fling93 loves fishies

Fair wrote a decent textbook, but man is he a boring lecturer.

Well, I’m probably pretty similar. Well, not that I ever give lectures, but I’m a much more interesting writer than a conversationalist. At least, I’d like to think so. I suppose I might be deathly boring at both and not realize it.

I don’t know what I would be like as a lecturer. I tend to mumble.

You know, if they’d had you give the lecture on Econ in my first college go-round, I might have stuck it out! I think I’m scheduled for Econ again in a couple of months - do you think you could be my tutor? :)

I just surfed in via Blog Explosion, by the way

Denise: You know, if they’d had you give the lecture on Econ in my first college go-round, I might have stuck it out!

Thanks!

do you think you could be my tutor? :)

Well, do feel free to e-mail any questions. No promises on whether I’ll be able to answer them, since I have just an undergraduate’s understanding of the subject. But I do have a strong interest in it, so I’ll probably at least try to track down the answer if it piques my curiosity and/or I think I’ll get a good blog post out of it.

Nice discussion and refresher. I kind of got distracted by the REALDOLL thing, though…

I remember a story that Jacque Cousteau wrote. His ship nad stopped at a place where there was a very small community of some sort of arabs. I don’t remember whether it was an island or whether it was just isolated by cliffs and desert; the only way to get to it was by sea. The people there collected rainwater in cisterns, there was no other water. They fished, the fishing was not particularly good. A delegation of villagers came to Cousteau’s ship and with gestures and translating through a crewman’s broken arabic, they offered to sell a pile of old rags. Cousteau started to make an offer since they could use them to clean the engine room, when he noticed that there were a couple of girls in the pile. He angrily ordered the villagers and the girls and the rags off his ship. The monaco oceanological expedition would not participate in slavery.

And yet it’s likely that daughters were those people’s only significant comparative advantage. If they weren’t competitive with french women still they came closer than any other commodity those people had.

I’ll try one of those diagrams. Pretend we’re talking pre-civil-war USA.

	Produce both	Specialize
	cotton	other	cotton	other
North	 1	30	 0	100
South	 5	20	50	0
Total	 6	50	50	100

I just made up the numbers, but say it was something like that. Everybody is better off (depending on how the bargaing goes) if the south makes lots of slave plantations to grow cotton and nothing else, while the north makes everything the south needs. The south is better off provided that the trade gives them more than 20 units of everything else for 45 units of cotton. The north is better off provided they get more than 1 unit of cotton for 50 units of everything else.

But isn’t this exactly what we’ve been telling third-world nations to avoid? If they base their whole economy on one cash crop what happens to them the years the rest of the world gets a bumper crop while their crop goes bad? They’re in serious trouble, and having a year when their crop does well and there’s a worldwide shortage doesn’t make up for it. Poor thirdworld countries are the ones that can least afford a big variability in demand.

There’s something wrong here, something left out of Ricardo’s model.

And are the results this clear when you include diminishing returns? The last unit of cotton the south produces might be the one that was hardest to produce, while the first unit of something-else is the easiest. The other way around for the yankees. They forgo producing their easiest unit of cotton to trade their hardest unit of something-else for the slave-owners’ hardest unit of cotton.

It just might settle out to less specialisation and trade than Ricardo suggests.

Even if it’s true that comparative advantage will always favor specialisation and trade over generalisation and self-sufficiency, how will people find out where their competitive advantage lies? Is there a sure-fire way for them to find it out, or is it one of those mathematical things where you can prove there’s a solution but you don’t know what it is? We can’t in general produce a table showing how much of everything the USA can produce in all combinations. If we produce the wrong mix then we won’t trade ideally. Worse, if we don’t coordinate properly we could get a tragedy. What if the south produced 50 units of cotton while depending on the north to produce everything else, but the north was busy producing cotton too? There wouldn’t be enough to go around. When you go after your comparative advantage you’d better make sure everybody else is doing the same or you could be in deep kimchi.

It wasn’t clear from your North/South table what the exact comparative advantages are, since you don’t specify that, nor the resource allocations. I think this is the complete picture, extrapolating from the numbers you had:

             Per Day
          cotton   other
North      1/7      10
South       5      20/9

Then the comparison between producing both and specialization is as per your table, where the “Produce both” means that…
North: 7 days producing cotton, 3 days producing other.
South: 1 days cotton, 9 days other.

          Produce both      Specialize
         cotton   other   cotton   other
North      1       30       0       100
South      5       20      50         0
Total      6       50      50       100

And then after trade, you get (depending on the bargaining, of course):

          Without Trade     With Trade
         cotton   other   cotton   other
North      1       30       2        79
South      5       20      48        21

I know that wasn’t your point, but I thought I’d clarify, as it’s an example where neither party has the absolute advantage and complement each other pretty well. By the way, I used the <pre> tag to keep the tables in a fixed-width font and to keep the whitespace (and I took the liberty of fixing that in your comment).

J Thomas: But isn’t [specialization] exactly what we’ve been telling third-world nations to avoid? If they base their whole economy on one cash crop what happens to them the years the rest of the world gets a bumper crop while their crop goes bad? They’re in serious trouble … There’s something wrong here, something left out of Ricardo’s model.

Ricardo’s model leaves out a lot, and I don’t mean to pretend it’s not a simplification. Economics generally starts with a simple model and then adds complexity to it. Similar to how we first learned about a model of the macroeconomy without taking government into consideration, and then added it later. But the basic point is that free trade benefits both sides even when it would appear that it wouldn’t, meaning that countries should not be protectionist. And as I understand it, making the model more complete doesn’t alter this conclusion. I have to admit that my knowledge on how exchange rates plays into this is rather limited, but I’ll try to learn more about that before I post the followup.

As you note, countries will not tend to specialize completely, especially if it means abandoning industries that could impact national security, like agriculture or weaponry. But the degree of specialization and trade that does occur will be beneficial to both sides.

If a country does not have a comparative advantage compared to another country, there will be no incentive to trade. Both sides have to have something to offer for an exchange to occur. But the odds that any two countries have exactly the same strengths across all industries and products seems pretty remote.

J Thomas: Even if it’s true that comparative advantage will always favor specialisation and trade over generalisation and self-sufficiency, how will people find out where their competitive advantage lies?

When one product doesn’t sell as well as another product due to overseas competition. And yes, it’s a gradual balancing mechanism that will be in constant flux, much like how producers learn the price where they can maximize profits and still have the market clear.

Constructive comment? Calvin. Yes! :)

Fling93, I’m confident that exchange rates don’t affect the model — independent of money the model is talking about maximising production. If you can make more stuff then that’s more stuff independent of money and independent of exchange rates. The comparative advantage is there regardless, just various things can distort the actual production and keep nations from actually maximising production.

And labor time needn’t be the only constraint or even the limiting constraint in a particular example, the point is that there are constraints and tradeoffs. Whatever it is that says it’s a choice between one bale of cotton versus four bushels of wheat is the limit that matters.

With this thinking, for two products you have an easy calculation and for a thousand products you wind up with something like a Leontieff matrix. And it still ignores marginal returns, we’re assuming it’s linear.

My concern about all this is that people are using a simple-minded interpretation of comparative advantage to inform policy decisions. If they were just letting the economy do whatever it was going to do there would be no problem — everybody would look at their costs and the prices they could charge and would make their choices independent of theory. But it’s easy to get really stupid government policies starting with poorly-understood economics. And when the economics are advertised as being counter-intuitive they become immune to common sense. Promise an impossible result and when people complain that it doesn’t make sense the answer is “Yes, that’s right! It’s counter-intuitive, but it’s guaranteed to work by the science of economics.”

J Thomas: But it’s easy to get really stupid government policies starting with poorly-understood economics. And when the economics are advertised as being counter-intuitive they become immune to common sense.

While that is a potential danger, I don’t think that will be the main problem for quite some time for a couple of reasons.

First of all, comparative advantage remains one of the most misunderstood concepts in economics. You will still see plenty of knowledgeable and intelligent people claim things like that comparative advantage doesn’t apply because the other country has an absolute advantage, or that comparative advantage only applied back in the time when capital is not mobile. So it seems to me that the fact that comparative advantage is nonintuitive seems to block it from becoming more widely understood.

Secondly, in our representative government, who champions the cause of comparative advantage? Economists. Meanwhile, who champions the cause of protectionism or mercantalism? Both labor AND business (specifically in industries where we don’t have a comparative advantage). Protectionism hurts everybody in the broader economy, but it’s always politically more viable to greatly help the few at the expense of slightly hurting the many (especially if they don’t even realize it). So I think that imbalance of influence is exactly why we still see protectionist policies. For example, Bush’s steel tariffs, both our and the EU’s agricultural subsidies, and the propping up of the dollar by Asian central banks.

