Misconceptions About Comparative Advantage
There is no shortage of muddled ideas in economics. Politicians, business leaders, and even
economists frequently make statements that do not stand up to careful economic analysis.
For some reason this seems to be especially true in international economics. Open the business
section of any Sunday newspaper or weekly news magazine and you will probably find
at least one article that makes foolish statements about international trade. Three misconceptions
in particular have proved highly persistent. In this section we will use our simple model
of comparative advantage to see why they are incorrect.
Productivity and Competitiveness
Myth 1: Free trade is beneficial only if your country is strong enough to stand up to foreign
competition. This argument seems extremely plausible to many people. For example,
a well-known historian once criticized the case for free trade by asserting that it may fail to
hold in reality: “What if there is nothing you can produce more cheaply or efficiently than
anywhere else, except by constantly cutting labor costs?” he worried.2
The problem with this commentator’s view is that he failed to understand the essential
point of Ricardo’s model—that gains from trade depend on comparative rather than
absolute advantage. He is concerned that your country may turn out not to have anything it
produces more efficiently than anyone else—that is, that you may not have an absolute
advantage in anything. Yet why is that such a terrible thing? In our simple numerical
example of trade, Home has lower unit labor requirements and hence higher productivity
in both the cheese and wine sectors. Yet, as we saw, both countries gain from trade.
It is always tempting to suppose that the ability to export a good depends on your
country having an absolute advantage in productivity. But an absolute productivity
advantage over other countries in producing a good is neither a necessary nor a sufficient
condition for having a comparative advantage in that good. In our one-factor model, the
reason that an absolute productivity advantage in an industry is neither necessary nor sufficient
to yield competitive advantage is clear: The competitive advantage of an industry
depends not only on its productivity relative to the foreign industry, but also on the
domestic wage rate relative to the foreign wage rate. A country’s wage rate, in turn,
depends on relative productivity in its other industries. In our numerical example,
Foreign is less efficient than Home in the manufacture of wine, but it is at an even greater
relative productivity disadvantage in cheese. Because of its overall lower productivity,
Foreign must pay lower wages than Home, sufficiently lower that it ends up with lower
costs in wine production. Similarly, in the real world, Portugal has low productivity in
producing, say, clothing as compared with the United States, but because Portugal’s productivity
disadvantage is even greater in other industries, it pays low enough wages to
have a comparative advantage in clothing over the United States all the same.
But isn’t a competitive advantage based on low wages somehow unfair? Many people
think so; their beliefs are summarized by our second misconception.
The Pauper Labor Argument
Myth 2: Foreign competition is unfair and hurts other countries when it is based on low
wages. This argument, sometimes referred to as the pauper labor argument, is a particular
favorite of labor unions seeking protection from foreign competition. People
who adhere to this belief argue that industries should not have to cope with foreign
industries that are less efficient but pay lower wages. This view is widespread and has
2Paul Kennedy, “The Threat of Modernization,” New Perspectives Quarterly (Winter 1995), pp. 31–33.
38 PART ONE International Trade Theory
acquired considerable political influence. In 1993, Ross Perot, a self-made billionaire
and former presidential candidate, warned that free trade between the United States and
Mexico, with the latter’s much lower wages, would lead to a “giant sucking sound” as
U.S. industry moved south. In the same year, another self-made billionaire, Sir James
Goldsmith, who was an influential member of the European Parliament, offered similar
if less picturesquely expressed views in his book The Trap, which became a best seller
in France.
Again, our simple example reveals the fallacy of this argument. In the example, Home
is more productive than Foreign in both industries, and Foreign’s lower cost of wine production
is entirely due to its much lower wage rate. Foreign’s lower wage rate, however, is
irrelevant to the question of whether Home gains from trade. Whether the lower cost of
wine produced in Foreign is due to high productivity or low wages does not matter. All
that matters to Home is that it is cheaper in terms of its own labor for Home to produce
cheese and trade it for wine than to produce wine for itself.
This is fine for Home, but what about Foreign? Isn’t there something wrong with basing
one’s exports on low wages? Certainly it is not an attractive position to be in, but the
idea that trade is good only if you receive high wages is our final fallacy.
Do Wages Reflect Productivity?
