December 3, 2007
No pearl, only swine: Senator Clinton takes Paul Samuelson’s name in vain
The Democratic Party has well-established and well-deserved ugly credentials as a hotbed of populist protectionism. Occasionally, we find a pearl among the Democratic swine. Bill Clinton, who never wavered in his support for free trade, even when it was electorally costly, is an example. Unfortunately, this wisdom and courage has not rubbed off on his wife, Senator Hillary Clinton, who is running hard and scared for President of the USA. The other Democratic candidates are, if anything, even more lamentably protectionist than Senator Clinton. The Republicans aren’t much better, but they don’t matter this election, because George W. Bush has made certain that the next president of the USA will be a a Democrat.
When educated persons are deeply ashamed of what they are about to say, they tend to either invoke God or spray the name of a Nobel Laureate around, as a form of mental smokescreen. Senator Clinton goes the Nobel route. Quoting:
I agree with Paul Samuelson, the very famous economist, who has recently spoken and written about how comparative advantage, as it is classically understood, may not be descriptive of the 21st century economy in which we find ourselves.”
This statement is complete codswallop. Granted, Senator Clinton, who doesn’t understand the first thing about economics (as demonstrated by her disastrous attempt at health care reform in the first (Bill) Clinton administration), may not understand precisely why she is talking rubbish. But the benighted adviser who fed her this bit of misinformation can be presumed to be aware that they are feeding their candidate a bill of goods.
One of the great things about intellectual property rights is that you cannot plagiarise yourself. I will therefore shamelessly reproduce a chunk of a comment I posted on July 1, 2007, on the FT Economists’ Forum in response to a careless piece of writing by Larry Summers which, come to think of it, ran along the same lines as the quote from Senator Clinton. Here it is:
In support of his claim that "If globalization is taken to mean a combination of more openness and growth of developing countries it is not even altogether clear that it benefits America in aggregate", Larry invokes Paul Samuelson’s elegant paper on the welfare effects on a nation of growth abroad. The appeal to Samuelson’s (correct) analysis should, however, be taken with a pinch of salt.
Samuelson’s paper deals with the effect of growth abroad on home country welfare in a world with two countries (or regions) that have fully integrated (free, competitive) trade in goods and services throughout (both before and after growth abroad takes place). There is no capital mobility or labour mobility. Samuelson’s analysis is intuitive: if growth abroad (whether through total factor productivity growth or the hard way) is concentrated in sectors where the home country used to have a comparative advantage, the terms of trade may turn so badly against the home country that everyone in the home country is worse off. A nation of candle-makers and candle-exporters who don’t have many productive alternative uses for their labour and capital resources may well be worse off when the rest of the world starts producing cheap gas lamps.
However, despite getting clobbered by this technological change abroad, the candle-makers’ nation can do no better for itself than imposing the optimal tariff and trading away. This was true also before the rest of the world invented and produced the gas lamp. Even with the optimal tariff, the candle-makers’ nation can be worse off than before. ‘Shutting off’ globalisation does not mean reducing openness in the sense of reducing trade. The only way to restore the status quo ante is to stop the rest of the world from producing gas lamps.
Back in the real world, the analogue would be to stop India from producing software, operating call centres and providing back office functions to the world at large. It would mean to stop China from acquiring or re-inventing and then using modern technological and managerial know-how to create a mighty manufacturing machine. You would have to stop both technology transfer and internal R&D and other knowledge creation in the Chindias of this world. This, fortunately, is as impossible as it would be immoral. The genie is out of the bottle.
Given that China, India, the other BRICS and ultimately most other emerging markets and developing countries will acquire modern technology, management techniques and governance institutions, the best response of the old industrial countries (the OECD countries, say) is to trade freely, with just the optimal tariff separating them from truly free trade. Even if the old industrial countries were to be worse off as a result of the growth of the emerging markets and developing countries (a theoretical but not a practical possibility for most countries, although individual groups of workers and owners of capital could well be worse off), they would minimize the extent of the welfare loss by optimal tariff-qualified free trade. Going self-sufficient would mean that the candlemakers would have to eat their own candles.
The optimal tariffs are optimal only from the perspective of the countries setting them. Globally they are welfare-reducing. Intelligent bargaining-with-side- payments at the level of the WTO should ensure that the optimal response of the old industrial countries to the rise of the new giants is unqualified free trade.