So I think we’ve a way to go before we have to worry about that.

J Thomas: I’m confident that exchange rates don’t affect the model…

Thanks. That was my impression, but I wasn’t sure.

And labor time needn’t be the only constraint or even the limiting constraint in a particular example, the point is that there are constraints and tradeoffs… …for two products you have an easy calculation and for a thousand products you wind up with something like a Leontieff matrix.

Yeah, I thought comparative advantage was enough material to digest for this post without getting into the production possibility frontier and price mechanisms and all that. Again, the simplifying assumptions don’t affect the broader conclusion that specialization and trade is beneficial to all parties. It just changes the optimal points the economies will end up at. But this post is (obviously) aimed at laypeople, not economists. And besides, I’m definitely not qualified to talk about the finer intricacies of all this.

“I’m definitely not qualified to talk about the finer intricacies of all this.”

I had no idea. You explained the standard theory so very clearly that I thought you were an expert. Besides, it isn’t that hard to get through the top few layers of complexity.

“Protectionism hurts everybody in the broader economy, but it’s always politically more viable to greatly help the few at the expense of slightly hurting the many (especially if they don’t even realize it). So I think that imbalance of influence is exactly why we still see protectionist policies.”

This is exactly the sort of danger I’m talking about. Comparative advantage emphatically does not say that everybody will be better off. It says that production will be maximised.

You have given the argument why comparative advantage rules over absolute advantage. But the argument why the price mechanism will give everybody their comparative advantage is only implied. Then there’s the question about what happens when one government intervenes. The usual assumption is that the government that puts in a tariff etc will hurt its own people more than the other countries’ people. But that may not be so. The basic premise of “economic warfare” is that you can hurt the other side worse.

You’ve pointed out the natural assumption that when government intervenes in the economy the purpose is to reward their campaign contributors and bribers at the expense of everybody else. But can’t there be tradeoffs that balance government policy against maximising world production? When we refused to buy cuban sugar, were we aiding corrupt inefficient american sugar producers or were we fighting international communism? Probably both. It’s as silly to accept maximum production as the only goal as it is to accept maximum profit as the only goal for an individual business.

I claim that comparative advantage is not as counterintuitive as people usually think. Its counterintuitive conclusions tend to be things that people extend past what it says, and they may often be wrong.

J Thomas: You explained the standard theory so very clearly that I thought you were an expert.

Well, I didn’t meant to misrepresent my expertise. I mentioned in my previous post that I’m now taking a night class in Political Science, which, like economics (until last semester), is a field in which I’ve never taken a single class in my life.

That being said, it’s obviously been an area of interest for some time, and it’s one of the fields I’m considering for further study if I go back to grad school.

J Thomas: It’s as silly to accept maximum production as the only goal as it is to accept maximum profit as the only goal for an individual business.

Certainly. I do support an oil import fee, for example. But I would think that these situations tend to be the exception and not the rule. In most cases, maximizing production does make things better off for almost everybody.

Then there’s the question about what happens when one government intervenes. The usual assumption is that the government that puts in a tariff etc will hurt its own people more than the other countries’ people. But that may not be so. The basic premise of “economic warfare” is that you can hurt the other side worse.

But it does hurt both sides. And presumably, the other government would retaliate, so I can’t imagine how the situation after this can possibly be better for anybody than it would be if the first government never raised the tariff in the first place.

And of course, as a libertarian, I’m not fond of having the government decide what consumers should and should not buy. But everybody seems to think of just the impact on the sellers, not the buyers.

I claim that comparative advantage is not as counterintuitive as people usually think.

Well, I’ll believe that when the EU gets rid of their agricultural subsidies and software engineers stop griping about outsourcing (we’re talking about college-educated folks here). And I can’t see how Bush could have raised steel tariffs if most voters understood comparative advantage. Indeed, if they did, wouldn’t Bush have merely explained that to Kerry when he brought up the outsourcing issue?

Indeed, I think the popular perception is that a tariff does not hurt both sides, but helps one side at the expense of the other because free trade can hurt one side if the other has an absolute advantage. And this misconception is the main reason why I wrote this.

Fling93, if one side can hurt the other worse, then that side might choose to do economic warfare. If US consumers pay double the price for sugar — which isn’t that good for them anyway — but cuba’s economy becomes a basket case, it might seem like a good strategy to americans who want to hurt cuba and to prove that socialism doesn’t work. Cuba can impose their own tariffs or embargoes and the USA won’ care much at all.

Then, suppose governments are doing retaliatory tariffs and embargoes etc. How do you persuade them not to? If you persuade your own government not to retaliate that doesn’t at all stop the guys on the other side who’re getting away with it. We tend to think about the sellers and not the buyers because the sellers are the ones who know how much the other country’s tariff hurts them. The buyers are more uncertain. A lot of US buyers feel they’d be better off with more cheap colombian cocaine, but their government disagrees.

When a government subsidises an export, or manipulates exchange rates, in the short run they’re doing a favor to the other country. They produce a lot of stuff that they don’t get full price for; they’re paying to give stuff away cheap. It seems like they’re hurting themselves and benefitting you. Less is produced than would under comparative advantage but you get a bigger share of it. Only — that’s what china is doing to us. They’ve destroyed industries where we might possibly have had a comparative advantage. They’re growing at 9%+ a year, we’re growing at — 0? They sell us stuff cheap and lend us the money to buy it. A great deal for us, right? Only when they cut off our credit what will happen to us then? Ideally we’d immediately switch to producing all that stuff ourselves, but … who would sell us oil? Under the circumstances our comparative advantage might be to sell oil, to become an oil exporter. We produce enough oil to satisfy 40% of our own needs, we could export that oil instead and use less and buy imports with the hard currency it got us. Would that really be our comparative advantage? Is that really the comparative advantage of the various other third-world oil exporters?

When other governments do things that affect trade, we might need to do so also for self-defense.

J Thomas: suppose governments are doing retaliatory tariffs and embargoes etc. How do you persuade them not to? If you persuade your own government not to retaliate that doesn’t at all stop the guys on the other side who’re getting away with it.

You’re right, it doesn’t. In that case, the government needs to negotiate for both sides to back down. But my argument was against the first government “firing the first shot” by raising tariffs in the first place. The economic warfare ends up making everybody worse off.

I’ve already acknowledged that maximizing production has to be weighed against self-defense issues. That’s not the issue for most protectionist measures.

J Thomas: We tend to think about the sellers and not the buyers because the sellers are the ones who know how much the other country’s tariff hurts them. The buyers are more uncertain. A lot of US buyers feel they’d be better off with more cheap colombian cocaine, but their government disagrees.

I think bringing the drug war into this will muddy matters, but I will say that creating such an artificially high price is a big reason sellers are willing to assume a lot of risk by entering the market. I think we’d be much better off addressing the supply side [whoops, I actually meant the demand side] and treating the drug problem as a public health issue instead of a criminal issue.

But this highlights another reason everybody thinks about sellers. Buyers don’t know why prices are high. They comparison shop based on the final price, but they don’t research the different components that went into the prices. So as I said, they don’t realize they are being hurt, which has the political implications of making protectionism easier to enact. Something that wouldn’t be true if most voters understood comparative advantage.

When a government subsidises an export, or manipulates exchange rates, in the short run they’re doing a favor to the other country. They produce a lot of stuff that they don’t get full price for; they’re paying to give stuff away cheap.

That hurts their sellers, who then decrease production, thus hurting their consumers as well.

They’re growing at 9%+ a year, we’re growing at — 0?

4.4% in 2004. And remember that our economy is a lot larger than China’s, and that China is artificially propping up their exports. And we also have a much lower unemployment rate.

Only when they cut off our credit what will happen to us then? Ideally we’d immediately switch to producing all that stuff ourselves, but … who would sell us oil?

Again, I do support an oil import fee, which is the only protectionist measure which would have a measurable impact on national security. As for what will happen, don’t underestimate the substitution effect, or the increased incentive that a high oil price will have to find and utilize domestic sources of oil. Remember, the price controls for oil in the 70’s exacerbated the shortage by lowering these incentives.

But also note what will happen to China’s economy, which is currently relying on its export-driven growth. With a weak dollar, demand for their goods will dry up, sending them into a tailspin. I’d say it’s pretty likely that they will be hurt a lot more than us, which is why their central bank is so willing to risk losing so much money in buying overvalued dollars.

