Month: September 2013

Why the theory of comparative advantage is overrated

Paul Samuelson once produced comparative advantage as an example of an economic theorem which was both true and non-trivial.  Obviously the theorem holds as proven, but how on the mark is the theory as an actual explanatory device?  (For background on the theory, you can start with Alex’s video here).  I hold a few reservations:

1. In virtually every other context, we insist that the dynamic perspective is critically important, yet we are remarkably content with the static take of comparative advantage.  If comparative advantage puts you into a job, or puts your economy into sectors, with no good learning curves, woe unto you.

2. The theory sits uneasily with the observation that long-term unemployment is indeed possible.

3. They do indeed send horses to the glue factory, so to speak.

4. In the real world, the “lawyer” and the “typist” are often not fully segregated workers, but they interact, whether in the workplace, in society, or politically.  Complementarity and O-Ring effects may be more important than comparative advantage effects, paging Gilbert Arenas.

5. It is easy enough to see how the theory works when you move from one person to two, or from five persons to ten.  But how about when two large nations trade with each other?  The macro embodiment of comparative advantage, namely the Heckscher-Ohlin theorem, has at best a mixed performance empirically and capital and labor endowments do not appear to predict the content or amount of trade very well.  Furthermore even defining comparative advantage (how do you measure the quality of labor or capital?  Is the U.S. in fact a capital-intensive or labor-intensive nation, taking qualities into account?  How about human capital?  etc.) is deeply problematic once you move past the basic Heckscher-Ohlin assumption that different nations have access to the same production function (and of course that assumption is obviously false).

6. In the simplest explanation of comparative advantage, we measure the productivities of the lawyer and the typist in terms of hours, a physical unit.  Usually, beyond a single input world, we need market prices to measure comparative advantage.  But then the original comparative advantages are endogenous to specialization decisions and other economic factors.  The true theory of comparative advantage, for a multi-factor world, isn’t nearly so simple.  It also can be said that the initial comparative advantages are in fact endogenous to trade.

7. Many of the most important gains from trade come from other mechanisms, including specialization, increasing returns, or the generation of commercial networks which lead to a later transmission of ideas and technologies.  That is not exactly an argument against comparative advantage, but it does suggest the idea is only one part of the case for trade.