In the numerical example that we use to puncture
common misconceptions about comparative advantage,
we assume that the relative wage of the two
countries reflects their relative productivity—specifically,
that the ratio of Home to Foreign wages is in a
range that gives each country a cost advantage in one
of the two goods. This is a necessary implication of
our theoretical model. But many people are unconvinced
by that model. In particular, rapid increases in
productivity in “emerging” economies like China
have worried some Western observers, who argue
that these countries will continue to pay low wages
even as their productivity increases—putting highwage
countries at a cost disadvantage—and dismiss
the contrary predictions of orthodox economists as
unrealistic theoretical speculation. Leaving aside the
logic of this position, what is the evidence?
The answer is that in the real world, national wage
rates do, in fact, reflect differences in productivity. The
accompanying figure compares estimates of productivity
with estimates of wage rates for a selection of
countries in 2007. Both measures are expressed as percentages
of U.S. levels. Our estimate of productivity is
GDP per worker measured in U.S. dollars. As we’ll
see in the second half of this book, that basis should
indicate productivity in the production of traded goods.
Wage rates are measured by wages in manufacturing.
If wages were exactly proportional to productivity,
all the points in this chart would lie along the indicated
45-degree line. In reality, the fit isn’t bad. In
particular, low wage rates in China and India reflect
low productivity.
The low estimate of overall Chinese productivity
may seem surprising, given all the stories one hears
about Americans who find themselves competing
with Chinese exports. The Chinese workers producing
those exports don’t seem to have extremely low
productivity. But remember what the theory of comparative
advantage says: Countries export the goods
in which they have relatively high productivity. So
it’s only to be expected that China’s overall relative
productivity is far below the level of its export
industries.
The figure that follows tells us that the orthodox
economists’ view that national wage rates reflect
national productivity is, in fact, verified by the data
at a point in time. It’s also true that in the past, rising
relative productivity led to rising wages. Consider,
for example, the case of South Korea. In 2007, South
Korea’s labor productivity was about half of the U.S.
level, and its wage rate was actually slightly higher
than that. But it wasn’t always that way: In the not
too distant past, South Korea was a low-productivity,
low-wage economy. As recently as 1975, South
CHAPTER 3 Labor Productivity and Comparative Advantage: The Ricardian Model 39
3Bob Herbert, “Sweatshop Beneficiaries: How to Get Rich on 56 Cents an Hour,” New York Times (July 24,
1995), p. A13.
Productivity and Wages
A country’s wage rate is roughly
proportional to the country’s
productivity.
Source: International Monetary Fund, Bureau of
Labor Statistics, and The Conference Board.
Korean wages were only 5 percent those of the
United States. But when South Korea’s productivity
rose, so did its wage rate.
In short, the evidence strongly supports the view,
based on economic models, that productivity increases
are reflected in wage increases.
Exploitation
Myth 3: Trade exploits a country and makes it worse off if its workers receive much lower
wages than workers in other nations. This argument is often expressed in emotional terms.
For example, one columnist contrasted the multimillion-dollar income of the chief executive
officer of the clothing chain The Gap with the low wages—often less than $1 an hour—paid
to the Central American workers who produce some of its merchandise.3 It can seem hardhearted
to try to justify the terrifyingly low wages paid to many of the world’s workers.
If one is asking about the desirability of free trade, however, the point is not to ask whether
low-wage workers deserve to be paid more but to ask whether they and their country are worse
off exporting goods based on low wages than they would be if they refused to enter into such
demeaning trade. And in asking this question, one must also ask, What is the alternative?
Abstract though it is, our numerical example makes the point that one cannot declare that
a low wage represents exploitation unless one knows what the alternative is. In that example,
Foreign workers are paid much less than Home workers, and one could easily imagine a
columnist writing angrily about their exploitation. Yet if Foreign refused to let itself be
“exploited” by refusing to trade with Home (or by insisting on much higher wages in its
export sector, which would have the same effect), real wages would be even lower: The purchasing
power of a worker’s hourly wage would fall from 1/3 to 1/6 pound of cheese.
The columnist who pointed out the contrast in incomes between the executive at The
Gap and the workers who make its clothes was angry at the poverty of Central American
workers. But to deny them the opportunity to export and trade might well be to condemn
them to even deeper poverty.