But of course, had they learned the lesson of comparative advantage, they wouldn’t have fallen into this trap in the first place.

“But my argument was against the first government “firing the first shot” by raising tariffs in the first place. The economic warfare ends up making everybody worse off.”

First off, remember that the argument that unrgulated economies will approach their comparative advantage has not yet been made. It’s only been assumed. Maybe the economies will make a random walk around their comparative advantage and never get close.

Then, remember that governments set rules for their own economies and for trade. That’s one of the essential points of government. You seem to be assuming that when governments do economic warfare there will not be a winner. That’s like assuming that when governments go to war there won’t be a winner. In recent years wars have been so expensive that the winners still don’t break even economically. (WWII might be an exception, the USA may have made a profit on it. But that’s arguable, it may not have. And Wolfowitz predicted we’d make a fine profit on iraq; if we can control the iraqi oil we might yet make a profit. It doesn’t look likely to me.)

It may be that governments can make a profit on economic warfare. First, there’s the difference in production between trade and autarky. That difference can be negotiated by governments, and the loser may accept little scraps while the winner gets most of the benefit. Second, since it’s an arcane economic judgement where your comparative advantage is anyway, a government might settle for a worse trade than it gets under autarky. Third, a government which depends on trade can be blackmailed. When they have you over a barrel you agree to whatever you have to agree to. Governments which believe they have to import oil, or have to import food, can be defeated by anyone who can restrict those imports.

“I’ve already acknowledged that maximizing production has to be weighed against self-defense issues. That’s not the issue for most protectionist measures.”

Are you sure? Consider, say, chip-making. It costs well over a billion dollars to make a new plant, and a whole lot of specialised technical knowledge. Giant fixed cost, low variable cost. When we let the supply of special parts be handled only by a couple of plants in japan, china, korea, etc it inevitably seems to turn out that there’s a production shortfall and the price rises until the weaker bidders give up. It takes awhile to increase capacity, too. Then when the capacity is high enough the price falls to something close to variable cost. This is no way to run an economy. Free enterprise works badly with high fixed costs and low variable costs. (What would work better? I dunno.) When it’s items that are vital to our military….

The trouble is, you can usually make a defense argument and you can usually make a claim that it’s just “protecting” domestic industries. The example with shoes is clearly bad. When it cost $100 in the USA for shoes that cost $20 in france, and the difference was entirely the tariffs, I don’t see any way to justify it. But usually there is a reasonable-sounding justification, and there isn’t a way to let the market work it out — you have to do politically.

The easy answer is to say we don’t need any government anyway and we ought to get rid of it. But in the short run we’re stuck; medieval serfs needed nobles to protect them from other nobles and we need governments to protect us from other governments.

“Buyers don’t know why prices are high. They comparison shop based on the final price, but they don’t research the different components that went into the prices. So as I said, they don’t realize they are being hurt, which has the political implications of making protectionism easier to enact. Something that wouldn’t be true if most voters understood comparative advantage.”

If they understood comparative advantage they still wouldn’t know about all the subsidies and tariffs. When another government subsidises exports they shift things away from comparative advantage. Then if we put on a corresponding tariff we move back toward comparative advantage, and convert their move to a transfer of money from their government to our government to boot. Understanding comparative advantage isn’t enough to tell you where the comparative advantage is.

“When a government subsidises an export, or manipulates exchange rates, in the short run they’re doing a favor to the other country. They produce a lot of stuff that they don’t get full price for; they’re paying to give stuff away cheap.”

“That hurts their sellers, who then decrease production, thus hurting their consumers as well.”

No, it doesn’t. The other way around. They pay people to produce more, and pay us to buy it. Their sellers produce more than their comparative advantage would tell them to. It hurts our sellers who decrease production. It helps our consumers who can buy the stuff cheaper.

“They’re growing at 9%+ a year, we’re growing at — 0?”

“4.4% in 2004.”

Do you believe those figures? (I find I don’t trust any numbers this administration produces if they’re important enough for appointed officials to pay attention.) Assuming they’re correct, we get .62% due to increased payments for computers and software, .33% due to increased defense expenditure, .46% due to increased food payments, .46% for increased medical costs. That’s almost 2% of it right there. Equipment and software costs go up by 13.5% from last year, not counting inflation, are we 13.5% better off in our computers? I guess maybe. They list increased military expense as only accounting for .33% of the increase in GDP. Do you believe that?

report

“And remember that our economy is a lot larger than China’s, and that China is artificially propping up their exports.”

China artificially propping up their exports is what we’re discussing at this point. Yes.

“And we also have a much lower unemployment rate.”

They’re calculated differently and aren’t comparable. For that matter current unemployment rates aren’t comparable with US unemployment rates 20 years ago. We keep changing the rules to make the unemployment rate look better.

“Again, I do support an oil import fee, which is the only protectionist measure which would have a measurable impact on national security.”

I’d support an oil use fee. It doesn’t necessarily help us to burn up the american oil first. It might go something like, for every three barrels of oil we pump or every two barrels we import we collect enough taxes to buy a gallon of proven american reserves to add to the strategic reserve. Pay to get it ready to pump but don’t actually pump it.

“As for what will happen, don’t underestimate the substitution effect, or the increased incentive that a high oil price will have to find and utilize domestic sources of oil.”

The substitution effect is good, but we’d need a way to get capital together to exploit it. When foreigners aren’t supplying our capital and we have big debts collecting interest, we’ll have to do something special.

And sure, we’ll be pumping domestic oil a lot faster but at present it meets 40% of our needs and there’ll be a giant temptation to export it for hard currency.

“But also note what will happen to China’s economy, which is currently relying on its export-driven growth. With a weak dollar, demand for their goods will dry up, sending them into a tailspin.”

What keeps their own people from having demand for their goods is they don’t make enough money to buy them. What would happen if they just paid their people enough to buy the stuff themselves? Right now they’re lending us the money to buy their exports, and then they invest the money in treasury bills. That only makes sense if they expect us not to devalue the dollar more, and they expect they can buy that much stuff from us. Why would they believe either of those? Unless we actually pay off someday, somehow, they’re throwing their production away. Why not throw it away on their own people, if they’d rather keep them working than lay them off? But it’s their choice. They’re the lenders, we’re the borrowers. “Beggars aren’t choosers.”

“But of course, had they learned the lesson of comparative advantage, they wouldn’t have fallen into this trap in the first place.”

Time will tell us who’s in a trap here. It looks to me like the chinese are following a mercantilist theory. They are intentionally arranging things so they build up industry (and we don’t) and they leave us to provide them with raw materials. Economic warfare. Imagine that we could have destroyed the economies of germany and japan before WWII just by spending a little money, by giving away products. Less stuff produced by the world economy. Less bombs, less tanks, they don’t make enough stuff to do WWII — what a waste of comparative advantage!

Increasing total world production isn’t the only goal. A shortsighted view of comparative advantage assumes it is the only goal.

J Thomas: Free enterprise works badly with high fixed costs and low variable costs. (What would work better? I dunno.)

Like democracy, I’d say capitalism is the worst economic system except for all those others that have been tried.

After all, socialism did much worse with high fixed costs and low variable costs. Governments are rarely willing to abandon sunk costs in an inefficient factory because it’s politically embarrassing. Mitterand found that out the hard way.

J Thomas: the argument that unrgulated economies will approach their comparative advantage has not yet been made.

That’s because they won’t necessarily. It depends on what the economy demands. If, for example, everybody wants just poems, then Calvin won’t specialize in his comparative advantage. On the other hand, if everyone wants more machines than poems, then Lisa won’t specialize completely in poems. How much of what gets produced will be determined by where the indifference curves intersect the production possibility frontier.

The real conclusion of comparative advantage is not that production will reach the maximum theoretical possibility under trade, but that you cannot maximize production without trade. This is because the production possibility frontiers for both sides are expanded by trade. But again, that goes into more details than the layperson needs to know.

J Thomas: First, there’s the difference in production between trade and autarky

As I understand it, the results of any country that’s attempted autarky are pretty dismal for reasons that should be obvious by now.

That difference can be negotiated by governments, and the loser may accept little scraps while the winner gets most of the benefit.

Comparative advantage does not suggest that everyone will benefit equally. Just that both trading partners will benefit from free trade. And yes, if the government intervenes, this will not necessarily be true anymore. And that’s the problem we see today.

Third, a government which depends on trade can be blackmailed. When they have you over a barrel you agree to whatever you have to agree to. Governments which believe they have to import oil, or have to import food, can be defeated by anyone who can restrict those imports.

