Saturday, 21 January 2017

Steve Keen thinks he’s spotted a flaw in comparative advantage.

That’s in this Forbes article by him entitled “Trump's Truthful Heresy On Globalization And Free Trade”.

Keen’s central point is that when switching from a restricted trade to a free trade scenario, the capital equipment in the industries which do not have comparative advantage has to be scrapped (nicely illustrated by the empty factories in the US rust belt). And according to Keen, that is not taken into account by standard ideas on comparative advantage. The relevant passage of Keen’s runs thus (in italics):

“Ricardo’s model assumed that you could produce wine or cloth with only labour, but of course you can’t. You need machines as well, and machinery is specific to each industry. The essential machinery for making wine can’t be used to make anything else, if its use becomes unprofitable. It is either scrapped, sold at a large loss, or shipped overseas. Ditto a spinning jenny, or a steel mill: if making steel becomes unprofitable, the capital involved in its production is effectively destroyed.

Ricardo ignored this little detail in his example, pretending that goods could be produced using labour alone. Later economists have made Ricardo’s example more complicated, and included the need to have machines as well as labour to make output. But they have been even worse than Ricardo, because they pretend that you can shift a machine (they call it “capital”) from one industry to another without loss.

That is simply nonsense.

The theory ignores the reality that, when foreign competition undercuts the profitability of a domestic industry, the capital in it can’t be “transformed” into an equal amount of capital in another industry. Sometimes it’s sold at a fire-sale price, often to overseas buyers. Most of the time, as ex-steel-mill workers throughout the Midwest know, it simply turns to rust.

Ricardo’s little shell and pea trick is therefore like most conventional economic theory: it’s neat, plausible, and wrong. It’s the product of armchair thinking by people who never put foot in the factories that their economic theories turned into rust buckets.”

Well there’s a simple flaw in Keen’s argument, namely his assumption that those who talk about transferring capital from industry to another are assuming you can magically turn steel mills into textile making machinery or whatever. In fact the very idea that it’s possible to turn one form of capital equipment into another is patently absurd (about 99% of the time). The average ten year old knows that!! So Keen is simply putting a straw man argument.

What those who talk about transferring capital from one industry to another mean (unless they are round the twist) is that the labour, materials, machinery etc that is used to produce capital equipment for one industry can be switched to producing capital equipment for another industry (a transition which will in most cases require a proportion of the relevant workforce to be retrained, no doubt).

A nice illustration of that was the the very large scale and quick conversion of motor vehicle factories in WWII to making aircraft, tanks, etc.

Moreover, as regards the LONG TERM changes in the pattern of trade which Ricardo was considering, the all important consideration for those contemplating setting up industries that are new to a particular country is the LONG TERM costs involved in doing that: i.e. the LONG TERM viability of the new industry.

Compared to those LONG TERM considerations, the cost of converting labour and machinery to producing new forms of capital equipment is near irrelevant.

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