There is no shortage of muddled ideas in economics. Politicians, business leaders, and even
economists frequently make statements that do not stand up to careful economic analysis.
For some reason this seems to be especially true in international economics. Open the business
section of any Sunday newspaper or weekly news magazine and you will probably find
at least one article that makes foolish statements about international trade. Three misconceptions
in particular have proved highly persistent. In this section we will use our simple model
of comparative advantage to see why they are incorrect.
Productivity and Competitiveness
Myth 1: Free trade is beneficial only if your country is strong enough to stand up to foreign
competition. This argument seems extremely plausible to many people. For example,
a well-known historian once criticized the case for free trade by asserting that it may fail to
hold in reality: “What if there is nothing you can produce more cheaply or efficiently than
anywhere else, except by constantly cutting labor costs?” he worried.2
The problem with this commentator’s view is that he failed to understand the essential
point of Ricardo’s model—that gains from trade depend on comparative rather than
absolute advantage. He is concerned that your country may turn out not to have anything it
produces more efficiently than anyone else—that is, that you may not have an absolute
advantage in anything. Yet why is that such a terrible thing? In our simple numerical
example of trade, Home has lower unit labor requirements and hence higher productivity
in both the cheese and wine sectors. Yet, as we saw, both countries gain from trade.
It is always tempting to suppose that the ability to export a good depends on your
country having an absolute advantage in productivity. But an absolute productivity
advantage over other countries in producing a good is neither a necessary nor a sufficient
condition for having a comparative advantage in that good. In our one-factor model, the
reason that an absolute productivity advantage in an industry is neither necessary nor sufficient
to yield competitive advantage is clear: The competitive advantage of an industry
depends not only on its productivity relative to the foreign industry, but also on the
domestic wage rate relative to the foreign wage rate. A country’s wage rate, in turn,
depends on relative productivity in its other industries. In our numerical example,
Foreign is less efficient than Home in the manufacture of wine, but it is at an even greater
relative productivity disadvantage in cheese. Because of its overall lower productivity,
Foreign must pay lower wages than Home, sufficiently lower that it ends up with lower
costs in wine production. Similarly, in the real world, Portugal has low productivity in
producing, say, clothing as compared with the United States, but because Portugal’s productivity
disadvantage is even greater in other industries, it pays low enough wages to
have a comparative advantage in clothing over the United States all the same.
But isn’t a competitive advantage based on low wages somehow unfair? Many people
think so; their beliefs are summarized by our second misconception.
The Pauper Labor Argument
Myth 2: Foreign competition is unfair and hurts other countries when it is based on low
wages. This argument, sometimes referred to as the pauper labor argument, is a particular
favorite of labor unions seeking protection from foreign competition. People
who adhere to this belief argue that industries should not have to cope with foreign
industries that are less efficient but pay lower wages. This view is widespread and has
2Paul Kennedy, “The Threat of Modernization,” New Perspectives Quarterly (Winter 1995), pp. 31–33.
38 PART ONE International Trade Theory
acquired considerable political influence. In 1993, Ross Perot, a self-made billionaire
and former presidential candidate, warned that free trade between the United States and
Mexico, with the latter’s much lower wages, would lead to a “giant sucking sound” as
U.S. industry moved south. In the same year, another self-made billionaire, Sir James
Goldsmith, who was an influential member of the European Parliament, offered similar
if less picturesquely expressed views in his book The Trap, which became a best seller
in France.
Again, our simple example reveals the fallacy of this argument. In the example, Home
is more productive than Foreign in both industries, and Foreign’s lower cost of wine production
is entirely due to its much lower wage rate. Foreign’s lower wage rate, however, is
irrelevant to the question of whether Home gains from trade. Whether the lower cost of
wine produced in Foreign is due to high productivity or low wages does not matter. All
that matters to Home is that it is cheaper in terms of its own labor for Home to produce
cheese and trade it for wine than to produce wine for itself.
This is fine for Home, but what about Foreign? Isn’t there something wrong with basing
one’s exports on low wages? Certainly it is not an attractive position to be in, but the
idea that trade is good only if you receive high wages is our final fallacy.
Do Wages Reflect Productivity?
