In an earlier post, I mentioned my need and fascination with financial blogs. I read them avidly and regularly to help understand the economic issues that are currently occurring. As a recent father and an employee during the Housing bubble and the current Great Recession, it seems that there is always an economic events in the news that impact me and my small universe. Understanding how that event will effect me is paramount to helping position myself and my family to weather the oncoming storm.
In trying to understand how the world works, I’ve found that some common economic principles helps one to understand the situation. One of my longstanding principles that I always seem to come back to is Ricardo and his concept of Comparative Advantage. Comparative advantage simply states that given more than one choice on how to produce a good the producer will choose the option that will cost him the least. If option A takes $5 to produce a good and option B takes $7, it makes prudent financial sense that the producer will take option A and save himself the $2 difference. This concept, while simple, has profound implications in the world and our increasingly globalized economy.
Once again I was reading Charles Hugh Smith, a blogger I thoroughly enjoy over at Of Two Minds, and found myself questioning one of his conclusions. His entire post can be found here:
In his post he states:
There is so much ideological, quasi-religious fanaticism around “free trade” (there is no such thing as “free trade,” there are only various permutations of managed trade) and “industrial policy” (every nation has one, explicit or implicit) that it is difficult to make any sense of the many intertwined issues.
Ideological purity is not a substitute for knowledge, any more than a superficial admiration of machines equals actually knowing how to assemble, maintain and repair them.
As a background context, we might start by noting that Marx outlined how finance capital comes to dominate industrial capital, as industry comes to depend on the credit extended by the banks/finance capital.
The key takeaway: if you don’t control the banks, then they will end up dominating industrial capital. In the U.S., we have the worst of both worlds: a dominant financial Elite and various cartels (military-industrial, sickcare, agribusiness, etc.) that have captured what little of the Central State that isn’t already beholden to financial capital.
Moving production around the world to exploit cheap labor–also knowns as “wage arbitrage”– is not free trade: it is merely the consequence of free capital flows, and an extension of capital’s dominance of labor. If capital can reap higher returns by flowing elsewhere and abandoning domestic labor, then it will do so, and “lowering the cost to consumers” is the marketing propaganda issued to placate the captive home markets.
Consumers, after all, are not free to travel the globe seeking “higher returns,” i.e. lower prices–that privilege is reserved for capital.
The last sentence, and Charles’ assertion, got me thinking. Is this really true? Are consumers restricted from traveling the globe and seeking ‘higher returns,’ i.e. lower prices? While Ricardo’s comparative advantage only talks about producers, we have to remember the context of his life. In his life the world was shifting from farms to manufacturing and production and the Industrial Revolution was in full swing. The great forward thinkers were Industrialists and they thought in terms of factories, goods, and producing things. The principle has been most commonly meant to refer to capital accumulation, but there isn’t any reason that it can’t be applied to consumption. If you think of consumption (i.e. the purchasing of a good to meet an individual need) as an equal and opposite transaction to capital allocation, you come to realize that Ricardo’s theory of Comparative Advantage applies to consumption as well.
Consider a simple rewording of the earlier definition. Comparative advantage simply states that given more than one choice on how to purchase a good the purchaser will choose the option that will cost him the least. If option A takes $5 to purchase a good and option B takes $7, it makes prudent financial sense that the purchaser will take option A and save himself the $2 difference. And herein lies the value of global free trade common American households; the ability to purchase the cheapest option is slowly becoming available. We’ve all seen it in the last decade. Companies that used to be the sole provider of a good could impose a tariff on that transaction that the American households had no choice but to pay slowly, but assuredly, being eclipsed by companies that provide the good and service at a lower cost.
Take a long look at the record music business. CD sales have been falling every year for the last decade. Does this mean that people are consuming less music, or there are less people? No! It means that the record label monopoly that forced me to buy a CD for $16.99 for two or three good songs and a dozen crappy ones isn’t working anymore. People are free to find and consume music in different mediums for prices that are way cheaper. If you like a single song on an album, buy just that song for $1.29 on iTunes and save yourself the remaining $15.70 for other songs you’ll like. Do you wonder if you’ll like the song your about to buy? Preview the song before purchasing.
This trend in consumer purchasing power isn’t only applicable to CD music sales. We can see the same thing in movie purchases and rentals (Blockbuster vs. Netflix), books (Barnes and Noble vs. Amazon), medical supplies (Canada online drug stores vs. American pharmacies), Home Electronics (Best Buy vs. Newegg.com), and countless more. This is all thanks to the Internet. It has become the American consumer’s greatest friend in global markets. Apple wants to produce their phones in China and save on the cost of American labor costs. Fine! Go to Chinese websites and purchase the phone directly from there! I even have friends that went to India for hair transplant surgeries and surrogate pregnancies!
The options to buy goods from the cheapest global provider are multiplying every year. I recently bought a management textbook for class over the internet. The ‘American’ version of the text book was $180.00. My wife went online and within 15 minutes found and ‘International’ version of the text book for $52.00 ($58.00 with shipping)! What’s the difference between the ‘Amerian’ version and the ‘International’ version? The Indian website states that the material is exactly the same, but that the publisher might print the material in black and white instead of color and softcover instead of hardcover. Seriously! $120.00 for color and a firm outer binding? I know when I’m being ripped off and, trust me, I’m buying that ‘International’ version and applying Ricardo’s principle of Comparative Advantage to my benefit.
And so should you.