That’s the self-defense argument, which I’ve agreed with three times now. But that doesn’t apply to most goods outside of oil, food, and weaponry. And in addition, there are multiple producers of all of these things, so it’s pretty tough to restrict those imports unless you can get all of the producers to cooperate with you.

Besides, China has to import food, and we export food. Does that mean we’ve got ‘em by the balls?

The trouble is, you can usually make a defense argument and you can usually make a claim that it’s just “protecting” domestic industries.

And as I’ve said, the first argument can be valid, but the second one is only made either by somebody who doesn’t understand comparative advantage or is trying to convince people who don’t understand it. And the only reason the explanations for protectionism and mercantilism sound reasonable is exactly because comparative advantage is counter-intuitive.

If they understood comparative advantage they still wouldn’t know about all the subsidies and tariffs.

No, buyers still wouldn’t see what goes into the prices — but if voters understood that tariffs hurt both sides, then tariffs wouldn’t be so politically beneficial anymore. Voters would finally see them as blatant attempts to buy votes.

When another government subsidises exports they shift things away from comparative advantage. Then if we put on a corresponding tariff we move back toward comparative advantage…

If you are saying retaliation can pay off, I agree. This is why the first government shouldn’t subsidize exports. In addition, I would argue that the second government’s economy will still be better off without the tariff, because they will already be benefiting from the artificially increased production, allowing them to shift more resources into other products. The fact that governments act otherwise seems to indicate that they (or their voters) don’t understand comparative advantage.

No, it doesn’t. The other way around. They pay people to produce more, and pay us to buy it.

Yes, you were right and I was wrong. We would benefit. But this still argues against the first government’s subsidies and the second government’s tariffs.

J Thomas: They’re growing at 9%+ a year, we’re growing at — 0?
fling93: 4.4% in 2004.
J Thomas: Do you believe those figures?

No offense, but I have a lot more faith in those figures than in your 9% and 0% figures. I’m not fond of how the Bush administration manipulates the public and the media, but they mostly rely on the American public’s inattention. This would be a much taller order for a smaller political benefit (Joe Sixpack doesn’t care about any economic numbers, he cares about his own job). Besides, if the Bush administration was capable of manipulating our economic data for political purposes, why did we have relatively disappointing employment numbers shortly before the election?

The substitution effect is good, but we’d need a way to get capital together to exploit it.

Consumer demand for energy should move domestic investment to it. Especially since foreign investments will no longer be attractive at the worsened exchange rate. And remember that consumer demand will also shift to domestic products. I’m not saying it won’t be painful, since we’ll most likely see a recession. But it won’t last forever.

And sure, we’ll be pumping domestic oil a lot faster but at present it meets 40% of our needs and there’ll be a giant temptation to export it for hard currency.

To exchange for what? Oil again?

They are intentionally arranging things so they build up industry (and we don’t) and they leave us to provide them with raw materials.

That would only make sense if they weren’t importing technology from us, helping build up our tech industries.

Right now they’re lending us the money to buy their exports, and then they invest the money in treasury bills. That only makes sense if they expect us not to devalue the dollar more, and they expect they can buy that much stuff from us. Why would they believe either of those?

They’re the ones propping up the dollar, not us. So if anybody devalues the dollar, it’ll be them. I believe the reason behind all this is that their government reacted to short-term political pressure to improve their economy, and they chose a method that is not sustainable in the long term. Again, this is a bigger problem for them than for us, unless you’re suggesting that China will continue to benefit from a strong dollar while our economy is hurt by a weak dollar.

Increasing total world production isn’t the only goal. A shortsighted view of comparative advantage assumes it is the only goal.

While that is true, I would argue that mercantalism and protectionism is even more shortsighted, and they are the problem right now. I would say that warning about comparative advantage being taken too far is rather like Greenspan’s warning that the surpluses would get too big.

“Free enterprise works badly with high fixed costs and low variable costs. (What would work better? I dunno.)”

“Like democracy, I’d say capitalism is the worst economic system except for all those others that have been tried.”

The problem is that you have to guess how much to invesr ahead of time, and when the economy gives you feedback on it, it’s too late. So somebody has to plan, and the plans come out wrong. And particularly when there aren’t a lot of competitors if you create too much capacity you lose big, while creating insufficient capacity means you win big. But when there are enough competitors to bid down prices, then everybody loses his shirt. It’s a problem for any system since you need reliable forecasts for demand and there aren’t any anywhere, but it’s almost designed for free-enterprise systems to choke on.

“the argument that unrgulated economies will approach their comparative advantage has not yet been made.”

“That’s because they won’t necessarily.”

Well, that settles that question.

But you still seem to be assuming that the right amount of everything will be produced.

“As I understand it, the results of any country that’s attempted autarky are pretty dismal for reasons that should be obvious by now.”

“That difference can be negotiated by governments, and the loser may accept little scraps while the winner gets most of the benefit.”

“Comparative advantage does not suggest that everyone will benefit equally.”

How the benefits get distributed is left as an exercise for the governments, right? And a certain amount of noncooperation can result in gains for that negotiation. The world as a whole would be better off if everybody just cooperated, but sometimes individual governments and their people are better off if they don’t.

“That’s the self-defense argument, which I’ve agreed with three times now. But that doesn’t apply to most goods outside of oil, food, and weaponry.”

Sorry, we’re talking past each other a little despite good will on both sides. I claim that the defense argument can be plausibly made about almost anything. Or at least semi-plausibly. Sometimes it isn’t plausible at all and it takes a lot of wilful self-deception to accept it.

“The trouble is, you can usually make a defense argument and you can usually make a claim that it’s just “protecting” domestic industries.”

“And as I’ve said, the first argument can be valid, but the second one is only made either by somebody who doesn’t understand comparative advantage or is trying to convince people who don’t understand it.”

I was unclear, sorry. For any particular attempt at a tariff etc, some attempt can be made to claim it for defense, and often that will be fairly plausible. Also it can almost always be interpreted as an evil attempt to benefit local competitors who make more money as a result. Even when there’s no obvious local business that can do a substitution. To take an extreme case, if we had a chance to import a working longevity drug, any attempt to put on a tariff or keep it out could be interpreted as an attempt to benefit funeral homes etc. Even if they had nothing to do with it.

“And the only reason the explanations for protectionism and mercantilism sound reasonable is exactly because comparative advantage is counter-intuitive.”

Here’s a generalised sometime argument for protectionism. When entry costs are high, or particularly when entry delays are long, it can make sense to keep a domestic industry ready to run even when it isn’t immediately competitive. But deciding how much money it’s worth, and how much capacity to maintain, and when to upgrade the technology and how much to spend on it, and when to quit are all arcane technical choices that ideally wouldn’t be handled politically. [sigh]

Mercantilism is generally discredited, and I’m not clear it ought to be. If it works for china we can expect a good 20 years of argument as the topic gets re-opened. Once again I stress, comparative advantage says that trade can result in more stuff for everybody. But more stuff to divide up doesn’t have to be a government’s main goal.

“When another government subsidises exports they shift things away from comparative advantage. Then if we put on a corresponding tariff we move back toward comparative advantage…”

“If you are saying retaliation can pay off, I agree. This is why the first government shouldn’t subsidize exports. In addition, I would argue that the second government’s economy will still be better off without the tariff, because they will already be benefiting from the artificially increased production, allowing them to shift more resources into other products.”

Let me remind you that I’m speaking about theory that has little relation to reality, as all of comparative advantage theory has little relation to reality. Suppose that another country has subsidised export A. In the absence of this subsidy we would have the comparative advantage and we would produce A and export it to them. (We might never get close to our comparative advantage, but for now let’s suppose we would.) Instead we stop making A and make B instead, something that are we are not as productive with. So they pay us for the privilege to export A to us and import B, while otherwise we would export A to them and import B. They are less efficient at producing A than we are; we are less efficient at producing B than we are at producing A. There is less of everything to go around. They have paid us to help them reduce global production.

If we subsidise our own A production to match theirs, the system will produce too much A and not enough B. But if we put a tariff on our A imports that just matches their subsidy, we can correct their distortion and everybody benefits. Their subsidy isn’t enough to outweigh comparative advantage so we export A to them and they export B to us just as it would have been without the subsidy or the tariff.

“No offense, but I have a lot more faith in those figures than in your 9% and 0% figures.”

I don’t want to get into a “If they can lie why don’t they tell us the Moon is made of solid gold and they’re going to land it in iowa” discussion. And I sure don’t want to claim any precision for my numbers. But put it this way, do you trust that GDP figure to be within 5%?