In the numerical example that we use to puncture
common misconceptions about comparative advantage,
we assume that the relative wage of the two
countries reflects their relative productivity—specifically,
that the ratio of Home to Foreign wages is in a
range that gives each country a cost advantage in one
of the two goods. This is a necessary implication of
our theoretical model. But many people are unconvinced
by that model. In particular, rapid increases in
productivity in “emerging” economies like China
have worried some Western observers, who argue
that these countries will continue to pay low wages
even as their productivity increases—putting highwage
countries at a cost disadvantage—and dismiss
the contrary predictions of orthodox economists as
unrealistic theoretical speculation. Leaving aside the
logic of this position, what is the evidence?
The answer is that in the real world, national wage
rates do, in fact, reflect differences in productivity. The
accompanying figure compares estimates of productivity
with estimates of wage rates for a selection of
countries in 2007. Both measures are expressed as percentages
of U.S. levels. Our estimate of productivity is
GDP per worker measured in U.S. dollars. As we’ll
see in the second half of this book, that basis should
indicate productivity in the production of traded goods.
Wage rates are measured by wages in manufacturing.
If wages were exactly proportional to productivity,
all the points in this chart would lie along the indicated
45-degree line. In reality, the fit isn’t bad. In
particular, low wage rates in China and India reflect
low productivity.
The low estimate of overall Chinese productivity
may seem surprising, given all the stories one hears
about Americans who find themselves competing
with Chinese exports. The Chinese workers producing
those exports don’t seem to have extremely low
productivity. But remember what the theory of comparative
advantage says: Countries export the goods
in which they have relatively high productivity. So
it’s only to be expected that China’s overall relative
productivity is far below the level of its export
industries.
The figure that follows tells us that the orthodox
economists’ view that national wage rates reflect
national productivity is, in fact, verified by the data
at a point in time. It’s also true that in the past, rising
relative productivity led to rising wages. Consider,
for example, the case of South Korea. In 2007, South
Korea’s labor productivity was about half of the U.S.
level, and its wage rate was actually slightly higher
than that. But it wasn’t always that way: In the not
too distant past, South Korea was a low-productivity,
low-wage economy. As recently as 1975, South
CHAPTER 3 Labor Productivity and Comparative Advantage: The Ricardian Model 39
3Bob Herbert, “Sweatshop Beneficiaries: How to Get Rich on 56 Cents an Hour,” New York Times (July 24,
1995), p. A13.
Productivity and Wages
A country’s wage rate is roughly
proportional to the country’s
productivity.
Source: International Monetary Fund, Bureau of
Labor Statistics, and The Conference Board.
Korean wages were only 5 percent those of the
United States. But when South Korea’s productivity
rose, so did its wage rate.
In short, the evidence strongly supports the view,
based on economic models, that productivity increases
are reflected in wage increases.
Exploitation
Myth 3: Trade exploits a country and makes it worse off if its workers receive much lower
wages than workers in other nations. This argument is often expressed in emotional terms.
For example, one columnist contrasted the multimillion-dollar income of the chief executive
officer of the clothing chain The Gap with the low wages—often less than $1 an hour—paid
to the Central American workers who produce some of its merchandise.3 It can seem hardhearted
to try to justify the terrifyingly low wages paid to many of the world’s workers.
If one is asking about the desirability of free trade, however, the point is not to ask whether
low-wage workers deserve to be paid more but to ask whether they and their country are worse
off exporting goods based on low wages than they would be if they refused to enter into such
demeaning trade. And in asking this question, one must also ask, What is the alternative?
Abstract though it is, our numerical example makes the point that one cannot declare that
a low wage represents exploitation unless one knows what the alternative is. In that example,
Foreign workers are paid much less than Home workers, and one could easily imagine a
columnist writing angrily about their exploitation. Yet if Foreign refused to let itself be
“exploited” by refusing to trade with Home (or by insisting on much higher wages in its
export sector, which would have the same effect), real wages would be even lower: The purchasing
power of a worker’s hourly wage would fall from 1/3 to 1/6 pound of cheese.
The columnist who pointed out the contrast in incomes between the executive at The
Gap and the workers who make its clothes was angry at the poverty of Central American
workers. But to deny them the opportunity to export and trade might well be to condemn
them to even deeper poverty.
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