Getting it right

United States President Donald Trump is not the only purveyor of confusion. The editorial page editor of the Washington Post, Fred Hiatt, writes: “How does the United States counter [China’s record of development]? One comparative advantage, historically, has been the depth and quality of America’s alliances. A visiting American once chided a Chinese leader for his country’s liaisons with unsavory regimes. ‘What do you expect?’ the leader replied. ‘You’ve taken all the good ones.’”

Hiatt is in the wrong ballpark. “Comparative advantage” is the economist’s term for the value of trading the good that you can produce most cheaply, in exchange for goods that you would find more costly to make.

A ridiculous example may help. Suppose that a worker in the US could produce either six cars or two barrels of oil in one day. In Kazakhstan, which has fewer machines than does America, a worker can provide either one barrel or one car in a day. Who should produce what?

One is tempted to say that the US should provide both cars and oil for itself, since its labor force is so much more productive than Kazakhstan’s in both industries. But there are times when one should resist temptation. In reality, the US would gain from trade.

Check out the table below. Suppose that the US extracts a barrel of oil for itself. Then it will have to give up three cars, since its worker could have manufactured them in the time that it took her to produce a barrel of oil instead.  The US would do better to make two cars and sell them to Kazakhstan in exchange for one barrel of oil. The cost to America of trading for the barrel is only two cars; had it produced the oil for itself, it would have had to give up three cars.

	US	Kazakhstan
Cars	6	1
Oil barrels	2	1

Table: Output per labor day in two countries

But is Kazakhstan willing to trade? Consider its situation. If it produces two cars for itself, it will have to forego two barrels of oil. So it would be willing to sell one barrel to the US in exchange for two cars: Losing one barrel is better than losing two.

In short, the US should produce cars and Kazakhstan oil; each should then trade for the other good. The reason is that the US can produce a car more cheaply than Kazakhstan can: the cost for the US is a third of a barrel of oil, whereas it’s a whole barrel for Kazakhstan. The US has a comparative advantage in cars. Similarly, Kazakhstan has a comparative advantage in oil: One barrel costs it only one car but costs the US three cars.

It’s not clear what Hiatt means by “comparative advantage.” He seems to say that a nation should ally with the US rather than with China because the former has a record of forming better alliances than the latter has. This may be closer to what Michael Porter calls a “competitive advantage.” 

-- Leon Taylor tayloralmaty@gmail.com

Reference

Fred Hiatt. Trump’s unilateral disarmament. Washington Post. December 3, 2018.