Tuesday, August 09, 2005

Kaleidoscopic Comparative Advantage

From a Jagdish Bhagwati op-ed in the Wall Street Journal last week:
remember that while the Chinese and Indians have lower wages, we have better infrastructure, stronger venture capital markets, an ability to attract talent from around the world, and a culture of inventiveness. Comparative advantage persists; the road is simply not flat. ... The real problem in the increasingly globalized economy is rather that most producers in traded activities -- an expanding set because services have become steadily more tradeable -- face intensified competition. ... Gone are Adam Smith's days, when no one in Haifa lost sleep because Edinburgh could grow oranges in greenhouses: The cost differences would be substantial. Comparative advantage was "thick," shielded by big buffers. This is no longer so: not predictably from India and China, but almost certainly from somewhere. Hence I use the metaphor: "kaleidoscopic comparative advantage." Today, you have it; but in our state of knife-edge equilibrium, you may lose it tomorrow and regain it the day after.
I like Bhagwati's metaphor. There are hundreds of different markets comparative advantages in each one come and go with small changes in relative productivities and other factors. Today, India may have the comparative advantage in radiology (India produces 1 unit of radiology expertise by giving up 1 unit of other goods and the U.S. produces 0.99 units of radiology by giving up 1 unit of other goods) but tomorrow it could easily flip (India produces 1 unit of radiology for 1 unit of other goods, the U.S. produces 1.01 units of radiology for 1 unit of other goods). Comparative advantage is no longer "thick", impenetrable, it can be easily lost or gained. But that doesn't invalidate the theory itself.

So the straightforward policy conclusion is this:
Evidently, we must strengthen the Adjustment Assistance Programs, which we have done from 1962 when they were introduced at the time of the Kennedy Round of Multilateral Trade Negotiations. They must be rapidly enlarged, especially to include service workers.
Bhagwati also argues that we have to improve education sufficiently such that, for example, engineers can easily move from aerospace to automobiles and back. You would expect transitions costs to be much higher in a world with "kaleidoscopic comparative advantage" because frictional losses from moving labor and human capital around so much would seem to be quite large. But the point is that Jacob Hacker is basically right. We need some kind of income insurance that amalgamates the risk to labor and spreads it out. Otherwise comparative advantage will cease to be useful because we won't have trade anymore.

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