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Archive for September 2011

Green Technology and Comparative Advantage

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When David Ricardo first developed the idea of comparative advantage in order to illustrate the gains from trade he used England and Portugal as examples. Portugal, he argued, had a comparative advantage in producing wine because of its warmer climate and more fertile soil. England, on the other hand, had a comparative advantage in producing wool because of its cooler climate and rockier terrain. That makes sense. England and Portugal, after all, can’t do anything about their climates and can’t do much about the quality of their arable land.

Let’s fast forward through the Industrial Revolution and look at the automobile market in the twentieth century. For the first half of the century, American car companies dominated the industry. Outside of perhaps Germany, American car manufacturers had a comparative advantage in producing cars. By Ricardo’s theory, other countries should allow the U.S. (and Germany) to produce cars and then export them around the world.

Instead, after WWII restrictions were lifter, Japan designated its nascent auto industry as key to economic recovery and growth and provided it with various protections from foreign competition. The result was a Japanese auto industry that eventually came to dominate much of the international market. South Korea followed a similar program and is now also a major international producer. China and India seem to be following the same path.

The story of the auto industry brings into question the theory of comparative advantage when applied to manufactured goods. After all, a factory can be built just as easily in cities in Japan, South Korea, China, or India as in Detroit or Montgomery. With the easy mobility of technology and capital, there is no reason to think that Chinese or Indian auto workers cannot become just as productive as their counterparts in the United States. That is, comparative advantage may fit well in a static situation in which things can’t change (like climate), but it doesn’t work well in a dynamic world in which technology, capital, and skill can change.

So what does this all have to do with green technology? Just about everything, actually. The current news is all of the U.S. solar companies that are either going out of business or moving production to China. In a static world there is little question that China has a comparative advantage in producing most manufactured goods. But if you think there is going to be a huge demand for these new green technologies (and I certainly do) and that China’s low cost labor won’t last forever (it won’t), then there is a strong argument for a U.S. industrial policy to support green manufacturers and try to keep those jobs in this country. The type of protection could be tariffs or quotas or subsidies. The protection could even be time limited (say 10 or 20 years). But if it’s successful it will allow U.S. manufacturers to develop the technology and skill that would allow them to compete globally.

The cost of such a program would be to hurt consumers of green technology and energy in the short run. We would all pay higher prices (for possibly inferior products) just as car buyers in Japan and South Korea did while those industries developed. But it would help U.S. workers (no small benefit in a world of 9% unemployment) and would likely change the long run equilibrium of where these products are produced in 20 years and beyond.

Written by Liam C Malloy

September 7, 2011 at 12:45 pm

Posted in Uncategorized

The Difference Between Being Pro-Market and Pro-Business

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As an economist, I’m generally pro-market. By that I mean I believe that the best way to produce most goods and services is with a free market system. Why? The profit incentive, combined with competition, generally is able to supply customers with what they want at the lowest cost. That is, the free market is generally the most efficient way to produce the stuff we want. Of course, there are times when the market fails. Sometimes there are fixed costs that are so large that competition is not possible (rail, utilities, etc.). Sometimes there are significant externalities (negative or positive) that mean the good or service is over or under produced. Sometimes there are information or bargaining asymmetries that lead to inefficient, or at least inequitable, outcomes. In those cases I believe it is the government’s job to come up with regulations that provide the correct incentives for market players, whether it is a pigovian tax (or surplus) or a cap and trade system, or whatever. On very rare occasions it makes sense for the government to supply or pay for the good itself (education and scientific research are two that come to mind. Oh, and national defense, of course).

But generally I’m pro-market. And as someone who is pro-market, I support policies that help the market function. One of the most important of these is anti-trust legislation. In order for the market to function effectively, there has to be competition. That’s why the justice department is correct in filing suit to stop the merger between AT&T and T Mobile. While mobile phone service will never be one in which there are hundreds or even dozens of firms due to the large fixed costs involved, consumers will end up paying significantly more if we go from four major carriers to three.

When most people think about economics and “the market” they think of business. After all, it’s businesses that compete in the market. And so one of the common misperceptions is that businesses are also pro-market. In fact, most businesses are not pro-market. As long as there have been “business interests” there have been businessmen (and union leaders) talking about “ruinous competition.”

Executives and managers basically have two goals: maximize profits and keep their jobs, not necessarily in that order. One way to do that is by constantly innovating, coming up with new products that customers want and new ways to make those goods more cheaply. But another (and perhaps easier) way of accomplishing those goals is to reduce competition by buying up competitors and keeping new entrants out of your market. If you can get tariffs to keep out foreign goods or legislation that limits competition, so much the better!

Pro-business policies, then, are rarely pro-market. If you limit competition you will increase profits for businesses, but you will do so by reducing choice for consumers and forcing them to pay higher prices. Politicians seem never to make this distinction, maybe because they don’t want to piss off their corporate donors. But it is not a terribly difficult distinction to make, and would be an easy way for Democrats to distinguish themselves from the “pro-business” Republicans. After all, we are all consumers, whether we are a factory worker, a school teacher, a police officer, or a farmer. Lower prices and better products are something we can all support.

Written by Liam C Malloy

September 1, 2011 at 10:24 am

Posted in Market, Policy