“The substitution effect is good, but we’d need a way to get capital together to exploit it.”

“Consumer demand for energy should move domestic investment to it. Especially since foreign investments will no longer be attractive at the worsened exchange rate.”

If foreign currencies look like they’ll inflate less compared to their interest rates, it makes sense to move money out of the USA, and the sooner the better. If foreign investment opportunities look better than local ones, it makes sense to invest there instead of here. This is the classic third-world problem, investment money that might help them grow goes to the USA instead. I can’t tell whether we could have that problem ourselves.

“And remember that consumer demand will also shift to domestic products.”

Yes, but export products that bring hard currency are more profitable, if they can be made. So the natural thing is to invest in those and satisfy consumer demand with the dregs.

“And sure, we’ll be pumping domestic oil a lot faster but at present it meets 40% of our needs and there’ll be a giant temptation to export it for hard currency.”

“To exchange for what? Oil again?”

For factories to make export goods? Using our advantage in cheap labor and cheap resources. For the foreign exchange that lets individual newly-rich americans live abroad or emigrate. For whatever we can’t produce ourselves that we need badly enough to spend hard currency for. Fur coats and diamonds and BMWs, imported stuff that shows how important you are, since only important people can afford importado.

“Again, this is a bigger problem for them than for us, unless you’re suggesting that China will continue to benefit from a strong dollar while our economy is hurt by a weak dollar.”

You’re basicly talking about equilibrium conditions, while I’m talking about war. In war you accept sacrifices to eliminate the enemy’s ability to make choices, to force their surrender. Certainly china will do worse than they would if everybody cooperated nicely and traded what they made best. But it’s an open question whether they can win and whether the victory will be worth what it cost. And at this point it’s an open question whether they’re trying to win versus trying to recover from an accidental costly mistake.

“I would argue that mercantalism and protectionism is even more shortsighted, and they are the problem right now.”

Militarism is also part of the problem. Our military is a continuing drain on our economy — so for example our military expenditures are something like 4.7% of GDP, and it’s an open question how much of that is actually improving the civilian economy. (Military research could have civilian applications, but it’s usually classified. Some isn’t like GPS but would we have done those anyway? Etc etc.) If all the nations of the world gave up militarism just think how much faster we could increase GDP! Or maybe not. Economic warfare is just a part of warfare, just like government intervention for purposes of protectionism or “protection” is just part of graft.

It takes more than simply deciding that tariffs are bad and we should get governments to agree to free trade. That’s precisely like concluding that militarism is bad and we should get governments to disarm.

J Thomas: The problem is that you have to guess how much to invesr ahead of time…. So somebody has to plan, and the plans come out wrong…. It’s a problem for any system…but it’s almost designed for free-enterprise systems to choke on.

Actually, I’d say it’s designed for planned economies to choke on. Investors have a financial interest in making their plans as accurate as possible and minimizing the damage when they are wrong. Governments are not as motivated to take such care because they are spending taxpayer money, and plus they are far more likely to throw good money after bad to avoid the political ramifications of admitting poor planning. Not to mention that the consequences of your bad plans might be somebody else’s problem.

J Thomas: But you still seem to be assuming that the right amount of everything will be produced.

There is no such thing as the right amount of everything. You’ll get as many answers as the people you ask. An expanded production possibility frontier just gives an economy more options and thus makes it more able to satisfy more people than without trade.

Their subsidy isn’t enough to outweigh comparative advantage so we export A to them and they export B to us just as it would have been without the subsidy or the tariff.

Again, this argues against the subsidy, since the money for it has to come from somewhere.

And a certain amount of noncooperation can result in gains for that negotiation.

How? None of your examples of mercantilism result in one side being better off than before.

do you trust that GDP figure to be within 5%?

Yes. As I said, very few voters pay attention to that number to make it worth manipulating, and manipulating it requires no less than a full-fledged conspiracy. So I’d say Occam’s Razor applies. It’s more likely for the Bush administration to have staged 9/11.

I claim that the defense argument can be plausibly made about almost anything. Or at least semi-plausibly. Sometimes it isn’t plausible at all and it takes a lot of wilful self-deception to accept it.

This willful self-deception is a lot easier because comparative advantage is counter-intuitive. I think we’d be better off starting with the assumption that free trade will be beneficial and then putting the burden of proof on those who would make exceptions. Instead, every attempt to open up trade runs into resistance from domestic labor and industry.

J Thomas: all of comparative advantage theory has little relation to reality.

I never claimed it did. I’m just saying it’s a lot closer to reality than the prevalent view that tariffs help one side.

J Thomas: you can usually make a claim that it’s just “protecting” domestic industries.
fling93: And as I’ve said, the…argument…is only made either by somebody who doesn’t understand comparative advantage or is trying to convince people who don’t understand it.
J Thomas: For any particular attempt at a tariff etc,…it can almost always be interpreted as an evil attempt to benefit local competitors who make more money as a result.

Again, I think you’re focused on something that isn’t a problem. We don’t live in a world with too few tariffs. The steel tariffs got passed with little complaint (except from the few who understood comparative advantage). Nobody seriously expects our agricultural subsidies to be going away anytime soon (let alone in Europe). Smart and educated people continue to complain about outsourcing. I have no idea how you can possibly think that we live in a world that overly condemns protectionism as evil because too many people draw the wrong conclusions from comparative advantage. That model of the world just doesn’t fit reality.

If foreign currencies look like they’ll inflate less compared to their interest rates, it makes sense to move money out of the USA, and the sooner the better.

But we’re assuming a crash in the dollar that makes it impossible to import enough oil to meet domestic demand. Well, that would also make foreign currencies and investments and goods prohibitively expensive compared to domestic options.

J Thomas: …we’ll be pumping domestic oil a lot faster but at present it meets 40% of our needs and there’ll be a giant temptation to export it for hard currency.
fling93: To exchange for what? Oil again?
J Thomas: For factories to make export goods?…For whatever we can’t produce ourselves that we need badly enough to spend hard currency for.

Since oil is a fungible commodity, the amount of dollars you could get with that oil by selling it domestically would be worth the same as what you would get in euros, or whatever currency you think will dominate. Indeed, taking shipping costs into account (and transportation costs will be greatly increased), the incentive would be to sell it domestically.

But it’s an open question whether they can win and whether the victory will be worth what it cost.

How do they win? A crash in the dollar burns an awfully big hole in their central bank’s reserves at the same time it destroys the demand for their exports, crippling their economy and their ability to do anything about it. How does this help them, economically or militarily?

It takes more than simply deciding that tariffs are bad and we should get governments to agree to free trade. That’s precisely like concluding that militarism is bad and we should get governments to disarm.

Getting governments to agree to free trade is a pretty darn good first step. As a bonus, interconnected economies also make war less likely exactly because it creates webs of dependencies, which gets back to Thomas Barnett’s strategy of shrinking the gap.

I think disarmament is an excellent analogy. But what’s wrong with disarmament? Do you think we’d be better off if we and the Soviets kept all the nukes we had? Proliferation is a pretty big problem just with the number they had left.

“The problem is that you have to guess how much to invesr ahead of time…. So somebody has to plan, and the plans come out wrong…. It’s a problem for any system…but it’s almost designed for free-enterprise systems to choke on.”

“Actually, I’d say it’s designed for planned economies to choke on.”

Yes, that too. It’s a hard problem.

The thing is, without anybody in charge you’re stuck reacting to what the other guy does. Get a real free-enterprise situation and you can expect prices to sink to the variable cost until somebody goes bankrupt. They only make money under oligopoly rules or when capacity is low enough they can’t meet demand. All the usual free-enterprise arguments are gone and the only fallback is that professional managers under capitalism are more accountable than managers under other systems. But all this is a side issue.

“There is no such thing as the right amount of everything. You’ll get as many answers as the people you ask. An expanded production possibility frontier just gives an economy more options and thus makes it more able to satisfy more people than without trade.”

See, comparative advantage is getting more intuitive the more we discuss it.

“Their subsidy isn’t enough to outweigh comparative advantage so we export A to them and they export B to us just as it would have been without the subsidy or the tariff.”

“Again, this argues against the subsidy, since the money for it has to come from somewhere.”

Well, yes. Their government has wasted its influence. It tried to distort the world economy and failed. Depending on how they set up the subsidy they might actually not waste much money; once their A producers find out that they can’t export to you even with the subsidy they won’t produce export A to be subsidised. But if they subsidise it for local use too then they might produce enough A for local consumption to reduce their A imports. That would cost them and maybe cost us too.

