CAMBRIDGE, Mass. — The theory of comparative advantage claims that a country should specialize in the goods that it can produce more easily than other countries. For example, if your country is relatively better at making computer motherboards and mine is relatively better at manufacturing television sets, yours should specialize in the former and let mine do the latter. With each country playing to its relative strengths, all would gain from trade, the theory says.
But if every country has a comparative advantage in something, why are there persistent complaints about jobs moving to Mexico, China or India?
The theory of comparative advantage was the brainchild of 19th century economist David Ricardo, who used it to explain how Portugal and England might mutually benefit from the differences in their natural resources. Hot, sunny Portugal ought to specialize in wine, advised Ricardo. Temperate, rainy England should stick to woolen cloth.
But the theory doesn't apply well to the contemporary world, and outsourcing shows why.
Suppose there's an all-purpose widget that high-tech Americans can produce at several times the speed of low-tech Indians. It might seem that with all-purpose widgets, there is nothing to trade. Not so, says the economist: Even in a world of all-purpose widgets, there is a second commodity, leisure. Ricardo would say that Americans have the comparative edge in widgets and Indians enjoy the advantage in leisure, which is to say, not producing the widgets with their inferior technology. Instead, India would sell its leisure to America.
In other words, U.S. producers should substitute Indian labor for their own. Both Americans and Indians gain from trade. We get more leisure without reducing the quantity of available widgets here because we can supplement our reduced domestic production by importing widgets made with our technology in low-wage India. In India, it's more widgets for the same amount of work, even taking account of what is shipped overseas, because a superior technology replaces an inferior one.
Where does it go wrong?
First, we don't live in Ricardo's world, where trade is determined by fixed natural resources. In his world, technology and capital are immobile: You can't move Portuguese vineyards to England, nor can England's lush sheep pastures survive in Portugal's climate. Today, technology and capital move almost as easily across international borders as within a country.
Second, the theory imagines a world of generic Englishmen and Portuguese who are both worker and consumer, both worker and owner. The Englishman raises sheep and manufactures cloth, consuming part of his production and trading the rest for Portuguese wine. A Portuguese grower-vintner produces wine for his table and ships his surplus to English tables. Today, few of us consume a significant part of what we produce. Consumption is separate from production. Even more important, few of us own the machines, tools and equipment needed to produce goods and services. Instead, we work for wages. The distinction between worker and owner is basic to capitalism.
The comparative advantage theory might still be useful if widget workers had a significant ownership stake in their factories, and if labor markets functioned like model competitive markets, in which workers were free to work as much or as little as they desired at the going wage. In such a world, there is, by definition, no unemployment beyond the leisure the individual chooses. Outsourcing might lower wages in this country and raise them in India, but U.S. workers would profit from the dividends and capital gains they received as shareholders, and the lower prices they paid as consumers. And these gains, according to the comparative advantage theory, would be greater than what workers lost in wages.
But American workers don't, in general, own much stock, and U.S. labor markets fall far short of the ideal in which the worker gets to choose how much to work. In today's world, we can't understand international trade in terms of abstractions like "Americans" and "Indians" because the consequences of outsourcing are dramatically different for different groups. American owners can gain while American workers lose. Consumers can gain while workers lose.
Shareholders prosper from the cost reductions associated with substituting Indian labor for American labor. Some workers lose big-time because the added leisure that comes from shifting production abroad is not widely shared. An unfortunate minority lose their jobs altogether -- their "leisure" is involuntary. For these folks, the added profits generated by outsourcing are cold comfort. U.S. consumers who don't lose their jobs benefit from lower prices, again cold comfort for folks whose old jobs are now overseas.