Putting the 'Comparative' Back in Comparative Advantage
It’s very rare that one feels bold enough to disagree with Professor Diedre McCloskey on economics (or history or English or anything else she chooses to master or simply take an interest in, which for her seems to be the same thing.) However, merely quibbling with something she has said is not nearly as intimidating. And sometimes a quibble can be important.
An excellent article by Daniel Hannan in International Business Times quotes Professor McCloskey as explaining that the problem with comparative advantage lies with the word "advantage", which makes people think that it is about outperforming rivals rather than optimizing co-operation. By purchasing goods and services from others, even if we can produce them better ourselves, we free ourselves up to concentrate on the things we are best able and positioned to do.
My quibble: The problem is not just with the word “advantage.” It is also in a misunderstanding of the word “comparative.” People hear the phrase “comparative advantage” and assume it denotes something we can do better than everyone else – rather than something we do better than everything else we do.
To trot out an oft-used analogy, say Gilligan and the Skipper are ship-wrecked. To survive, they need to continuously perform two tasks: Crack open coconuts and spear fish. The skipper, not surprisingly, is better at both than Gilligan. Gilligan, while weaker and clumsier than the Skipper, is marginally better at spearing fish than cracking open coconuts.
How to divide the tasks? Should Gilligan lie on the beach while the skipper does all the work, because the skip is better at both? Or should the skipper and Gilligan simultaneously crack open as many coconuts and spear as many fish as they can, even though the first mate will come nowhere near the captain’s production? Or is the most sensible approach for the skipper to concentrate on cracking coconuts, while Gilligan focuses on spearing fish, because he does that better than anything else he does?
That is comparative advantage in a (coco)nutshell: If everyone pursues their own area of specialization, we are all better off. The same is true of countries. If France is better than Spain at producing both wine and cheese, it doesn’t make sense for Spain to concentrate on neither. Rather, it makes more sense for Spain to concentrate on making wine, if they make it better than they produce cheese. As David Ricardo explained when he developed the theory of comparative advantage, relative wage rates allow everyone to focus on what they do best, and earn a continuously improving living at it even if others may do it better and earn a better living.
But unfortunately, too many focus on the word comparative, and assume they are in a contest in which they must do better at something – or everything – than everyone else. Countries that have tried to produce everything for themselves have paid the price. In the early 1970s, for example, North and South Korea had roughly the same GDP per capita. One of the reasons South Korea has raced ahead is that North Korea has virtually pursued autarky. South Korea has become so much wealthier not simply because it exports far more, but because it exports and imports far more. By buying things they need from other countries, they free themselves to do the things they are best at doing. Importing is not a necessary evil; it is a necessary ingredient.
Of course, some assume the best way to pursue comparative advantage is by government designating which industries to focus on. But when you designate some industries as “winners” you inherently designate others as “losers” – made up of the people who pay higher taxes and reap fewer rewards. And you open yourself up to crony capitalism, with everyone wasting resources lobbying government to become “winners”, and politicians taking advantage of the opportunity to choose who gets ahead and therefore who is held behind.
Moreover, no one has a crystal ball that allows them to predict the future. If government had decided what industries to target 25 years ago, what are the chances they would have targeted search engine companies or internet book sellers, much less social networks or companies that exploit the gig economy? Rather than letting sunshine industries rise, they would try to prevent sunset industries from falling.
As the legendary film mogul Samuel Goldwyn once said: Never make predictions, especially about the future. There is only one way to forecast what the marketplace will want and need; let the marketplace do the forecasting.
The world would be a lot better off if we let the marketplace decide what we are best at, and pursue those areas of comparative advantage – rather than ending up pursuing areas of comparative disadvantage.