My point is that if you believe that subsidies and tariffs distort the economy in bad ways, then it logically follows that a tariff that undercuts a subsidy will distort the economy back with good effect. So they aren’t always bad, they’re good when they correct somebody else’s mistakes.

“And a certain amount of noncooperation can result in gains for that negotiation.”

“How? None of your examples of mercantilism result in one side being better off than before.”

It isn’t a necessary conclusion. But when there’s a surplus then somebody has to negotiate how that surplus is distributed. Sometimes noncooperation can help win those negotiations. Also, remember that the supposed advantages of mercantilism may be second-order effects that we’ve assumed away. Mercantilists consistently believe that the country that sells manufactured goods has a big advantage over the countries it buys raw materials from. I’m not clear a priori why that would be true but they believe it.

“I think we’d be better off starting with the assumption that free trade will be beneficial and then putting the burden of proof on those who would make exceptions.”

I tend to agree for the particular examples I can think of. But in principle, when our government does free trade that only handles half the problem. What about other governments that do unfree trade? Can they do it in a way that hurts us more than them? Can they do it in a way that helps them but hurts us more? If so, we shouldn’t just ignore it when they do that. We need to be ready to persuade them not to.

“If foreign currencies look like they’ll inflate less compared to their interest rates, it makes sense to move money out of the USA, and the sooner the better.”

“But we’re assuming a crash in the dollar that makes it impossible to import enough oil to meet domestic demand. Well, that would also make foreign currencies and investments and goods prohibitively expensive compared to domestic options.”

If you can invest dollars and hope to make 2% over inflation or invest euros and hope to make 4% over inflation, it makes sense to convert to euros. If investing in the US is likely to come out 10% behind inflation then you need to invest overseas instead, if you have investment money. I’m not saying it would get that bad, but if it did….

“Since oil is a fungible commodity, the amount of dollars you could get with that oil by selling it domestically would be worth the same as what you would get in euros, or whatever currency you think will dominate. Indeed, taking shipping costs into account (and transportation costs will be greatly increased), the incentive would be to sell it domestically.”

Why was that not true in the USSR? Why is it not generally true for exports from third-world countries?

“How do they win? A crash in the dollar burns an awfully big hole in their central bank’s reserves at the same time it destroys the demand for their exports, crippling their economy and their ability to do anything about it. How does this help them, economically or militarily?”

What good is demand for their products when it’s paid in dollars?

“I think disarmament is an excellent analogy. But what’s wrong with disarmament? “

Disarmament is a fine idea but it’s hard to get governments to do it because they don’t want to take the chance that if they disarm some other government might get a military win because of it.

It would be a big help if we could argue that regardless what other nations do, our economy is always better off without any government regulation including tariffs and subsidies.

But I’m not sure it’s true. I expect it tends to be true in practice because even if such things might sometimes be useful it’s hard for governments to know which times they’re a benefit, and the political process would tend to ignore whether it’s a real benefit or not. But I doubt we could get a credible economic theory that says it has to be true.

J Thomas: Get a real free-enterprise situation and you can expect prices to sink to the variable cost until somebody goes bankrupt.

This is how less efficient producers are incentivized to leave that market, leaving behind the more efficient producers who can still make a profit at the lower price. This is also why investment flows away from production of lower-priced goods (where demand is generally satisfied) towards higher-priced goods (where demand is still unmet). Tendencies that don’t exist under a planned economy.

Yes, I do believe government should counteract the tendency towards oligopoly and monopoly. As you said, this is all a side issue, but don’t worry about that so much, as I’m really good at keeping a focus on the original issue.

fling93: An expanded production possibility frontier just gives an economy more options and thus makes it more able to satisfy more people than without trade.
J Thomas: See, comparative advantage is getting more intuitive the more we discuss it.

First of all, the counterintuitive part is that trade expands the production possibility frontier (PPF) for a country even if the trade partner has an absolute advantage. Secondly, the two of us understand economics a lot more than the average voter or politician.

My point is that if you believe that subsidies and tariffs distort the economy in bad ways, then it logically follows that a tariff that undercuts a subsidy will distort the economy back with good effect.

The second government’s economy is better off without the tariff. They get more of the subsidized good at a cheaper price and can shift more resources to other goods where the gap between supply and demand is larger. The tariff undoes this.

You seem to be thinking in terms of governments trying to make sure each economy is concentrating on its comparative advantage, instead of in terms of maximizing the PPF so that the economy is better able to meet more demands. Comparative advantage is merely a means to an end.

What about other governments that do unfree trade? Can they do it in a way that hurts us more than them?

I don’t think so. A subsidy means you fund production so that the other economy gets more goods at your expense. A tariff means your own economy gets fewer goods. This doesn’t even take the retaliation into account.

Mercantilists consistently believe that the country that sells manufactured goods has a big advantage over the countries it buys raw materials from.

I think they believe that because they don’t understand comparative advantage (probably because it’s counterintuitive). Either that, or their beliefs are irrelevant because they benefit financially from mercantilism on their behalf (at the expense of everybody else in both economies).

If you can invest dollars and hope to make 2% over inflation or invest euros and hope to make 4% over inflation, it makes sense to convert to euros.

Not if you expect the dollar to improve against the euro. After all, the dollar’s low point would probably be shortly after the crash, and it would recover as our current-account situation improves.

If investing in the US is likely to come out 10% behind inflation then you need to invest overseas instead

Sure, that would make it worth taking the hit. But why would that be true? Are you saying a crash in the dollar means we’ll never see growth again? Or are you saying that the Federal Reserve would be motivated to lower interest rates and allow inflation? I would expect the opposite.

fling93: Since oil is a fungible commodity, the amount of dollars you could get with that oil by selling it domestically would be worth the same as what you would get in euros
J Thomas: Why was that not true in the USSR?

Are you talking about Russia’s currency crisis in 1998? Are you saying their domestic demand for oil was unmet? Their demand for it isn’t anywhere near ours, which is a big reason they are a net exporter of oil. So I don’t remember hearing about long gas lines in Russia, but maybe you can jog my memory.

Why is it not generally true for exports from third-world countries?

Can you be more specific? When did a currency crisis cause a country to export a good even though domestic demand was unmet? A good that is also a fungible commodity.

fling93: How do they win? A crash in the dollar burns an awfully big hole in their central bank’s reserves at the same time it destroys the demand for their exports, crippling their economy and their ability to do anything about it. How does this help them, economically or militarily?
J Thomas: What good is demand for their products when it’s paid in dollars?

Plenty while the dollar is still worth something. Which is exactly why they prop it up and have a strong interest in continuing to prop it up. They know that a crash in the dollar totally screws them.

Disarmament is a fine idea but it’s hard to get governments to do it

Likewise, free trade is a fine idea, but trade agreements are hard as well. Why would that be so if comparative advantage was so well-understood by everybody to the point that they take it too far? Instead, it sounds like the problem is a predominance of the misconception that tariffs and subsidies can help one side at the expense of the other. Getting more people to understand comparative advantage would go a long way towards addressing this.

We may be on the edge of exposing fundamental differences in assumption. If we can get those clear then we can look into researching them. So I think we’re making progress even when it may look like we’re just arguing the same points repeatedly.

“Get a real free-enterprise situation and you can expect prices to sink to the variable cost until somebody goes bankrupt.”

“This is how less efficient producers are incentivized to leave that market, leaving behind the more efficient producers who can still make a profit at the lower price.”

Yes. The example of chip makers demonstrates the pathological case. When you’re planning a chip factory you have to design in a maximum capacity, when you don’t know what demand will be. You have to guess. The plant will cost on the order of a billion dollars and variable costs will be quite low.

If you wind up the sole source for a chip nobody will want to usze it. You can change the price just when they ramp up production, and if you go bankrupt or get into a lawsuit the rights to the chip might be tied up for decades. So there must always be a second source.

So the two of you have each built a billion-dollar plant to produce a commodity chip, and you compete on price. It’s an oligopoly. If you can reach an agreement you can both maximise profits. But if there is excess capacity and you don’t agree about how much market share you’ll each get, you are likely to compete on price and that can continue until the price goes down to the variable cost. But of course as price goes down demand may go up (or maybe not) and at some point you may reach capacity. You aren’t going to retool another billion-dollar plant to produce an aging chip, so at that point supply is fixed and price rises according to demand. Whether or not you paid off the plant, you’ll either raise a billion dollars or so to build the next-generation plant or you’ll get out of the business.

This is a real-life example where none of the arguments for the efficiency of free enterprise work. With the possible exception of the one that says managers make better decisions if they’re hired by private corporations instead of anybody else.

