Saturday, November 5, 2011

The Law of Comparative Advantage, Migration, Outsourcing, and Wealth

The law of comparative advantages was originally explained by David Ricardo. People, firms, cities, regions, nations will specialize where they will have a comparative advantage (comparative advantage being defined as the activity where you have the lowest opportunity cost) and trade what they produce against goods and services produced by people specialized in the production of goods and services where they have other comparative advantages. What Ricardo explained is that when you allow people to specialize where they have their comparative advantages and freely trade, the overall amount of goods and services produced increase and everybody is better off (not necessarily equally better off but better off). In itself this model is very powerful but it is not a static model. It implies that you have to allow people to freely exercise their comparative advantage where their skills are being demanded (free immigration). If you don't allow this, businesses trying to hire people with skills for which they have a comparative advantage will relocate their operations (outsourcing). In other words, for that model to work, either you have a free labor movement or you have free movement of capital goods to where the labor skills you are seeking are. We call this the LAW of comparative advantages because this law is universal (applies everywhere, anywhere, at anytime).

I have read a few posts about a very passionate exchange about non-Alaskans taking jobs from Alaskans (I wasn't there so I can only assume the discussion might have been about immigration). Assuming this is to say that Alaskan's labor and non-Alaskan labor are perfect substitute but research shows that, for example, in the case of immigration, that this is not the case. In other words, non-Alaskans tend to get jobs where they have a comparative advantage allowing Alaskans to occupy activities where they have a comparative advantage, which traditionally higher paid. In the short run, it might be true to some Alaskans lose jobs but in the long run there is no evidence that immigrants (or labor migration) displace "native" jobs or depress wages. Neither is there any evidence that proves that immigrants depress wages. Actually, if any else happens, in the long run, native wages increase because they specialize in activities with higher salaries.

The topic of the post is obviously not immigration even though it's part of the discussion. But I want to remind all students what Bastiat wrote in What is Seen and What is Not Seen: the difference between a good and a bad economist is that bad economists tend to focus on the short run, on what's immediately observable while good economists will look both at short run and long run effects because sometimes short run costs actually produce long term benefits.

When it comes to immigration and outsourcing, many see costs but those are short run costs. In the long run, both produce long term benefits. Outsourcing might displace jobs in the short run but in the long run, they produce lower costs of production which benefit to consumers in the long run including the people who lost their jobs as a result of outsourcing.

PS: I apologize for my late posts recently but I have both moved to a new apartment and hosted an IHS week-end seminar on my campus the same week.

1 comment:

  1. comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.