Reassessing Comparative Advantage: The Impact of Capital Flows on the Argument for Laissez-Faire
Prasch, Robert E., Journal of Economic Issues
The theory of comparative advantage is one of the oldest, and judged by its widespread acceptance, one of the most successful theories in the history of economic doctrines. The essential attributes of the theory of comparative advantage are disarmingly simple, and the implications that can be drawn from the model appear to be widely applicable. Specifically, comparative advantage draws upon the idea that specialization is efficient in order to forcefully establish the broader generalization that free trade must be in the best interest of all trading countries. In the words of one prominent neoclassical economist, "There is a basic presumption that free and voluntary exchanges increase welfare, both within national borders and across national borders" [Aliber 1994].
Unfortunately, Professor Aliber's "basic presumption" is intellectually suspect. It may seem obvious, but it is nevertheless important to recall that under a free trade regime a country does not typically engage in the exchange of goods. Individuals and firms within a country participate in exchange relations with individuals and firms in other countries [Culbertson 1985, 8-9]. This simple fact directly raises the possibility of a "coordination failure" within the larger, international market. If it is a host of individuals, rather than two countries, who are engaged in trade, it is reasonable to raise the following questions: What is the effect of trade on employment levels? What is the effect of trade on a country's distribution of income? Is the system subject to effective demand failures? These issues are not typically addressed by the theory of comparative advantage. Unfortunately, a failure to address questions does not assure us that such questions are ill-conceived.
Capital Flows, Productivity, and Income Distribution
When David Ricardo first articulated the theory of comparative advantage, capital flows did not constitute a significant issue. Ricardo could draw up his theory of comparative advantage in the absence of such concerns [Ricardo 1821, chap. 7].(1) Now, for better or for worse, we no longer live in the world as it was in the early nineteenth century. At this point in global history, international capital flows are enormous and as a result, Ricardo's theory of trade should be subject to revision or modification.
Not surprisingly, economists have argued that the bulk of capital flows are merely financial flows and that real capital movements are considerably slower. Neoclassical trade economists maintain that due to the nature of fixed assets, real capital may take much longer to shift locations. They argue that, at a minimum, one would have to wait for fixed assets to mature and depreciate before physical replacement elsewhere would take place.
There are two problems with this argument. First, the theory of comparative advantage does not incorporate time into its presentation. This is a fault to the extent that projections that estimate the gains to be obtained from liberalized trade are typically long term. Indeed, most estimates of the "gains from trade" are of a comparative static variety. This implies that such studies are concerned with the level and mix of output that will prevail after a nation's productive resources are redeployed to their most efficient uses. However, such an exercise can only make sense if the model under investigation is a "long-term" theory-one that allows for the mobility of physical capital. The point is that it is presumably just as time-consuming to switch a country's endowment of capital and technological skill into sectors where its comparative advantage is strongest as it is time-consuming for the same capital to actually move completely out of the country. This being the case, if it is legitimate for proponents of liberalized trade to discuss long-term gains from trade, it is equally legitimate for detractors to discuss the long-term impact of real capital leaving a given country. …