Saturday, April 28, 2007

Ricardo, H-O, and the Gains from Trade

Dani Rodrik and Greg have an exchange over the gains from trade. Dani points out that real wage can fall via Stolper-Samuelson first derived in a Heckscher-Ohlin framework, but Greg feels that Ricardo is a better model for the real world because in Heckscher-Ohlin capital cannot move.

The problem with Greg's take is that it is, as he sometimes writes, at odds with the facts.

The big problem here, the one that generates all of this hoopla in the first place, is that economies differ greatly in their "capital stock."

Now perhaps, all investors care about is their real rate of return. Though, this itself is not entirely clear. There is some apparent return to having your assets simply denominated in dollars or pounds. Ignoring that, however, persistently different per capita capital stocks means either

(1) Capital is not completely mobile

(2) The production function is not constant returns to scale

(3) There are radically different technologies


In the first case we are back to Heckscher-Ohlin. In the second case we are presented almost immediately with an argument for infant industries. If there are scale effects then it pays to build local business. In the third case it might be technically true that the returns to capital are unaffected but policy makers aren't going to see it that way. Since capital and intellectual property are typically both held intermediately by firms an increase in the return to intellectual property is going to be seen as gains to the investor class.

Moreover, the larger point is that there are multiple factors to production and there are systematic differences in the people who own them. We can replace capital with skilled labor and get the same result.

However, I do find Dani's argument about Argentine beef and wheat strange. In a one shot setting its clear that the material gains to winners outweigh the losses to the losers over all trading partners. Now, if one nation has the ability to tilt relative prices in its favor then restrictions on trade can benefit that nation. Perhaps that's what his has in mind, but I don't know.

My real concern over free trade dogma is that trade is a policy lever. Since, we are in the position of weighing the merits of lots of second-best options it isn't clear to me that ruling out trade restrictions is a priori the best way to go.

Suppose I need to raise living standards in the rural South. Its not clear to me that increasing marginal tax rates to provide a subsidy is a better policy than restricting textile imports. Both have negative side effects but if I am going to raise living standards of the rural poor it is going to have negative effects for the economy as a whole. If there was a magical win-win it would have been used already.

Now, as Dani pointed out perhaps this is really a debate about how economists talk about policy. I understand Greg's view that economists should always offer the best policy regardless of political reality. We should all understand, however, that real policy involves interpersonal comparisons of utility. If it didn't most policy work would be impossible.

What Ricardo shows is that the nation as a whole will be wealthier, this does not mean at all that any particular social welfare function will be maximized.

Moreover, as a paper I a working on will show it is possible to have a policy which passes Kaldor-Hicks yet which no person in the economy would want to see implemented. Like Greg's paper on height I think this may cast doubt on the whole notion of net benefit.

15 comments:

Gabriel Mihalache said...

> "Moreover, as a paper I a working on will show it is possible to have a policy which passes Kaldor-Hicks yet which no person in the economy would want to see implemented. Like Greg's paper on height I think this may cast doubt on the whole notion of net benefit."

Looking forward to it. I think this issue related to the "exotic" examples where the decision of a representative agent make everyone whom he represents worse off.

That, and maybe with the issues with SWFs in general (Arrow, etc.)

Gabriel Mihalache said...

P.S.

> "We should all understand, however, that real policy involves interpersonal comparisons of utility. If it didn't most policy work would be impossible."

You also assume that policy is about utility. That's a very utilitarian thing to do :-) and a bad habit of economists.

What about rights? And good and evil? -- Just saying.

Another problem of policy is keeping the public choice aspect in mind.

I pretty much stop reading if someone is making a public finance argument based on the allegedly optimal actions of a fictitious, benevolent planner.

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