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1. Opportunity Cost, Comparative Advantage
& Competitiveness
If the production function is the most elegant
contribution to thought by economics, i.e., Y = f (K, L,
N), then the theory of comparative advantage is one of its most
obscure. When challenged by mathematician Stanislaw Ulam to “name me
one proposition in all of the social sciences which is both true and
non-trivial,” the Nobel Prize winning economist Paul Samuelson
responded with the theory of comparative advantage because:
"That it is logically true need not be argued before a
mathematician; that it is not trivial is attested by the thousands of
important and intelligent men who have never been able to grasp the
doctrine for themselves or to believe it after it was explained to
them (Samuelson 1969)."
This obscurity partially results because the
theory engages a complex web of economic ideas including absolute
advantage, division and specialization of labour, exchange, factor
endowments, opportunity cost, production possibility frontiers,
relative prices, separation of consumption from production and trade. Furthermore, it would more accurately be
called the theory of comparative cost rather than of advantage. And,
of course, some of its results appear counter-intuitive.
Semantic obscurity has lead to the theory
finding general expression as a numeric example such as that first
used by David Ricardo to demonstrate the theory in his 1817 book
The Principles of Political Economy and Taxation. In his case, it
concerned wheat and wine production in England and Portugal. In
summary, comparative advantage means that mutually beneficial exchange
is possible whenever relative production costs differ prior to trade.
One of its counter-intuitive deductions, however, is that if a country
enjoys an absolute advantage in the production of all goods and
services, i.e., can produce all of them cheaper than anyone
else, it is still better off trading with other countries. The theory
was used by Ricardo to counter arguments in favour of protective
tariffs and trade barriers which, intuitively, promise national
prosperity. It continues to serve this free-trade purpose.
The theory attributes the cause and
benefits of international trade to the differences among countries in
the opportunity cost (cost in terms of other goods given up) of
producing the same commodities. In Ricardo's theory, labour was
the only factor of production. Furthermore, according to Ricardo, the
fact that one country could produce everything more efficiently than
another was not an argument against international trade.
The theory of comparative advantage, in effect,
separates consumption from production. Without trade, a nation can
only consume what it produces. With trade, it is able to consume
more than it produces. Put another way, by specializing in what
it does best, a nation can afford to buy more of what it does worst.
There are, however,
limits - see: Ideological Evolution: Ch. 14 - Competitiveness,
14.4 - Comparative Advantage
The theory of comparative advantage
provides a strong argument in
favour of free international trade and specialization among countries. For clarity, the theory
is usually first outlined as though only two countries and only two commodities
are involved, although the principles are by no means limited to such cases. Consider
the production possibility frontier (PPF) of 'Farmland' (P&B Fig. 35.1;
7th Ed not displayed). If all resources were committed to producing grain then 36 millions
tons would result. If all resources were committed to producing cars some
9 million cars would be produced. The PPF shows the alternative amounts of
grain or cars that could be produced if resources were divided between these two
activities. The slope of the PPF measures the 'opportunity cost' of
producing one car measured by how many tons of grain could not be
produced.
By
way of contrast consider the PPF of Mobilia (P&B
Fig. 35.2;
7th Ed not displayed). If all
resources were committed to grain then 19 tons would be produced; if all
resources were committed to cars, then about 10 million cars would come off the
production line. As above the slope of the PPF measures the opportunity
cost of producing cars vs grain.
In
both cases, a country chooses which combination of the two goods to produce and
consume. For Farmland it is assumed to be 15 tons of grain and 8 million
cars. For Mobilia, it is 18 million tons of grain and 4 million
cars. This mix of outputs assumes no international trade between the
two. The production/consumption mix must be on the PPF.
Cars
are cheaper in Mobilia (one car costs one ton of grain compared to 9 tons in
Farmland; grain is cheaper in Farmland (9 tons cost one car compared to nine
cars in Mobilia). Each has a comparative advantage in one commodity where
comparative advantage is defined as the ability to produce a given good or
service cheaper than another country. If they were to trade both
would benefit. Mobilia would get cheaper grain and Farmland would get
cheaper cars.
