Saturday, December 10, 2016

Comparative advantage: a partial truth

I believe I mentioned that I am sitting in on Nassim Nicholas Taleb's lectures on "Strange Risk" this fall. He brought up a slide on things we could throw out once we properly took account of volatility, and one of them was Ricardo's Law of Comparative Advantage.

That prompted a question from me as to what he meant. I thought the answer was interesting: once we take price volatility into account, it would be foolish to "obey" the law of comparative advantage to slavishly. Why?

Well, he explained, imagine you are France, and you produce only wine (your comparative advantage) and export it in exchange for everything else you need. What happens if, say, everywhere you are exporting to falls under Sharia Law? Or you are Saudi Arabia, in reality producing pretty much only oil, and some great new source of clean energy is developed?

If your nation has hyper-specialized in one good, and the market for that good collapses, your nation is in deep trouble.


5 comments:

  1. Isn't comparative advantage a theory that explains the potential benefits of specialization and international trade rather than a law that can be obeyed or disobeyed ?

    French people engaged in the wine business might choose to diversify their wealth and/or their skill set so they are insured against the wine market collapsing and this would in no way disprove any economic "law" of comparative advantage.

    In reality, being French , they would probably set up a state commission on industrial diversification which would decide to tax wine producers so they could build alternate industries and so open the door for cheaper new world wine to take a chunk of their market share. The theory might be useful to explain this process.

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    Replies
    1. Well, if people treat it as normative, it *can* be obeyed or not! And in discussions of trade, people often *do* treat it as normative.

      And I am not trying to disprove the law: I am pointing out that it is an abstraction, and thus only a "partial truth"!

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    2. I think my concern is that its often the people who think we should use tariffs, subsidies etc to nudge the economy to what they think is its appropriate structure who would have reason to categorize the theory of comparative advantage as a "dangerous law" not to be followed.

      Being of the free-market persuasion I think we would likely get a better outcome if we work towards removing things that hamper free trade (not only taxes and subsidies but also the kind if unfair trade advantages obtained by global corporations as a result of their interactions with state power). And the theory of comparative advantage, combined with other stuff (risk-management and portfolio diversification?) might provide a useful theoretical framework for explaining how this better outcome may be derived.

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    3. "In reality, being French…"

      What the hell is this supposed to mean?

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  2. Actually, this is a very interesting point. It reminds me (in a way) of how panda's eat only bamboo and koala's eucalyptus. Perhaps this specialisation was a great niche at first and no-one else could compete - perhaps they could avoid predators or just enjoy some bounty without competitors, or whatever.
    But now, it seems like a dangerous niche that has "boxed them in" to a particular geography and they are exposed to deforestation or other limits to their supply or something but now they're too "committed" to this one path and have lost adaptability.
    Or something.
    Anyway, great point. Let it percolate for a bit and write it up, I say.

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