””An expanded production possibility frontier just gives an economy more options and thus makes it more able to satisfy more people than without trade.””

“See, comparative advantage is getting more intuitive the more we discuss it.”

“First of all, the counterintuitive part is that trade expands the production possibility frontier (PPF) for a country even if the trade partner has an absolute advantage. Secondly, the two of us understand economics a lot more than the average voter or politician.”

The first point is easy to explain. You sit the person down and tell them, “Let’s suppose you’re the best brain surgeon in the world. You can make a million dollars a year doing brain surgery. And with those same hands you’re also the best concert pianist in the world, you can travel around the world giving concerts and making out with groupies and make a hundred thousand dollars a year. Comparative advantage says you’re going to spend all your time doing brain surgery and let the second-best concert pianist travel around the world, because that’s how you’re better off. Even if you’re the best in the world at something you won’t do it if you make more money doing something else.

“Same with nations. If we’re the best in the world at making steel but we make more money if the steelworkers do telemarketing, we’ll do the telemarketing and buy our steel from china.”

See, it’s easy to explain. People get it right away.

“My point is that if you believe that subsidies and tariffs distort the economy in bad ways, then it logically follows that a tariff that undercuts a subsidy will distort the economy back with good effect.”

“The second government’s economy is better off without the tariff. They get more of the subsidized good at a cheaper price and can shift more resources to other goods where the gap between supply and demand is larger. The tariff undoes this.”

Let’s think out our assumptions. I’m starting with the assumption that the world economy actually does operate at comparative advantage, except when governments distort it to do otherwise. We know this isn’t true in reality, that at best the world economy gets closer to comparative advantage in fits and starts when the comparative advantage isn’t changing much.

So we assume that the two nations start out at their comparative advantage, and they’re producing the most good stuff that they can, and each nation is maximising its wealth sa a reasult.

Now the first nation puts a subsidy on some of its exports. The result is to distort its economy. It produces more of the subsidised stuff and less of the others. And more of the subsidised stuff is exported. Since they were at comparative advantage before, the result is they have less stuff.

When product A comes into nation 2 at a low enough price, nation 2 stops making A and makes B instead, trading some of it to country 1. The result is that while under comparative advantage contry 1 would produce only A and country 2 would produce only B, instead country 1 produces only B and country 2 produces only A. They have managed to get a result that’s worse than autarchy! The combined nations are definitely worse off. Nation 1’s decision has resulted in less A and B to go around. Is nation 2 better off? Maybe the luck of the draw resulted in nation 2 not getting much of the surplus under comparative advantage, but nation 1’s subsidy results in nation 2 getting the lion’s share of A and B both? I dunno. Is there some reason that nation 2 would necessarily benefit even though production is lower in everything? I could imagine it going either way but I haven’t done the numbers.

“Mercantilists consistently believe that the country that sells manufactured goods has a big advantage over the countries it buys raw materials from.”

“I think they believe that because they don’t understand comparative advantage (probably because it’s counterintuitive). Either that, or their beliefs are irrelevant because they benefit financially from mercantilism on their behalf (at the expense of everybody else in both economies).”

Then there’s the defense angle; you have an easier time intimidating people into favorable trade agreements if you make your own guns.

And manufactured items come in bewildering variety, lots of room to come up with new commodities. You might have a thousand kinds of dried beans for sale but people mostly don’t care.

When you sell raw materials you have a few exported products with a lot of variation in sales year to year. When you sell manufactured products that evens out a lot.

If you import raw materials and export finished stuff your growth is limited by your population and your ability to build factories for them to work in — and your ability to import raw materials. If you provide raw materials you have physical limitations in the amount of ore you can mine or the amount of farmland you can plow, rainfall, etc. So it’s only natural for empires to do manufacturing in their homeland and collect raw materials from the provinces.

When your economy depends on extracting raw materials to export, your transportation system will based around that. “All roads lead to Buenos Aires.” So you get less internal trade which itself affects where your comparative advantage will lie, and it will have a big effect if you ever get into a war etc.

Maybe it’s more that mercantilists tend to arise in nations that have large populations and limited natural resources, that have no choice but poverty or empire. But they generally seem to believe that once they have an empire and they control the local governments, they can get riches for their home nation. I don’t know how often that comes true.

More later.

On the topic of China/USA economic warfare etc, which is not precisely about comparative advantage:

””Since oil is a fungible commodity, the amount of dollars you could get with that oil by selling it domestically would be worth the same as what you would get in euros””

“Why was that not true in the USSR?”

“Are you talking about Russia’s currency crisis in 1998? Are you saying their domestic demand for oil was unmet? Their demand for it isn’t anywhere near ours, which is a big reason they are a net exporter of oil. So I don’t remember hearing about long gas lines in Russia, but maybe you can jog my memory.”

I don’t truly know what to expect from a crash. Since it’s a lot of interlocking pieces where the interactions may be hard to predict, I doubt anybody can predict real well. But try this first-order stuff.

Say the exchange rate for dollars falls to half what it is now. I haven’t seen predictions that it would fall lower than that, though this looks like a reasonable equilibrium so it would likely fall much lower and rise back to that. So for us the price of oil would go to around $100/barrel while for the rest of the world it’s still effectively $50/barrel. Everything imported doubles in price, local production has price increases on everything that uses oil including plastic, gasoline, heating oil (if the crisis holds off til winter) etc. US Airlines get emergency government bailouts or they go out of business. Airline tickets get real expensive, of course, as does anything bought mailorder.

America has a whole lot of consumers who’re deep in debt. They get scared and stop spending. Will interest rates rise? If so we’ll get a lot of people who can’t pay their mortgages. Variable rate mortgages are evil that way. People who can pay higher mortgages will not be spending that money on consumer goods. When everything in WalMart essentially doubles in price, where will the WalMart shoppers go? All that’s left is stuff that’s already priced out of their range.

So, say you grow strawberries in the USA. You’ve been facing tough competition from mexican strawberries at $2/pint, when you can hardly sell them for under $2.50. But all of a sudden you can export them easily for $4. You can sell them in the USA for $4 too, as many as will sell.

That way with everything we can export. Prices double here, but don’t double to foreigners. All of a sudden we’re a real cheap vacation spot. A fancy restaurant that costs americans $200 a seat costs visitors only $100/seat. A $5 hamburger costs foreigners just $2.50. But why sell hamburger at the old price in the USA when you can get a nice premium exporting it? Hamburger prices rise.

So the result is basicly prices come close to doubling, instant inflation. And there aren’t so many retail etc jobs because americans plain can’t afford to buy as much. Manufacturing jobs ought to be plentiful, low-cost american labor is suddenly in demand, but at present around 10% of our labor force is in manufacturing. That could ramp up pretty fast without generating a lot of jobs.

So we’d have a sort of third-world economy, unless the government found a good way to intervene. Lots of hard work available for small rewards, much of the production going overseas to pay old debts. You mentioned the problems china would have with their bank reserves diminished — wouldn’t we expect financial problems at least as bad?

We’d have lots of investment opportunities but would we have capital to exploit them? Foreigners would have just gotten burned bad for investing in the USA.

“Why is it not generally true for exports from third-world countries?”

“Can you be more specific? When did a currency crisis cause a country to export a good even though domestic demand was unmet? A good that is also a fungible commodity.”

In various cases when third-world countries had debts they couldn’t pay, the WB and IMF enforced austerity measures. Those countries got a lot of suffering along with policies that tended to keep them permanently third-world. I don’t know how it would work for the USA in almost precisely that situation. Would we get special treatment that would let us recover easily? We do have nukes and a strong military, if they tried to enforce austerity could we become a rogue nation and steal wealth? I don’t have it thought out at all, everything I think of there are important other factors that might change it all around.

But the result in, say, argentina was not to export when there was local demand. What they did was to strongly reduce local demand by devaluing the currency so that local demand went way down relative to foreign demand.

I’m a bit behind at work, so I’ll hopefully respond more fully later tonight. But on the point that it’s easy to explain comparative advantage, the problem is sitting people down to listen to you. Economics and numbers bore a lot of people, which is why I tried to liven things up in this post (and even then, I think your average Joe Sixpack is still not going to bother to read it).

Even if they do get it, they still may not like it if they’re one of those people that personally benefits financially from mercantilism on their behalf. Given a choice between more money for yourself or more stuff for everybody, most people pick the former, for obvious reasons. Nevermind cognitive dissonance, where some people’s brains will just refuse to believe something because it means they’re living a life that makes others worse off, and they’re not willing to accept that possibility.

J Thomas: So I think we’re making progress even when it may look like we’re just arguing the same points repeatedly.