First considering only international trade in cars. Farmland has a demand curve
reflecting the quantity of imported cars it would be willing to buy at various
prices (measured in tons of grain - P&B
Fig.
35.3; 7th Ed not displayed). If the price
were the same as the domestic cost of production (9 tons) no cars would be
imported. At any price less that that some cars would be imported.
For Mobilia there is a supply curve of cars it would be willing to sell at
various prices (measured in tons of grain). If the price were the same as
the cost of domestic production (1 ton) the Mobilia would not trade. At
any price higher than the domestic cost of production it would be willing to
trade. Where demand equals supply exchange takes place at a price of 3
tons of grain 4 million cars will be imported into Farmland and 12 million tons
of grain exported to Mobilia. In this exchange it is assumed a balance of
trade will result.
The
effect of trade is to move the consumption possibility curve off and away from
the PPF (P&B
Fig. 35.4). The consumption possibility curve reflects the
'terms of trade', i.e. 3 tons of grain for 1 car. Where this curve is
tangent to each countries PPF marks the new output combination. For
Farmland 30 tons of grain and 5 million cars; for Mobilia, 9 tons of grain and 9
million cars. However, due to trade each can now consume more than before
trade. Thus Farmland now consumes 18 million tons of grain an 9 million
cars (compared to 15 million tons of grain and 8 million cars without trade);
and Mobilia now consumes 21 million tons of grain and 5 million cars (compared
to 18 tons of grain and 4 million cars without trade). Both are better
off.
Even
if one country has an 'absolute advantage' in both commodities, it still pays to
trade. The reason is opportunity cost. Thus while output may be
greater for the same level of inputs in one country, there remains an
opportunity cost to producing one vs. the other commodity. As long as the
opportunity cost of another country is less it still pays to trade.
There is no doubt that competitiveness in
the division and specialization of labour available through free trade leads to a
higher level of consumption and hence well-being of domestic consumers.
Similarly, there is no doubt that some industries win and some lose in a
given nation creating lobbying forces in favour and against trade. But
competitiveness in the form of comparative advantage has its limits.
Competitiveness is generally expressed in sports metaphors such
as: “skating where the puck is going, not where it is” which captures its
anticipative nature (Wilson 1992). In this game, however, some win and some lose
in an “us/them” conflict deciding the destiny of our children, our communities
and our country. Arguably, global competitiveness has ideologically quenched the
last embers of the ‘60s revolution of rising expectations. Fear of job loss has
smothered the hopes of citizen consumers and workers. Instead of George H. Bush
Sr.’s “kinder and gentler society”, we live with George W. Bush Jr.s fear of
downsizing, obsolescence, out sourcing, privatization, redundancies and
technological displacement.
In sports, it is the opposing team that is the challenge. The
playing field, the environment itself, is generally fixed, invariant and
subsidiary to the consciousness of players at play. In biology, however, natural
selection involves not just an opponent but also new invariants and affordances
thrown up by an ever changing environment including predator, prey, possible
mates and/or symbionts (Grene & Depew 2004). Environmental invariants
become subsidiary or 'tacit' to our focal awareness of affordances. In this view,
'knowledge' is orientation in an environment resulting from the tacit
integration of subsidiary and focal awareness into a gestalt whole (Polanyi Oct.
1962) called 'knowing' one's 'fitness landscape'.
