“Ricardo revisited”: Back to 2004

In a piece titled “Ricardo Revisited: Sino-American Trade and Economic Conflict,” Ralph E. Gomory and William J. Baumol write:

In this note we look carefully at the impact on a developed nation of the economic development of its trading partner; a trading partner that is developing from a rather undeveloped state. If you want to keep the China-U.S. relationship and the impact on the United States of China’s development in mind as a possible example, you will not go far wrong.

We will discuss what a very standard model, the Ricardo model, shows about this situation. We will see that this very familiar model, properly analyzed, has a number of very unfamiliar consequences. Notably:

  1. The economic development of your trading partner can be harmful to you, the home country.  Although the effect of that development starts out good, it ends badly.
  2. That there is a dominant and dominated relation possible between the two countries that is good for the dominant one and bad for the dominated one.
  3. A country can attain a dominant position only by having an undeveloped trading partner. This can occur naturally if the trading partner is simply there in an underdeveloped state, or the underdevelopment can be brought about by mercantilist actions that destroy that partner’s industries.
  4. There is inherent conflict not only between a nation in a dominant position and its trading partner, but also between that dominant nation and what may loosely be called the interests of the world. In a two-country model of the sort we discuss here this simply is measured as the sum of the benefits obtained by the two countries’ economies.  We assert that from a world point of view, having either nation dominant is bad.
  5. While a country cannot gain a dominant position solely by building up its industries, it can avoid a dominated position by developing its own industries and not allowing them to be destroyed.

We will explain more clearly what we mean by these assertions as we go along… We will also explain enough about the Ricardo model to make that intelligible to those not already familiar with it.

A quick skim of their Appendix A shows that this is literally the standard Ricardian model. They’re just going to discuss comparative statics — what happens to the equilibrium outcome when countries’ productivities change? Unfortunately, a lot seems to obscured by their choice of words.

In the model, countries are symmetric in size and the representative consumers have identical Cobb-Douglas preferences. The “dominant” country is the economy with a larger share of world income — this means that it is more productive and/or makes the good with the larger expenditure share. The words “mercantilist” and “destroy” only appear in the introduction and conclusion, so I can’t say how they’re related to the analysis. Productivity is exogenous in the model and there are no policy instruments, so I don’t see how one avoids destroying industries or can actively frustrate the other economy’s productivity growth.

The word choice is frustrating, because some commentators have interpreted this as an attack on mainstream international economics: “Ralph Gomory and William Baumol, who have posited a much more widely applicable, if equally mathematically watertight, challenge to conventional trade theory.”

Nonsense. This is conventional trade theory. Whip out your copy of Dornbusch, Fischer, and Samuelson (AER, 1977) and turn to page 827:

An alternative form of technical progress that can be studied is the international transfer of the least cost technology. Such transfers reduce the discrepancies in relative unit labor requirements — by lowering them for each z in the relatively less efficient country — and therefore flatten the A(z) schedule in Figure 1. It can be shown that such harmonization of technology must benefit the low-wage country, and that it may reduce real income in the high-wage country whose technology comes to be adopted. In fact, the high-wage country must lose if harmonization is complete so that relative unit labor requirements now become identical across countries and all our consumer’s surplus from international trade vanishes.

According to Arvind Panagariya, this result was first shown by Harry Johnson in the 1950s. It had another widespread discussion in 2004 when Paul Samuelson revived it with a JEP article. (I remember blogging that seven years ago!) I see no challenge to orthodoxy here.

The standard Ricardian model doesn’t have intertemporal dynamics, so Gomory and Baumol aren’t in a great position to do welfare analysis, but let’s discuss it nonetheless. Note that free trade is preferable to autarky in every period. So cutting ourselves off from trade with China isn’t the answer. The options are either to (1) improve US productivity or (2) retard Chinese technical progress. I’m not aware of any free trader opposing the former, and the policy instruments available for the latter are, in the words of Avinash Dixit and Gene Grossman, “to ‘bomb China back into the stone age’ of their older lower productivity.”