Saturday, September 12, 2009

Absolute vs. Comparative Advantage

Pres. Obama "opted" today to impose a tariff on tires imported from China [1]. It's funny that today I listened to the chapter in Thomas Sowell's book "Basic Economics" on why tariffs are a bad economic decision.

I also listened to the chapter explaining absolute economic advantage and relative economic advantage. An absolute advantage would be the case where a country can build products cheaper than another country. Dr. Sowell gave an interesting example to explain a relative advantage. Hang in there while I try to explain this (the result is surprising).

In his example, he considers two products: chairs and televisions. The countries are America and Canada. America has the absolute advantage since one American can produce 500 chairs per month while one Canadian can only produce 450. Also, an American can produce 200 television sets per month while a Canadian can only produce 100 (If you're Canadian, switch the numbers if it makes you feel better).

If there are 500 hundred American workers and 500 hundred Canadian workers, we could have 300 of each make chairs while 200 make televisions. I'll spare you the math, but the result is 190,000 chairs and 90,000 televisions.

If instead, all 500 Americans make televisions and all 500 Canadians make chairs, you end up with 225,000 chairs and 100,000 televisions. This is an increase in both numbers! The reason is "that Canada has a comparative advantage making chairs. That is, Canada loses fewer television sets by shifting resources to the production of chairs than the United States would lose by such a shift." This seemed counter-intuitive to me.

Back to tariffs. History shows that countries that reduce trade barriers prosper more (gain more jobs) than countries that impose tariffs. If this is true, why do Politicians support tariffs?

The answer is comparative advantage. For a politician that wants to get reelected, the workers (from our example, American chair makers) have the comparative advantage when voting, since they will be angry about losing their job and more likely to "vote the bum out". The rest of the voters will probably be split about the decision. The problem here is that the comparative advantage for voting is BAD for the whole economy, since this influences the politician to impose tariffs to save jobs. But what if China has a comparative advantage at making tires? Wouldn't it be better to have Americans making something that they are more productive at than making tires?

Many economists believe that the protectionist policies imposed in the 1930's are what lead us into a depression. If so, why do our politicians keep making stupid financial decisions? It's simple, they follow the economics of the vote, instead of the economics of prosperity.

What does the average citizen do about it? They attend Tea Parties and Town Hall meetings, talk to neighbors, forward emails, write on blogs, etc. Hopefully this will get the attention of politicians and result in a realignment the two economies.

Vote for prosperity!

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1 comment:

Kevin said...

One of the problems with capitalism and democracy is that, while capitalism provides the best long-term aggregate economic results, it exhibits real-world dynamical system effects like overshoots, time delays, etc.; individuals are never guaranteed their own specific positive outcome. So, in times like these when the big complex dynamical system that is the economy is busy oscillating, the individuals who are getting whipsawed are vulnerable to people who claim to have a way to improve each person's specific outcome, usually by taking that which belongs to others via taxes (including tariffs). They may be well-meaning, but are wrong just the same.

This is summed up wonderfully in an essay by William Graham Sumner called "The Forgotten Man"; the opening lines are:
The type and formula of most schemes of philanthropy or humanitarianism is this: A and B put their heads together to decide what C shall be made to do for D. The radical vice of all these schemes, from a sociological point of view, is that C is not allowed a voice in the matter, and his position, character, and interests, as well as the ultimate effects on society through C's interests, are entirely overlooked. I call C the Forgotten Man.

For more on this, especially as it relates to bad economic times, check out a recent history of the Great Depression - The Forgotten Man by Amity Shlaes. The parallels to today, especially in the type of government intervention advocated by those in power, is worrisome, especially the causes of the "Depression within the Depression" of 1937 onward.