In fact, comparative advantage is a natural phenonmenon:
Economics has its roots in agency and the emergence
of advantages of trade among autonomous agents. The advantages of
trade predate the human economy by essentially the entire history of
life on this planet. Advantages of trade are found in the metabolic
exchange of legume root nodule and fungi, sugar for fixed nitrogen
carried in amino acids. Advantages of trade were found among the
mixed microbial and algal communities along the littoral of the
earth’s oceans four billion years ago. The trading of the
econosphere is an outgrowth of the trading of the biosphere. (Kauffman
2000, 211)
Given such an active environment, autonomous agents – organisms
or institutions – constantly adapt, adjust and evolve or go extinct. They adapt
by experimenting with mutations called preadaptations or exaptations. According
to Kauffman, these come from the adjacent possible consisting “of all those
molecular species that are not members of the actual, but are one reaction step
away from the actual” (Kauffman 2000, 142). In the noösphere, it is those new
ideas generated by 'research & development' in the natural & engineering
sciences, new ideologies generated by the humanities & social sciences including
the so-called management sciences and by the new aesthetics, forms and designs
thrown up by the Arts. Economic, epistemic and biological systems expand
or explore the adjacent possible as quickly as possible subject to timely
selection of the fit and unfit, e.g., going out of business. Such timely
selection is called ‘early visibility’ and ‘fast failing’ in the innovation
literature (Economist October 11, 2007). I
If selection takes too long, then fitness may decline or
simply melt away. Arguably, this explains ‘de-industrialization’ of some First
World Nation-States. They maintained existing plant and equipment, e.g., in
steel production, until fully depreciated through voluntary (and sometimes
involuntary) quotas on imports from developing Asian producers who were
investing in the best new technologies emerging from the adjacent possible. The
fitness of the West fell, at least in terms of the traditional
manufacturing-based economy. In this sense Darwinian fitness is not simply
bodily strength, intelligence, vigor or bravery vis-à-vis rivals. Rather,
fitness is a compounded result of the mutual relationship between an organism
and its environment including symbiotic as well as predator/prey relationships.
And symbionts can significantly enhance fitness, i.e., the
probability one will survive and leave descendants. Arguably this is what
the European Union and to a lesser extent what NAFTA represent: the symbiotic
survival of the nation-state in a global knowledge-based economy.
For a more detailed analysis, please see my
assessment of the changing sands of sovereignty upon which the modern
Nation-State rest
as well as my comparison
between competitiveness and 'fitness' as a test:
2. Exports, Imports, Deficit & Surplus
Exports
are what we sell and imports are what we buy from other countries. The
balance of trade is the difference between our exports and imports. If
imports exceed exports there is a 'trade deficit' that must be financed by
borrowing from abroad or selling off assets. If exports exceed imports
there is a 'trade surplus' and the difference can be used to lend to other
countries or buy assets. As will be seen trade in goods & services makes
up the bulk of the 'current account' with other countries. There is also a
'capital account'. Together - capital and current - constitute the
'balance of payments'.
What
we buy and sell includes goods and services. Goods are fairly straight
forward. They essential include things produced by the primary and
secondary sectors of the economy. The primary sector includes
farming, fishing, forestry and mining industries. The secondary sector
involves the manufacturing industries. The tertiary sector involves services are a little more
complex. Some are fairly obvious like tourism and transportation, e.g. a
Canadian goes to France and stays in a hotel, buys restaurant food, etc. and
this counts as an import; a French person comes to Canada and does the same and
it counts as an export. As they say: follow the money. Some services
are more intangible like banking and management services, engineering and design
services as well as the flow of intellectual property royalties.
Canada's pattern of trade is
dominated by the U.S., both with respect to imports and exports.
China, Japan and the UK are our next most important export markets.
While our exports flow principally from the primary industries,
secondary and tertiary industries are slowly growing as export players.
We are no longer just "hewers of wood and drawers of water". By contrast our imports are dominated by secondary and tertiary sectors.
However, it is increasingly from, what I call, the 'quaternary sector',
i.e. royalties on intellectual property rights (IPRs) which constitute the legal
foundation for the industrial organization of a knowledge-based economy.
The evolution of the
multilateral intellectual and cultural property rights regime is the
subject of one of my articles. I will, in class, outline the
nature of IPRs.