Okay, I don’t see it, but I’ll take your word for it.

J Thomas: If you wind up the sole source for a chip nobody will want to usze it.

Why? Intel made a lot of money selling chips that nobody else makes but plenty of people want to use. The reason the market attracted a second source, AMD, was because Intel could charge a high price that AMD hoped to undercut in order to win market share.

J Thomas: You aren’t going to retool another billion-dollar plant to produce an aging chip, so at that point supply is fixed and price rises according to demand.

The key being “aging chip.” The reason a chip is considered “aging” is not due to physical age, but because there are better chips available at this point. Why? If you are selling the best chip at a high price, not only will other companies try to produce that chip to get a piece of that market, other companies will try and make a better and/or cheaper chip to steal the entire market altogether. You need to advance quicker than they do. So this acts as a strong incentive for innovation, which is why chips become obsolete so quickly.

J Thomas: We know this isn’t true in reality, that at best the world economy gets closer to comparative advantage in fits and starts when the comparative advantage isn’t changing much.

I think you misunderstand. As I said earlier, reaching comparative advantage isn’t the goal. Comparative advantage is merely a tool that can be used to increase the PPF, allowing more consumers to have more of their demands satisfied. As I said before, the point where the indifference curves of the market interesect the PPF will determine what gets produced. Supply reacts to demand because no company or investor wants to spend money on a plant that makes something that nobody wants.

Utilizing comparative advantage means an economy where more people will be able to afford what they want. That’s all. Of course, that’s the goal of most economists: finding a distribution of limited resources that satisfies as many people as possible.

J Thomas: When product A comes into nation 2 at a low enough price, nation 2 stops making A and makes B instead, trading some of it to country 1. The result is that while under comparative advantage contry 1 would produce only A and country 2 would produce only B, instead country 1 produces only B and country 2 produces only A.

I think something is backwards. Nation 2 won’t end up producing A if Nation 2 is subsidizing it. So I think you meant to say that Nation 1 produces product A under free trade because that it has a comparative advantage, and Nation 1 subsidizes product B (not A, as you said), causing Nation 2 to stop making B and making A.

J Thomas: Is nation 2 better off?

With Nation 1’s subsidy, yes. Nation 2 gets more of product A cheaper, and can produce more of product B. More products get produced at the expense of Nation 1’s taxpayers.

Regardless of whether Nation 2 is better off or not or whether the situation ends up worse than even autarky, Nation 1 still shouldn’t implement subsidies in the first place. I’m not really sure what you’re trying to illustrate here.

J Thomas: Then there’s the defense angle; you have an easier time intimidating people into favorable trade agreements if you make your own guns.

You can’t come up with a trade agreement that favors only one side. A trade cannot occur unless it benefits both sides, or else one party wouldn’t agree to it. It seems to me that what you’re thinking about is imperialism, which isn’t trade, but looting. You occupy a country and just take its resources.

J Thomas: You might have a thousand kinds of dried beans for sale but people mostly don’t care.

The beans that nobody wants stop getting sold — unless the producers are subsidized. We see a wide variety of products because different people like different things, and there are a lot of different people (which is what the Long Tail is all about).

J Thomas: When you sell raw materials you have a few exported products with a lot of variation in sales year to year. When you sell manufactured products that evens out a lot.

Also, selling raw materials doesn’t create much of an economy. The money goes to a few (typically to those in the corrupt government) who spend it on foreign luxuries, and very few domestic jobs are created. This is the main problem facing a lot of the oil-rich Arab states — but then, few of those allow free enterprise.

In contrast, manufacturing creates jobs, regardless of whether you import raw materials. And companies and investors love to build factories that are close to its raw materials and also to a source of cheap labor. When they aren’t allowed to build these, it’s typically the government that stopped it.

I’ll get to your China comments later.

Fling93, I finally made the beginnings of an argument for my Nation 1&2, product A&B thing. Here it is:

Assume two nations 1 & 2, and two products A and B.

Ideally, people prefer to consume a 50:50 mix of product A and product B.

Here are tables that I hope are self-explanatory. Ideally the argument would include functions showing the amounts produced by each at each ratio of A:B, and some simplified argument about equilibrium prices that would support my claims about equilibrium production and consumption. I’m confident that sort of thing could be constructed.

Autarky — production and consumption

		Product A	Product B
Nation 1		22		20
Nation 2		20		22

Ideal production

		Product A	Product B
Nation 1		100		0
Nation 2		0		100

Ideal consumption

		Product A	Product B
Nation 1		50		50
Nation 2		50		50

Less-ideal production

		Product A	Product B
Nation 1		0		50
Nation 2		50		0

Less-ideal consumption

		Product A	Product B
Nation 1		25		25
Nation 2		25		25

Or possibly

Less-ideal consumption

		Product A	Product B
Nation 1		23		21
Nation 2		27		29

Under autarchy they lose economy of scale etc to produce less than they would at either extreme.

Now, suppose that under a misguided policy of subsidies etc, Nation 1 chooses to produce 50 B instead of 100 A. And they offer 25 B at a subsidised price to Nation 2, cheap enough that Nation 2 can’t compete. Clearly Nation 2’s best response is to produce 50 A and trade 25 A for Nation 2’s 25 B.

Nation 1 and Nation 2 are both better off than they’d be under autarky.

They aren’t as well off as they’d be if their economies actually optimised things. Nation 1’s subsidy has distorted both economies and made them poorer.

Suppose that Nation 2 put a tariff on imports of B from Nation 1. That would reverse the distortion and allow the economy do what it presumably would have done without the subsidy.

Two wrongs don’t produce a right, but sometimes a right and a left produce straight ahead.

“If you wind up the sole source for a chip nobody will want to use it.”

Why? Intel made a lot of money selling chips that nobody else makes but plenty of people want to use.

Intel’s PC chips are the horrible example that no product vendor wants to allow again.

These days if you come out with a new chip you have to provide a second source — somebody who can produce the same chip even if you get into an extended lawsuit or go bankrupt — or there’s no market. It isn’t just a matter of a competitor coming up with something that gets all the same results except for a few minor incompatibilities. If there isn’t a bona fide second source for your particular chip then you won’t get sales beyond samples.

“You aren’t going to retool another billion-dollar plant to produce an aging chip, so at that point supply is fixed and price rises according to demand.”

The key being “aging chip.” The reason a chip is considered “aging” is not due to physical age, but because there are better chips available at this point.

Better for some purposes. If there are better chips that are back-compatible with yours for the products that use yours already, then you have no sales except for those you locked in before plus you can try to compete on price.

But failing that, maximum supply is fixed and demand won’t stimulate supply at all. Customers can redesign their products to avoid your chip so that demand can fall.

“We know this isn’t true in reality, that at best the world economy gets closer to comparative advantage in fits and starts when the comparative advantage isn’t changing much.”

I think you misunderstand. As I said earlier, reaching comparative advantage isn’t the goal.

Comparative advantage is where everyone is most productive. It gives them their best chance to bargain for what they want or need. Why wouldn’t it be an economist’s goal?

Utilizing comparative advantage means an economy where more people will be able to afford what they want. That’s all. Of course, that’s the goal of most economists: finding a distribution of limited resources that satisfies as many people as possible.

So isn’t it good for everyone to come as close to their comparative advantage as they can?

“Is nation 2 better off?”

With Nation 1’s subsidy, yes. Nation 2 gets more of product A cheaper, and can produce more of product B. More products get produced at the expense of Nation 1’s taxpayers.

I say they might not be better off than they would be if both nations were at comparative advantage. But they might be. I think it could go either way for Nation 2.

Nation 1 still shouldn’t implement subsidies in the first place. I’m not really sure what you’re trying to illustrate here.

Sure, but they’re a sovereign nation. What if they do? If we’re Nation 2, can they damage us by doing it? Can they hurt us worse than they hurt themselves? I’ve seen only handwaving arguments that they can or they can’t.

“Then there’s the defense angle; you have an easier time intimidating people into favorable trade agreements if you make your own guns.”

You can’t come up with a trade agreement that favors only one side. A trade cannot occur unless it benefits both sides, or else one party wouldn’t agree to it. It seems to me that what you’re thinking about is imperialism, which isn’t trade, but looting.

Yes, but it doesn’t have to go that far. You might get considerable trade advantage simply by making the private threat you might invade. Their economy is much better off if their cities don’t get bombed. The government officials that negotiate with you are personally better off if you don’t stage a quick invasion, hang them, and replace them with a government you like more.

“You might have a thousand kinds of dried beans for sale but people mostly don