Rethinking Comparative Advantage

Once again, the Supreme Court torpedoed my plan to write about its tariff decision by not making one, and it now appears that the column will have to wait until February. Meanwhile, tariff payments will continue to grow, increasing the amount that will have to be refunded if the president loses the case.

Instead, I want to pass along some reflections on comparative advantage—how the concept has evolved and how it has been used and misused by policy makers. Its initial articulation by David Ricardo in the nineteenth century focused on how the traditional elements of production—land, labor, and capital—could be different in different countries, and that trade occurred between countries where each had a comparative (relative) advantage in something. Ricardo’s famous example was English cloth and Portuguese wine. England could produce cloth cheaper than Portugal, while Portugal could produce wine cheaper than England, creating the basis of trade of cloth for wine. Ricardo’s insight was that the key distinction was relative advantage. Portugal, in fact, might produce both items cheaper than England, but it made sense for it to concentrate where its advantage was the greatest. The modern analogy is a company with an executive and a secretary. The executive is a better manager than the secretary, and they are also a faster typist, but their comparative advantage is in managing, not typing. It makes the most sense for the executive to stick to managing and their secretary to typing.

That concept was made more complicated in the twentieth century by the realization that there is a fourth element of production—technology—which is more subject to manipulation than labor, which is fairly fixed, at least in the short term. Technology, however, can be created, which means comparative advantage can be created. Japan recognized this early and adroitly used a combination of protection, subsidies, and government “guidance” to industries to develop highly competitive companies in a wide variety of sectors like steel, automobiles, motorcycles, semiconductors, and consumer electronics.  

This approach was taken up by other Asian countries—South Korea, Taiwan, Singapore, and, most recently, China—all of whom have created formidable companies in selected sectors which would not have happened without direct government intervention. The result is we now have a world where comparative advantage is more often the result of government policy than it is of natural attributes.

This newer world is now becoming even more complicated because of the realization that labor is also a factor of production that can be manipulated, both in quantity and quality. Richard Baldwin, in his book The Great Convergence: Information Technology and the New Globalization, made the point that the combination of developed country technology with developing country labor wins every time. Globalization has been the result of that, as companies realized they could innovate at home, transfer their innovations to developing countries, where the end products could be produced more cheaply.

Now, governments are beginning to realize that worker quality is also an important element of comparative advantage. The modern digital economy requires trained workers. They may not need college degrees—though many positions require one—but they do need training. The lack of trained, skilled workers in the United States is already slowing down some of the planned investments in semiconductor manufacturing. Building the plant is difficult, but populating it with trained workers is even harder.

As a result, there has been increasing interest in “workforce development”—building a workforce that will meet current and future needs. In the United States, this task has largely been left to state governments, academic institutions, and businesses. Businesses need the workers; institutions can train and provide them; and state governments can provide incentives and guardrails.

There have been successful efforts along these lines—Indiana is a good example—but supply is not meeting demand, and demand is only going to grow. This is, however, an area where other countries have a comparative advantage, and Germany is one of them. It has a more than a century-long history of successful worker training in manufacturing, which has focused on apprenticeship programs. CSIS published a report on U.S. worker training several years ago, and the strong recommendation from everyone interviewed was that apprenticeships were the best way to achieve the desired results.

The current administration seems to believe that it does not have much to learn from anybody who is not American, but this is a case where comparative advantage lies in Europe, particularly Germany, and not the United States. It would be smart for the United States to study Europe’s successes and take them on board here.

Acknowledging where comparative advantage lies can be a smart move. Europe is spending a lot of time and eventually a lot of money trying to decide how to develop a competitive semiconductor manufacturing sector, even though comparative advantage in most parts of that supply chain lies elsewhere. It would be smart for Europe to concentrate on its own comparative advantage—its skilled workers and its ability to train more. The United States could also take that lesson to heart when it comes to shipbuilding. For better or worse, that ship has sailed, to make a bad pun, and spending billions to recreate an industry where comparative advantage has moved to Asia is an enormous waste. The lesson of comparative advantage is to exploit your strengths and work with others to compensate for your weaknesses.

William A. Reinsch is senior adviser and Scholl Chair emeritus with the Economics Program and Scholl Chair at the Center for Strategic and International Studies in Washington, D.C.