Whatever happens, the candle-makers can never get their export markets back. Living with it and trading despite it, is the only efficient policy. Using domestic distributional instruments to meet domestic distributional objectives is the other blade of the policy scissors.
So, no Senator Clinton, you are quite wrong about comparative advantage. Paul Samuelson is, not surprisingly, absolutely right. Despite outsourcing and off-shoring, despite alleged Chinese currency manipulation and the threat of Sovereign Wealth Funds from the Gulf and the far East owning most of Main Street before long, comparative advantage continues to provide the valid foundations for pursuing free trade, preferably multilaterally, but if necessary unilaterally. The exercise of national market power is the only reason to depart from this, if you are confident that there will be no retaliation.
There is more to international economic policy than trade policy of course, and I encourage Senator Clinton to develop new initiatives in the fields of intellectual property rights, multilateral surveillance by the IMF, migration policy, global regulation of internationally mobile financial institutions and instruments, co-operation in tax policy, including tax administration and a co-ordinated crackdown on tax havens and "regulators of convenience".
Many Britons have well-deserved and ugly credentials when it comes to predicting US presidential elections. You seem particularly shrill and rather sure of yourself. Don’t underestimate how badly people hate Hilary on the other side of the pond.
As an MIT alum, having met Paul Samuelson and learned something about the very open-minded, inquisitive way in which he views economics, I doubt he’d be nearly as exorcised about this as you appear. If anything, my guess is he’d be lightly amused–by both you and Hilary.
Posted by: David | December 3rd, 2007 at 12:35 pm | Report this commentArguably, the US can slow down technological progress in China by reducing its trade with China, as much of that progress is supported by the profits (and encouraged by the expected profits) of firms that export largely to the US. To the extent that (as per Samuelson) the US may be harmed by technological progress in China, there is a (selfishly nationalistic) case for reducing trade with China.
Posted by: knzn | December 3rd, 2007 at 2:46 pm | Report this commentI will readily admit to being even more of an ignoramus about economics than Mr. Buiter believes Hillary Clinton to be. However, at the risk of seeming to be impertinent, I would like to ask a question about comparative advantage: Doesn’t this much vaunted concept really boil down to little more than the fact that people in richer countries receive higher salaries because of various union and governmental protections, while those doing the same work in countries like China, which bans unions and has little, if any, protection for workers, do the same work in sweatshop conditions for rock-bottom pay?
Posted by: Semakweli | December 3rd, 2007 at 2:57 pm | Report this commentMr Semakweli is right: he (or she) is even more of an ignoramus than Hillary Clinton. Here, then, is the principle of comparative advantage explained by the great Paul Samuelson.
Imagine a city where the best lawyer happens also to be the best secretary, that is he would be the most productive lawyer and he would also be the best secretary in town. However it is quite clear that this lawyer would focus on the task of being an attorney by employing a secretary instead of doing all the paperwork by himself. This can easily be explained with the concept of comparative advantage: He is the best secretary AND the best lawyer, however by comparing what he can earn as a secretary with the income he could earn by running a law firm AND employing a secretary one can clearly see that the latter option is the better one.
What does this mean for US and Chinese trade? Well, the former has higher productivity than the latter at everything. That is why it also has much higher average real incomes, which is the point Semakweli cannot understand. But the US is relatively more productive at producing skill-intensive goods and services (just like the attorney in the above example), while China is relatively least unproductive at producing labour-intensive goods and services (just like the secretary). So the US exports the former set of goods and services and China exports the latter. That is the end of the story (more or less).
Posted by: Martin Wolf | December 3rd, 2007 at 8:55 pm | Report this commentPaul Samuelson from MIT did write a paper in joujrnal of economic perspective in 2004. In that paper he looked what comparative advantage meant to the US in the age of globalization. I think comparative advatage is one of the “laws” in economics.
Posted by: Tom Hansen | December 3rd, 2007 at 9:16 pm | Report this commentI would like to thank Martin Wolf for restating Ricardo’s important principle of comparative advantage for the benefit of Mr/Ms Semakweli and any others who may have inferred, erroneously, from Senator Clinton’s statement, that Paul Samuelson had refuted Ricardo’s principle of comparative advantage.
