Alan Blinder bugs me (Part 1: The "law" of comparative advantage)

Watching Charlie Rose tonight, I was disturbed to hear Princeton economist Alan Blinder basically call Americans idiots for not understanding the so-called “‘Law’ of Comparative Advantage” (which states that individuals and countries should just produce whatever they have a comparative advantage in producing).

Well, I understand the “Law,” and I oppose unfettered free trade. The “Law” is an extremely simplified “toy” model of trade… exactly the kind of toy model economists so often create by focusing in on just one or two features of the real world and ignoring everything else. Unfortunately, Ricardo’s “Law” ignores critically important features of the real world that render suspect all conclusions drawn from it.

Blinder attacked Senator Sherrod Brown (D-OH)’s stance that free trade agreements should require a relatively level playing field (e.g., on environmental standards). Blinder seemed to dismiss Sen. Brown as a populist, know-nothing hick. Even if you buy Blinder’s comparative advantage argument (which I don’t; see below), it’s hard to understand his objection to demanding environmental standards in trade agreements: Does Blinder really think some nations possess a comparative advantage in their ability to pollute their environments or that this “comparative advantage” is why some countries pollute so much more than others? He apparently does because he said:

We don’t want a level playing field! We are the richer country. We are more productive. We ought to have, for example, compared to a poor country, higher domestic environmental standards. We ought to have higher [safety] protections for our workers.

Why should poor countries protect their environments less and protect their workers' safety less than we do? And why should American workers and employers have to compete against companies that are allowed to despoil their rivers, foul their air, kill their mine workers, turn their children into wage slaves, and cripple their dangerous machine workers?

The “‘Law’ of Comparative Advantage” sounds simple. But where did Japan’s comparative advantage in automobiles come from? Japan hasn’t produced automobiles for hundreds of years. It developed its comparative advantage. In fact, neither the U.S. nor Japan invented the automobile. France’s Nicolas-Joseph Cugnot invented the first self-propelled road vehicle, powered by steam. Scotsman Robert Anderson invented the first electric carriage. Germany’s Karl Friedrich Benz invented the gasoline-powered automobile. And Germany’s Gottlieb Wilhelm Daimler invented the first four-stroke, four-wheeled car. Doesn’t the “Law” imply one of these countries should be producing all the world’s cars? At one point in time, only Germany possessed the knowledge to build gasoline-powered cars. They should, therefore, monopolize the car industry for all time, right?

Ricardo’s toy model ignores inventions (like Henry Ford and mass production). It also ignores the fact that trade policies and business decisions change competitive advantage over time. Ricardo’s (overly) simple one-period model simply does not hold true in a dynamic model:

R. Mendez develops the argument that international trade of goods or direct investments carry within themselves convergence forces via the voluntary technological diffusion (production under license) or unintentional (imitation): the exchange of goods implies a certain exchange of ideas, but commercial trade also carries within itself divergent forces. Trade leads to specialization which modifies the dynamics of factors through reinforcing comparative advantage which strengthens economies’ specialization. The author illustrates this idea with an endogenous growth model where the dynamics (i.e. convergence or divergence of standards of living) depends on the process of ideas spreading (international transfers of technology) and of economies’ history (via their initial relative endowment).

Nor does the “Law” hold in the real world. And since the premise of Blinder’s argument for unfettered free trade is the unassailable truth of the “‘Law’ of Comparative Advantage,” the irrelevance of that simple model to the real world implies the irrelevance of Blinder’s conclusion.

The American people feel in their guts (and in their paychecks, if they still have one) that free trade is hurting them. Blinder’s blindly trusting in a model. The American people have heard the “giant sucking sound” H. Ross Perot warned of long ago. The American people’s objections to free trade aren’t completely valid either. But neither is Alan Blinder’s unquestioning faith in free trade.

Posted by James on Thursday, May 07, 2009