Sunday, August 7, 2005

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The law of comparative advantage is not dead

That's the message Jagdish Bhawgati delivered in a Wall Street Journal op-ed on Friday, responding to Thomas "The World is Flat" Friedman.

[I]t is wrong to infer from this that the world has gone "flat," and that there is no comparative advantage left. The notion of a flat world is as wrong metaphorically now as it was when Copernicus showed it to be literally wrong. To be more precise than his metaphor, Mr. Friedman has on his mind not the world but a large fraction of it -- India and China. He believes that the gradient which the citizens of these countries had to climb to get to our shores and out-compete us has now disappeared, giving way to a level playing field that we ignore at our peril.

But he takes too literally his friends in Bangalore. They flex their muscles on IT the way Popeye does on spinach, and tell him that some Indians can now do anything that the Americans can do. But it is a leap to translate this into the proposition that several Indians will now do everything that the Americans do. Then again, we have Intel Chairman Craig Barrett talking about 300 million Indians and Chinese professionals who will hurtle down the flat road. And Clyde Prestowitz, in his latest book, carries the argument to its logical conclusion with the American nightmare that there will be three billion Indians and Chinese capitalists soon down that road.

In truth, the flat road is not flat at all. Take the supply of educated manpower in India. Of the numbers in the age cohort for college education, only about 6% make it to college. Of these, only two-thirds graduate, and just a small fraction can read English. Of these, a further fraction can speak it; and of these, a smaller fraction still can speak it in a way which you and I can understand. The truth of the matter, therefore, is that even for the call-answer and back-office services, the numbers who will compete are only a very small fraction of the numbers being thrown about. India's huge size and the dazzle of the few Institutes of Technology are totally misleading. The road is not flat; the gradient becomes steep as wages rise for those who can manage while others cannot qualify.

Again, just think back on why China has not managed to break into IT the way it has on a range of manufactures, while India has. Surely, that has to do with the fact that India is democratic and hence IT can flourish. By contrast, the CP (the Communist Party) is not compatible with the PC: Authoritarian regimes are fearful of IT -- a gigantic pothole in the road!

Such fears of a flat road were rampant when many thought that Japan would be a fearsome Godzilla, trampling over our activities all around. But then it turned out that the Japanese were real klutzes in the financial sector. They still are. And remember that while the Chinese and Indians have lower wages, we have better infrastructure, stronger venture capital markets, an ability to attract talent from around the world, and a culture of inventiveness. Comparative advantage persists; the road is simply not flat.

The best rebuttal to Bhagwati's argument, by the way, is not Thomas Friedman, but labor economist Richard Freeman. So go check both of them out.

posted by Dan on 08.07.05 at 11:55 AM


It looks to me as if Friedman and Freeman end up in essentially the same place, one supporting his arguments with anecdotes and the other with data. Thy are both highly critical of the complacency inherent in Bhagwati's analysis.

Actually that may not be quite fair to Bhagwati. But his analysis pretty clearly can be used to support complacency in policy, which is what we have now and will have for the forseeable future. Certainly we will have it as long as George Bush is in the White House.

posted by: Zathras on 08.07.05 at 11:55 AM [permalink]

And Clyde Prestowitz, in his latest book, carries the argument to its logical conclusion with the American nightmare that there will be three billion Indians and Chinese capitalists soon down that road.

And why is this a nightmare, exactly? A massive increase in worldwide productivity is a good thing that will raise wages throughout the world. Wages always relate to productivity. I don't worry at all about India and China lifting out of poverty and joining the first world. Japan becoming rich, Europe recovering from World War II, the recent rise of South Korea-- none of these things made us poorer.

posted by: John Thacker on 08.07.05 at 11:55 AM [permalink]

I question this from Freeman though: "For the first time, the vast majority of humans will operate under market capitalism, with access to the most modern technology."

Does he really consider the Chinese workforce to be operating under market capitalism? And given what we've seen about the limits Microsoft and Cisco are willing to put on the technology they have, I'd argue they don't have good access to the most modern technology either. I still see China's threat to the US as primarily military rather than technological in nature.

posted by: Bob on 08.07.05 at 11:55 AM [permalink]

If there really is this excess of lab or to capital, and I'm not arguing there isn't, why isn't the cost of capital being bid up? Instead, returns to capital see abysmal.

China's threat, and that of India do not result from tehcnology or military power but simply numbers. Did we wrest primacy from Europe because of technology? or Military power? No.

posted by: Richard Heddleson on 08.07.05 at 11:55 AM [permalink] Richard points out: if the ratio of workers to capital is increasing, as Freeman argues, then one would expect there to be a high demand for capital and consequently high returns. Yet many analysts argue that we are now in a time of capital surplus and low returns. How can this be reconciled?

posted by: David Foster on 08.07.05 at 11:55 AM [permalink]

I think we may be confusing the relationship of capital to labor. Increasing the ratio of one to the other does not necessarily make the other more valuable. Quite the reverse can occur. Capital investments in some manufacturing sectors can increase productivity and make cuts in labor costs (either cuts in wages or layoffs) possible. In, for example the textile sector, extremely low cost Chinese labor can make much factories there more productive than American plants that cost much more to build and run.

posted by: Zathras on 08.07.05 at 11:55 AM [permalink]

"Wages always relate to productivity."

