In the Wolf-Stiglitz trade discussion the other day, there were several threads going, and in that I lost sight of (or time for) some of the questions others had posed. I will begin today with some observations to bring together some key themes from Wolf and Stiglitz, then we'll move onto the context for the discussion today. Specifically, the impacts of trade on domestic economies in "rich" countries like the U.S.
Two questions from the other day that deserve more than the half-treatment they got the other day. Both are linked to comparative advantage and factors of production. Robert and Amanda raised these questions. Let's discuss them a bit.
Robert asked about page 83 in Wolf. The crux of that quote is the following. If you think about it, comparative advantage matters most when the factors of production (capital and labor) are not really free to spill across borders. That is, when they are confined to their home country. Imagine capital and labor could "flow" anywhere. Capital would move wherever the best profit opportunities are, and if we had totally free migration, laborers could move wherever the best wage-earning opportunities are.
At the extreme, for reasons I can explain in class, we would expect labor's wages (for instance) to converge in all different countries to some global average. No longer would US wages be high and Burkinabe wages be low; Burkinabe and other people would flock to the US, driving down US wages and making labor more scarce in Burkina (thereby raising wages in Burkina) until the wages averaged out (or the "market cleared" or global "equilibrium" was reacted). Again, that's an extreme example, but you see the logic. Similar story with capital. People would put their money wherever the opportunities are, and in the long run (hopefully before "we are all dead") the returns to capital should converge across countries. (There is actually a wrinkle here that takes into account the "Silicon Valley" phenomenon we discussed the other day, and that Ben hinted at on his blog, which is that returns should converge towards the actual productivity of inputs, but let's set that aside momentarily and discuss it in class.) What Wolf is getting at is that comparative advantage matters mainly because these "extreme" conditions do not hold. Labor and (to a lesser extent) capital tend to be somewhat more confined to their homes, for reasons ranging from government policies to language barriers to the fact that geography still matters and it still costs something to move things around (see again Ben's comments). We can follow up as needed.
Amanda asked a question (on p. 81) that is related, or has a related answer. Keep in your head the observation above: totally free flow of factors of production (capital and labor) would tend to equalize the returns to each (profits and wages, respectively). As a term of art, you can call this "factor price equalization", a phrase we will see down the line. So what about this, from Wolf: "The shrinking import-competing industry is not competing with imports from foreigners, but with what its own domestic export industry can pay." Let's go to an example to illustrate. North Carolina used to make lots of furniture (around Hickory, e.g.), but now has to compete with Malaysia. It is a "shrinking import-competing industry". You might think, of course North Carolina furniture makers compete with Malaysian furniture makers. (Fair enough.) But Wolf's point is that North Carolina furniture makers fundamentally compete with other American industries for workers. A central issue is that workers in the U.S. command and expect certain average wages, and this is part of what makes North Carolina furniture less competitive. It's not only low wages in Malaysia, it's high wages in the U.S. Look at the previous sentence on p. 81 and fill in some blanks "Opening [the U.S.] to trade moves output in the direction of activities that offer domestic factors of production the highest returns. Read: freer trade with Malaysia will lead the U.S. to produce less furniture and more jet engines because furniture makers can't compete with Boeing in one of two ways:
a) They can't compete in terms of the wages they can pay American workers and still compete with the Malaysians, or
b) If they do pay the same wages as a Malaysian furniture maker, they won't attract capital (Because, well... where would you invest your hard-earned money if you want a return? A Malaysian furniture maker with low costs or an American one with high costs?)
Thus, "industries compete inside countries for the services of [labor and capital]".
We can talk about this more in class, but I wanted to follow up since I left this conversation underdeveloped the other day.
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