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Teaching Tip: Challenging the Theory of Comparative Advantage

September 28, 2011

An interesting article in The Wall Street Journal (Sept.27,2011), about the toll China is taking on US manufacturing, challenges the long-held Theory of Comparative Advantage which we discuss in Supp.11, Outsourcing as a Supply Chain Strategy. The theory, framed two centuries ago by a British economist, says that nations prosper by focusing on what they do best and trading with other countries that have different strengths. For years, economists have stated that  the benefits of trade with China far outweigh its costs. But in 2004,  Nobel Laureate Paul Samuelson argued that while  such “trade may benefit some Americans, it does so by ‘decimating’ the wages of blue-collar factory workers”.  So when you teach the topic of outsourcing, how should the Theory of Comparative Advantage be described?

A new MIT study of US-China trade suggests the damage to the US is even deeper than these economists like Samuelson have supposed. “A big portion of the ways trade with China has helped the US–such as inexpensive Chinese goods to consumers–has been wiped out”, reports the Journal. This is because increased government payments to unemployment insurance, food stamps, disability payments, and other benefits amount to 1/3 to 2/3 of the gains from trade. And these estimates don’t include the economic losses experienced by those who lost their jobs.

The reason? The breakneck pace of China’s development overwhelmed American communities that produced goods such as small appliances. Factory jobs were quickly lost without a long window to create replacement wages.  And with fewer high-paying factory jobs supporting the local economy, non-manufacturing wages were depressed as well. The research found that in communities that had industries such as heavy machinery production, Chinese competition was slower to enter and the US had more time to recover. The normal process of adaptation simply had more time to take place.

One Comment leave one →
  1. terry boardman permalink
    September 28, 2011 10:23 am

    amen finally

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