This is monumentally false.

posted by: No von Mises on 08.07.05 at 11:55 AM [permalink]

"Yet many analysts argue that we are now in a time of capital surplus and low returns. How can this be reconciled?"

Material and financial expansions are both processes of a system of accumulation and rule that has increased in scale and scope over the centuries but has from its earliest beginnings encompassed a large number and variety of governmental and business agencies. Within each cycle, material expansions occur because of the emergence of a particular bloc of governmental and business agencies capable of leading the system towards a new spatial fix that creates the conditions for wider or deeper divisions of labour. Under these conditions, returns to capital invested in trade and production increase; profits tend to be ploughed back into the further expansion of trade and production more or less routinely; and, knowingly or unknowingly, the system’s main centres cooperate in sustaining one another’s expansion. Over time, however, the investment of an ever-growing mass of profits in trade and production inevitably leads to the accumulation of capital over and above what can be reinvested in the purchase and sale of commodities without drastically reducing profit margins. At this point, capitalist agencies tend to invade one another’s spheres of operation; the division of labour that previously defined the terms of their mutual co-operation breaks down; and competition becomes increasingly vicious. The prospects of recouping the capital invested in trade and production decrease, and capitalist agencies tend to keep in liquid form a larger proportion of their incoming cash flows. The stage is thus set for the change of phase from material to financial expansion.

In all financial expansions of systemic significance, the accumulation of surplus capital in liquid form had three main effects. First, it transformed surplus capital embodied in landscapes, infrastructures and means of trade and production into an expanding supply of money and credit. Second, it deprived governments and populations of the revenues that they previously derived from the trade and production that were no longer undertaken because unprofitable or too risky. Finally, and largely as a corollary of the first two effects, it created highly profitable market niches for financial intermediaries capable of channelling the growing supply of liquidity into the hands either of governments and populations in financial straits, or of public and private entrepreneurs intent on opening up new avenues of profit-making in trade and production.

As a rule, the leading agencies of the preceding material expansion were best positioned to occupy these market niches and thus lead the system of accumulation toward the financial expansion. This capacity to switch from one kind of leadership to another has been the main reason why, after experiencing the signal crisis of their hegemonies, all incumbent centres of world capitalism enjoyed a belle époque of temporary but nonetheless quite significant reflation of their wealth and power. The reason why belles époques of historical capitalism have all been temporary phenomena is because they have tended to deepen rather than solve the underlying overaccumulation crisis. They have thereby exacerbated economic competition, social conflicts, and interstate rivalries to levels that it was beyond the incumbent centres’ powers to control.

posted by: No von Mises on 08.07.05 at 11:55 AM [permalink]

This may be a relatively minor matter, but I found slightly funny Professor Bhagwati's comments about Indian English speakers.

"a smaller fraction still can speak it in a way which you and I can understand"

Given that Bhagwati was born and spent his early years in India, one would assume that he is able to understand Indian English speakers very well.

And higher wages are a very strong incentive to learn English as she is rightly spoken.

posted by: erg on 08.07.05 at 11:55 AM [permalink]

"a smaller fraction still can speak it in a way which you and I can understand"

i am and indian, hindi being my native language), and i live in Chicago now. But I can certainly vouch for Bhagwati's argument.

Ofcourse, it will not benefit anybody to be dismissive of this particular English, or 'Hinglish.' There's certainly or perhaps even several strains of English in development on the South Asian continent, and few of these would be hard (not impossible) to decipher for anybody outside of those contexts. And very likely not usable for most cross-national commercial purposes.

posted by: yoger on 08.07.05 at 11:55 AM [permalink]'s true that the lower the wages in a given country/industry, the less incentive there will be for productivity-increasing capital investment. In the auto plants being built in Eastern Europe, for example, things are done by hand that would be done by robotics in an American or Western European plant.

As wage pressures grow in these developing economies, I would expect demand to grow for robotics, CNC machine tools, etc...which may have some effect on increasing returns on capital.

posted by: David Foster on 08.07.05 at 11:55 AM [permalink]

John Thacker makes an excellent point. The more
good brains we - the Human Race - has to work on
our problems, the better it is for everyone.

Yoger suggests a barrier might be understanding
non-Native english speakers. While that may be
correct for the 'spoken' word, I can provide
anecdotal evidence it does not hold true for
written english.

I have had the good luck to work with a number
of men and women from various parts of the
world. Almost none of them spoke American
English as their 'native' tounge. I hasten
to add that their Hindi or Mandarin or Arabic
or Spanish or Romanian or Hebrew was much
better than mine! :-}

But ... gosh and golly ... the computer
code they wrote sure seemed to be highly
usable from the compilers point of view.

And their written english memos and
documentation, while containing less
slang than mine might have, was were
all easily understandable.

You have to realize someone has high
bandwidth when a particularly terrible
english pun is made in a heavily
eastern-European accented voice.

Bring on the Brains! We can certainly
use them here in the states.

posted by: Ted on 08.07.05 at 11:55 AM [permalink]

"If you don't believe that (globalization) changes the average wages in America, you believe in the tooth fairy.'

Do you know who said that?

Paul Samuelson, age 90."

July 30, 2005, Saturday
By Joseph Nocera (New York Times)

posted by: bhaim on 08.07.05 at 11:55 AM [permalink]

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