Friday, June 4, 2010

Not All Comparative Advantages Are Made Equal

One of the foundations of international trade theory is the old idea of comparative advantage. However, in light of Latin American history, I'd like to make a tweak to it.

Quick overview of comparative advantage
Countries have a certain amount of productive resources (land, labor, capital, etc.) and they use them to produce goods and services. When resources are channeled towards a certain good or service, that means that they can't be used for something else; that is, there's an implicit trade-off every time something is produced. Different countries have different resources and are able to channel them in different ways, which means that different countries give up different amounts of other possible production when they produce the same good. When Country A is able to produce a good without having to give up as much other production as Country B, we say that Country A has a comparative advantage in that good over Country B.

Comparative advantage forms the basis of the argument in favor of trade specialization. Countries should specialize in those things in which they have comparative advantages, and trade for the rest. That way they can have more than what they could have produced individually.

Something's not quite right
After reading about the history of Argentina, and relating it with the history of all the other Latin American countries that tried Import Substitution Industrialization, it's clear that Latin America's experience in specializing in agriculture didn't work out too well for them. Indeed, these countries seem to have been (and, to some extent, still are) rather like leaves tossed about at the mercy of economic winds. At the diplomacy table, they've never had much stature either; rather, it was always the industrial powers that were naming the rules of the game.

Why is it that Latin America found itself in such a weak position? The theory of comparative advantage doesn't give preference to one type of specialization over another. It treats them all as equal. Then why was having a comparative advantage in agriculture such a disadvantage?

Technology and Comparative Advantage
I think the answer to these questions lies in the existence of a technology gap between different types of production.

Some countries are producers of inventions, and some countries are consumers of inventions. For some reason (which I leave to future research) the number of countries that produce inventions has always been small, and the number of countries that rely on those inventions is large. Because the invention-producing countries (currently known as the "developed world," or the "first world") have something that it is rare, and something that the whole world relies on, they gain power. In short, developed countries have a natural monopoly on inventions, and inventions are the most valuable thing humanity has to offer.

To illustrate the point, let's take the case of Argentina and Great Britain in the early 20th century. Great Britain was Argentina's biggest customer of agricultural products, and with the foreign currency that Argentina received in the trade it imported manufactured goods from abroad. Great Britain traded with Argentina because it was convenient; if necessary it could have imported from any other country in the world (because all countries have agriculture), or, at worst, it could have produced its own food. Argentina, however, depended on Great Britain. It needed the foreign currency to buy manufactured goods from Great Britain and the United States, which it wasn't able to produce on its own.

Thus, trading bananas for computers is not an innocent, equal trade; it implicitly signifies a power and dependency relationship.

If economics were only a story about stuff, then the old Ricardian comparative advantage idea would be just fine. But economics is also—and perhaps even more so—a story about power, and that obligates countries to develop the capacity for self-sufficiency.

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