Pissing Down Your Leg

Thoughts on Economics and Economic Policy

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.

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Written by Liam C Malloy

September 7, 2011 at 12:45 pm

Posted in Uncategorized

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