Palley on Comparative Advantage

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Mark Thoma sends us to Thomas Palley’s critique of modern trade policy. Frankly, I find much of his post rather confusing.

For example, Palley opens by writing:

The classical theory of comparative advantage has driven US trade policy for the past fifty years. That policy, in combination with technical innovations that have lowered costs of transportation and communication, has opened the global economy. Yet paradoxically, this opening has rendered classical trade theory obsolete. That in turn has left the US economically vulnerable because its trade policy remains stuck in the past and based on ideas that no longer hold.

US trade policy has been driven by the theory comparative advantage? I doubt this. Immediately after WWII, the founding of the GATT was largely motivated by the economic disaster of the interwar period and protectionism’s exacerbation of international tensions in the 1930s. Once the GATT members started cutting tariffs, they largely liberalized industrial sectors, not areas in which poor countries had comparative advantage, like agriculture and textiles.

In fact, the motivation for new trade theory was the inability of the classic theory to explain trade:

For some time now there has been considerable skepticism about the ability of comparative cost theory to explain the actual pattern of international trade. Neither the extensive trade among the indsutrial countries nor the prevalence in this trade of two way exchanges of differentiated products make much sense in terms of standard theory. As a result many people have concluded that a new framework for analyzing trade is needed. [Paul Krugman, Rethinking International Trade, p.22]

Although Ricardian or Hecksher-Ohlin theories of comparative advantage may have constituted the bulk of trade theory prior to 1980, I think it would be very difficult to make the case that they were important determinants of US trade policy.

In his next paragraph, Palley writes:

The logic behind classical free trade is that all can benefit when countries specialize in producing those things in which they have comparative advantage. The necessary requirement is that the means of production (capital and technology) are internationally immobile and stuck in each country. That is what globalization has undone.

While it is true that the basic Hecksher-Ohlin model features KF and KH, this simple assumption is not critical to the logic of comparative advantage. Where there are differences in factor endowments and opportunity costs, there are potential gains from trade. If capital is more scarce in poor countries, then capital mobility will result in some rich country capital owners investing in the poor countries to earn higher returns. But only in the extreme case that all countries have the same proportional factor endowments will there be no potential gains from trade. Capital mobility is far from a “necessary requirement” for comparative advantage. See Paul Krugman and Don Boudreaux (pdf) for past encounters with this argument.

The rest of Thomas Palley’s post is largely about empirical issues, but they are either well-worn (the “race to the bottom” arguments) or under-researched at present (trade and income inequality). I’ll leave those for others to tackle.

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