“Filthy Lucre” and International Trade

“Filthy Lucre” by Joseph Heath is quite a good book.[1, 2]   It takes a careful, logical look at a lot of economics and social policy, and manages to do it without much political/idealogical bias.  [“Unbiassed” is a bit of a fuzzy term, but it gives credit to all sides, when credit is due.]  In fact, the book takes pride in shooting down some bad ideas from both ends of the political spectrum.  It’s clearly argued and pleasant to read.  The only real problem with the book is the title, which sounds wildly leftist, far more than the book itself.  [The world would be a better place if more people read this book; it helps one think about economics.  FYI, I saw and appreciated a bumper sticker yesterday: “Critical Thinking: The Other National Deficit“.]

But there’s one place where it falls down: Chapter 5, “Uncompetitive in Everything”.  This is an analysis of international trade, and Heath attempts to show that globalization does not force your country to become more competitive.  He makes the claim that you cannot be uncompetitive in everything.

Heath uses an example of two bakeries: A “Rich Side” bakery that is especially good at making bagels, but relatively inefficient at making tarts, and a “Poor Side” bakery that is good at tarts and poor at bagels.   The bakeries are in different countries, so they do not share a common currency.  He goes on to show that — even if the labor costs are much higher on the rich side — both sides are better off if they trade bagels for tarts.

The essential argument is this:  suppose the rich side makes bagels for £1 and tarts for £2.   Suppose the poor side makes bagels for ¥2 and tarts for ¥1.  [I’m not saying Brits are rich and Japanese are poor here: £ and ¥ are just two convenient, different currency symbols that people will recognize.]  Now, someone on the poor side has two ways to get a bagel.   One way is that they can make it locally, for ¥2.   The other way is that they can make a tart (for ¥1) and sell it to someone on the rich side.  If international trade is rare, they’ll get a price near £2, and they can then go over to the rich side and buy two bagels with that amount of money.      So, with international trade, they could end up with two bagels for half the price.     And, of course, the same logic applies to both sides.     Trade benefits both countries.  This isn’t a new idea.  It comes from David Ricardo, around 1817.  [1, 2, 3]

The arguments presented are absolutely correct, as far as they go.  But the model presented is just too simple to capture a couple of important effects in the real world.   Two goods is not enough.  The trouble is, there need to be at least two other goods in the model:

  1. Goods that you cannot produce at all in your country.    Foreign travel is one example of these.   If you live in Alberta (or Yorkshire), you cannot produce a trip to Paris no matter how hard you try.  You can only do it in France.   Another example is stuff that requires huge capital or intellectual investments, like semiconductor fabrication plants.   Building anything close to state-of-the-art chips takes multi-billion dollar investments and lots of specially educated people, and most nations will not have the capability within their borders.
  2. Goods that you really don’t want to sell, on moral/ethical grounds.     Such as the slave trade, sex tourism, one’s kidney, or the right for other nations to dump their waste on your ground.   And, there are a whole bunch of milder variants of #2 that one would also prefer to avoid:  for instance, “Ship us your recycling, we’ll sort it and send it back.” — honest, but dirty jobs.

Now, the trouble is, there is a certain insatiable demand for #1.  Everyone wants to do a little travel, and the political elite will arrange to do some, by fair means or foul.   Or, the elite will send their kids to expensive private schools in England.   And, you can bet that whomever has money and power will have new PCs and iPads or whatever nearby.   This demand is not very elastic, and will never go quite to zero no matter what the exchange rate is.

Therefore, if conventional trade becomes sufficiently uncompetitive, the outflow of money for #1 will end up being balanced against category #2.    Therefore, it does matter (to a degree) how competitive you are.   You don’t want your industries to be less valuable to outsiders than things in category #2.

[Oh, and there are other ways in which Ricardo’s analysis doesn’t quite represent reality.   It assumes that the bagels produced on the rich side and the poor side are completely indistinguishable (which might easily be false).  It also assumes that trade is free, the costs of trade are small, that prices are reasonably stable so that the risk of the price changing badly between the time you decide to bake tarts and the time you finally end up buying bagels.   All these simple models are [of course] simplifications of the real world.]