or something else?"

Lack of knowledge among leaders, a confusion of comparative with competitive advantage, lack of understanding on the public's part, dispersion of gains from trade and concentration of losses (public choice argument). Take your pick. Neo-mercantilism is alive and well.

Matt

"And most people believe it to be obviously true that a £10 tax paid by X, costs X £10, and costs nobody else anything."

Errr....this is a red herring. You seemed to be proposing as an argument for tariffs the fact that under standard tax incidence theory both producers and consumers pay par of any tax wedge placed between them. People who subscribe to this argument are therefore not quite as ignorant as your next post would make them out to be. If they understand the tax incidence of an import tariff then they should also understand the tax incidence of an export tariff.

Bob B

"Quoting an IMF paper to support trade liberalisation, oh dear, never mind."

What matters is the analysis there and the evidence cited - not the source. If you don't like the IMF then try Martin Wolf: Why Globalization Works (Yale University Press, 2004)
http://www.amazon.co.uk/Why-Globalization-Works-Martin-Wolf/dp/0300102526

Trade liberalisation may not benefit every country but the evidence is that many countries did gain from liberalisation.

The infant industry argument for protection to change a country's comparative advantage needs to be treated with extreme caution.

Around the mid 1980s, the government of Brazil thought to promote an indigenous computer industry by hiking tariffs on computer electronic products. By the early 1990s, Brazil recognised that the policy had failed - the outcome was that computers had indeed become more expensive as the result of raised trade barriers with the result that computers were therefore used less and the economy was tardy in ascending the learning curve for the IT revolution.

One of the last acts of the outgoing Bush (snr) presidency in 1991 was to impose anti-dumping duties on US imports of flat screens then used mostly for notebook computers. The intention was to encourage US indigenous production. One of the early actions of the incoming Clinton administration in 1992 was to rescind the dumping duties as one of the unintended consequences was that assembly of notebook computers moved off-shore to take advantage of access to lower cost screens.

Try this analysis of duties to protect the US steel industry:
http://www.iie.com/publications/pb/pb.cfm?researchid=77

It's easy to make facile claims about the prospective benefits from infant industry protection to change (or defend) comparative advantage. Besides other considerations, creating and administering trade barriers is a frequent cause of corruption and the barriers tend to stay in place long after they have served any useful purpose so consumers lose out.

charlieman

Bob B: "One of the early actions of the incoming Clinton administration in 1992 was to rescind the dumping duties as one of the unintended consequences was that assembly of notebook computers moved off-shore to take advantage of access to lower cost screens."

A further point that Bob B omits is that when a manufacturing industry moves production abroad (in response to wage costs, taxes etc), it doesn't move back when that cost is removed. Google for the 2005 stories about Dell in North Carolina and the $277 million for 1,700 direct jobs.

ad

“People who subscribe to this argument are therefore not quite as ignorant as your next post would make them out to be.”

Matt, I may have explained my thoughts poorly.

Obviously, not everyone in a country will have the same interests and information when they decide to support a policy. It is perfectly possible for one person or group to support a policy because they wisely expect it to benefit them, and for another group to support a policy because they foolishly expect it to benefit them.

My initial argument was that the government would desire to tax people in other countries if they could find a way to do so (seems pretty likely), and I thought that tariffs might allow them to do so. You have persuaded me that this would probably not be very effective, and that therefore well-informed people in the government are unlikely to honestly support this argument.

On the other hand, less well-informed people, not unlike myself before I read your argument, might think this policy likely to succeed. (And some people are even less well-informed than I was.) They might then support tariffs because they believed tariffs would allow their government to take money from foreigners they did not care about, and spend it on people they did care about.

Conrad Barwa

Read Wolfy and not impressed with him either. There are better free trade advocates out there imo and he has become very predictable and stale in his arguements.

The Brazil case and the Indian case are excellent case studies - the best one is an article by Peter Evans which actually looks at specific ministries in Brazil and why they succeeded or didn't. There was a follow up to this by Vibha Pingle who did a comparative study of the Steel Ministry in India and the Dept of Electronics in the Government of India - and why one was a behemoth that captured everything that represented public sector inefficiency and why the other laid the groundwork for India's software boom.

Industrial policy is tricky and there is, as Dani Rodrik points out no one size fits all solution. However, no country has industrialised or modernised from being a poor agrarian economy to an industrial or post-industrial one without having a coherent industrial policy and managed trade (as opposed to a pure reliance on market forces and free trade) the only exception was England and economic historians are still arguing about why this was so.

I have not made any facile claims about infant industry arguements or commented on the comparative advantage arguement's rightness/wrongness. I have simply said that to simplictically use it as a basis for policy is stupid - which it is. I think it is pretty worthless if you are going to use it as a stick to beat the free trade drum; HOWEVER, comparative advantage has a lot to tell you about how to manage trade policy.

Planeshift

Out of interest, do mainstream economists regard the following as forms of protectionism:

Immigration controls?
Intellectual property laws applying to more than one country (eg: trips)?
Subsidies to industry?
Nationalist advertising campaigns (eg: buy british)?
Gun control laws?

reason

It only works if the real exchange rate adjusts appropriately. I think it is reasonable to speculate that in fact it doesn't.

reason

Besides which, the argument is comparitive static, it is not necessarily so that the dynamic outcome is as benign.

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