Trade, Comparative Advantage, and Their Critics

Last updated November 2004

In January, a highly controversial article was published in the New York Times and International Herald Tribune by Senator Charles Schumer and Paul Craig Roberts, a former Reagan administration official. In this article entitled 'Exporting jobs is not free trade,' Schumer and Roberts make several claims about why Ricardo's doctrine of comparative advantage no longer holds in today's economy.

They begin by arguing that Ricardo assumed in the 18th century that the factors of production - e.g., capital (money), labour, land, etc. - were not easily moved across international borders. This is true. They further argue, however, that: 'Comparative advantage is undermined if the factors of production can relocate to wherever they are most productive: in today's case, to a relatively few countries with abundant cheap labor.'

Consequently, they say, 'some countries win and others lose,' and any new jobs that are created are created overseas, and not in America, or more generally, developed countries. They also emphasize that this is not only the case for unskilled jobs, but also for highly skilled jobs. They cite as examples, as many other have done, the growing outsourcing of IT jobs and radiology analysis to Asia. They conclude by saying: 'Old-fashioned protectionist measures are not the answer, but the new era will demand new thinking and new solutions.'

Responses were quick in coming. Paul Krugman referred to it directly in his New York Times column, saying that 'old fallacies about international trade have been making a comeback lately (yes Senator Charles Schumer, that means you)...' The Economist was similarly disdainful in its recent leader article, arguing strongly that the doctrine of comparative advantage is still a useful one, even if it creates dislocation in the short term. Why do these free traders think Schumer and Roberts are so wrong?

To start, comparative advantage implies that different countries specialize in different products, each producing them as efficiently as possible. That is, productivity is increased, because each country is producing more output with the same inputs it had before. Thus, the economic pie increases, though little is generally said about how this larger pie is distributed among the two countries in Ricardo's theory. So, to the extent that low-wage, unskilled jobs migrate to poorer countries, comparative advantage still holds. Similarly, if there are skilled jobs that can be done more cheaply in poor countries, then those ones will also tend to migrate there.

In fact, trade theory has long recognized this fact in what is called the "factor-proportions" theory of trade. In theory - and remember, this is largely the level on which Roberts and Schumer argue their case - factor mobility has the same effects as trade. That is, in the most basic case, a country relatively abundant in labor will tend to export goods that are labor-intensive, while a country relatively abundant in capital will tend to export goods that are capital-intensive. Trade in goods is thought to be equivalent to trade in factors: it's as if the Indian IT worker was shipped over to the US to perform his job at lower wages. But instead, the IT worker stays in India, and his or her services are shipped via phone lines and satellite signals. The effect is theoretically the same, though many dispute whether this is the case in practice. This is why some are now pushing for immigration to raise the living standards of the poor from developing countries. The impact of such immigration on the (relatively) poor in the developed world, however, would likely be negative. So, America now imports somewhat sophisticated software services from India, which can provide them more cheaply. Both countries are more productive. Indeed, this idea forms much of the logic behind trade liberalization and organizations like the WTO. But there are those who lose as a result.

What Krugman, The Economist, and others dispute is that there will be no jobs left for Americans. They generally admit that IT workers and American radiologists may lose their jobs in the short term. But they also believe that the economy will change structurally in the long term to provide new jobs, because, after all, the economic pie has gotten larger as a result of specialization. Predicting what these may be, however, is difficult, and it may still be the case that those who have lost their jobs will have to upgrade or change their skills to work in these new jobs. Thus, 'winners' and 'losers' do arise from trade, but sorting out who wins and loses is much more difficult than saying winners are poor countries and losers are rich countries. After all, rich countries now get cheaper software and radiology services, other things equal. Rather, winners and losers tend to be specific sectors, occupations and geographic areas.

Furthermore, trade economists generally recognize that this is far from the end of the story (though one could be forgiven for not seeing this in the press). Comparative advantage does not explain all trade. Nor are the welfare effects of trade always clear. Indeed, trade economists have spent much of the past two decades investigating these issues. What does seem clear, however, is that the grounds on which Schumer and Roberts have argued against international trade are not the right ones. That is not to say, however, that there are not others.

What is also worth noting is that Schumer and Roberts called in their article for debate, rather than protectionist measures per se. It seems that in this respect at least, they have succeeded.

See articles:
Exporting jobs is not free trade, by Charles Schumer and Paul Craig Roberts (IHT)
Free Trade in the New Global Economy: A Discussion of the State of US Trade Policy, with Charles Schumer, Paul Craig Roberts, Thomas J. Donahue, Lael Brainard and Ron Nessen (Brookings Institution)
The Churn, by Katherine Boo (New Yorker)