3. Trade Restrictions
- autarky, trade barriers and war
- Effects of a Tariff (P&B
Fig. 35.6;
7th Ed Fig. 31.3)
-
Effects of a Quota (P&B
Fig. 35.7;
7th Ed Fig. 31.4)
4. The WTO
& the Global Knowledge-Based Economy
In 1995 the World Trade Organization (WTO)
began operations and a new global economy was born (WTO 1994a).
Today, 2005, virtually all member states of the United Nations (UN)
belong to the WTO with the notable exception of the Russian
Federation. Put another way, global regulation of political and
military competition by the UN beginning in 1945 was extended to
global regulation of economic competition by the WTO fifty years
later. This was possible only because of the global triumph of the
Market over Marx.
For the first time, virtually all
nation-states agreed to abide by common rules of trade recognizing the
WTO as final arbitrator of disputes and authorizing it to sanction
countervailing measures against offenders of its rules. Given the
historical role of trade disputes fueling international conflict, the
WTO compliments the UN as a bulwark of international peace, law and
order.
As an international legal instrument, the
WTO is a ‘single undertaking’, i.e., it is a set of instruments
constituting a single package permitting only a single signature
without reservation. One of these instruments is the Trade-Related
Intellectual Properties and Services Agreement (TRIPS, WTO 1994b) that
constitutes, in effect, a global agreement on trade in knowledge, or
more precisely, in intellectual property rights (IPRs) such as
copyrights, patents, registered industrial designs and trademarks.
TRIPS is, however, but one part of the complex WTO package that
includes the General Agreement on Tariffs and Trade (GATT) and
twenty-six other technical agreements.
TRIPS, in turn, exists in the context of a
constellation of international agreements, conventions, covenants and
treaties administered by the World Intellectual Property Organization
(WIPO
1979) a special subject agency of the United Nations. TRIPS requires
accession to some but not to all WIPO instruments. In turn, WIPO
instruments apply only to Nations-States that accede to them.
Generally, acceding States provide only ‘national treatment’ to
citizens of other States, i.e., the same rights are extended as
if they were nationals but the rights so extended are defined by each
national legislature. This treatment contrasts with ‘harmonization’,
characteristic of other WTO efforts, e.g., definition of
subsidies. Currently ‘in force’ WIPO instruments, as well as TRIPS,
ignore and thereby deny protection to ‘non-marketable’ intellectual
property rights, e.g., aboriginal heritage rights (Farrer 1994;
Chartrand 1995)
including rights to traditional ecological knowledge or (TEK) as well
as collective or community-based intellectual property rights in
general (Shiva 1993). Such ignored rights, together with commercial
rights that have lapsed through time, constitute the public domain of
knowledge from which any and all may freely draw.
In 1996, the Organization for Economic
Cooperation and Development (OECD), whose members constitute the First
World of developed, democratic market economies, published
The Knowledge-Based Economy
(OECD 1996). The next year the OECD published guidelines for
competitiveness in this new economy: National Innovation Systems
(OECD 1997).
Creation of the WTO and recognition of the
knowledge-based economy by the OECD initiated an avalanche of change.
Almost immediately, rapid institution building began, continuing to
this day, in public and private sectors around the world. A new
specialty emerged – ‘knowledge management’, not to be confused with
its predecessor - information management; the ‘Chief Knowledge
Officer’ (CKO) is becoming an hierarchical feature of multi- and
trans-national corporations; governments are creating knowledge
ministries, departments and agencies; ‘knowledge audits’ are being
conducted by firms and nation-states around the world (Malhorta
2000); and, nation-states themselves are designing
‘national innovation systems’ (NIS) to generate and market new
knowledge (OECD 1997). Even a standardized lexicon or vocabulary is
being drafted to guide public and private sector discussion and debate
(American
National Standards Institute and the Global Knowledge Economics
Council 2001).
Only time will tell whether all this
conceptual and institutional activity is a passing policy fad or marks
a true evolutionary leap in economic development and thinking. What
is certain is that knowledge is now recognized as a strategic asset in
the competitiveness of nations. What is equally certain, however, is
that the ‘Standard Model’ of economic thought is theoretically
inadequate to deal with this new economy.
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