I should have provided the reference to the very elegant paper by Paul Samuelson that is at the centre of this discussion. It is: Paul A. Samuelson (2004), “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization”, The Journal of Economic Perspectives, Vol. 18, No. 3 (Summer, 2004), pp. 135-146. Here is a stable URL (subscription only): http://links.jstor.org/sici?sici=0895-3309%28200422%2918%3A3%3C135%3AWRAMRA%3E2.0.CO%3B2-X
Posted by: Willem H. Buiter | December 3rd, 2007 at 11:40 pm | Report this commentThe FT article was headlined ‘Clinton doubts benefits of Doha revival’. But there are huge implications for Britain too.
Mrs Clinton’s remarks echo the scepticism of the public in the US about the benefits of an open global economy.
The debt building up is astronomical. It was reported elsewhere yesterday:
“Foreign governments and investors now hold some $2.23 trillion — or about 44 percent — of all publicly held U.S. debt. That’s up 9.5 percent from a year earlier. Japan is first with $586 billion, followed by China ($400 billion) and Britain ($244 billion). Saudi Arabia and other oil-exporting countries account for $123 billion, according to the Treasury.”
Japan and China are stepping back from supporting the US - the loans from Britain are increasing. Will we get the money back - Northern Rock is pennies by comparison.
Posted by: Slightly Optimistic | December 4th, 2007 at 9:39 am | Report this commentUsing domestic distributional instruments to meet domestic distributional objectives ? I think you probably have a better way of explaining your point than with academia slang that gives an akward twist, probably enjoyed by a few. The use of optimal tariffs is also misleading in your article.
Posted by: Alexandre | December 4th, 2007 at 3:43 pm | Report this commentBut thanks for sharing some light on the topic
The flaw with the “law” of comparative advantage: it is a static model, like most of mainstream classical economics. In a multi-period model there might be advantages to be gained, for example by protecting nascent industries which do not have a comparative advantage, until their productivity rises. It is one way to climb up the value-added ladder, so that a nation doesen’t remain a secretary for life.
Posted by: Ron Cohen-Seban | December 4th, 2007 at 6:11 pm | Report this commentThe Law of comparative advantage is no law [see Tom Hansen’s contribution]. It is the conclusion of a logical piece of reasoning. Change the assumptions of that reasoning and it will probably result in a change of conclusions. According to the FT [3rd Dec. 2007] Senator Hilary Clinton said she agreed with the view that “comparative advantage, as it is classically understood, may not be descriptive of the 21st century economy in which we find ourselves.” Simply repeating the theory doesn’t deal with that problem.
The theory was formulated in about 1816. It’s now 2007. Many things have changed in the intervening period. The theory’s assumptions are fairly stringent and not obviously applicable to a modern economy viz. perfect competition, zero transport costs, factor mobility. We live in a world where trade has expanded on an east west axis much faster than on a north south axis. Germany sells Volkswagons to France whilst the French sell Renaults to Germany. The gravity model of international trade and economies of scale seem a better basis for explaining such patterns than comparative advantage. Capital mobility is greater than in Ricardo’s day, but oddly it moves mainly from high wage economies to other high wage economies, rather than too low wage economies. A large amount of trade now occurs inside multinationals rather than through markets. Some of these factors have been addressed such as the reformulation of theory around imperfect competition but it is by no means certain that these assumptions are any more realistic than the ones they replaced.
Nor should we think that the United States current commitment to free trade springs from its acceptance of the theory. After the American War of independence the British were only to eager re-establish trading relationships with their old colonies on the basis of comparative advantage. Britain would supply manufactured goods the United States agricultural products. George Washington and Alexander Hamilton had no difficulty seeing the flaw in that proposal as the latter pointed out in his ‘Defence of Manufacturing’.
Posted by: paul embley | December 4th, 2007 at 11:37 pm | Report this commentThe United States rose to become the worlds leading economy behind an extensive tariff wall. Its commitment to free trade occurred only after it rose to pre-eminence. Clearly some people in the US are beginning to wonder if that situation has changed
Clive Crook, a former journalist for The Economist, and now a columnist for the Financial Times wrote this in Atlantic last year:
“Paul Samuelson, an undisputed titan of 20th-century
Posted by: Tom Hansen | December 6th, 2007 at 12:55 am | Report this commenteconomics, was once challenged by the mathematician Stanislaw Ulam to
name a single proposition in all social science that was both true and
nontrivial. It took a while, but Samuelson finally thought of a good
answer: the principle of comparative advantage.”
How about Arrow’s impossibility theorem? That would have been my first example.
Posted by: Ron Cohen-Seban | December 6th, 2007 at 4:30 am | Report this comment