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The elegant economics of comparative advantage, and its messy consequences February 5, 2010

Posted by Angelique in Food ethics.
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The notion that local communities should be self-sufficient has always fallen foul of my economics-trained, productivity-loving mind. To the argument that buying local keeps dollars in the local community, I have two responses: first, if everyone thought that way, communities would have nowhere to export products, thereby losing lucrative export markets just as they gained local markets. At the end of the day, that tradeoff would leave the average local community no richer than it was before. Second, why should we care so much about enriching our local communities anyway? Does a worker in Mankato deserve my dollar more than a worker in Bangalore just because he happened to be born in a place that’s driving distance from the place I happened to be born?

But even someone who agrees with me on the above two points could conclude that the choice between self-sufficiency and trade is a wash. The Econ 101 case for trade and against local self-sufficiency is stronger. It rests on the principle of comparative advantage. If different communities specialize in what they do best – meaning, not necessarily what they excel at, but what they are “good enough” at to satisfy demand at the lowest cost compared to what everyone else can do – the overall cost of production falls. When we buy a new computer, the physical box will likely have been made in China, the software installed on it designed in the US, and the call centers servicing it run in India. We may not like hearing Indian accents when we call with questions, but we sure do love buying $399 computers. And although we chide ourselves for our insistence on cheap stuff, it’s what allows us to have money left over to spend on a night at the movies, or our kids’ piano lessons, or a new coat of paint on the front door.

When evaluated in terms of providing the best product for the lowest possible cost, the system of specialization and trade entailed by comparative advantage works great. But it only works if all the players – the ones in China, India, and the US – are doing their jobs properly. That seems an obvious point, and true whether you’re a champion of comparative advantage or local self-sufficiency. Even if you’re on the local self-sufficiency bandwagon, all the local players need to do their jobs right to make the system work. But there is one hulking difference between the two systems, and that’s the scale of the damage if something goes wrong. When there’s a glitch in the local system, one community gets screwed. But the rest of the world goes on as before, and if it’s doing just fine, can even lend a helping hand to that unfortunate spot. On the other hand, the wider net cast by the comparative advantage system means that the impact of minor glitches can be magnified by thousands or millions. The sheer scale of the damage also undercuts our ability to recover.  

The scale of recent ground beef recalls due to E. coli contamination offers a prime example. Let’s say we were on the local system, and the beef for each community was provided by local herds slaughtered and processed in neighborhood facilities. If contamination were discovered in the meat from one herd of say, 200 cattle, we’d have about 15,000 pounds of risky ground beef that we’d have to recall. That’s a big deal, but manageable. After all, at one pound of ground beef per household, we’re only talking about a medium-sized suburb’s worth of people who would be affected.

In fact, the most recent ground beef recall, from Huntington Meat Packing in California, was for 390 tons of ground beef. That’s 780,000 pounds, which at one pound of ground beef per household is enough to feed the state of Arkansas. The recall also spanned beef sold over nearly a two-year period. Cargill’s big 2007 recall of ground beef came to over a million pounds, 3000 grocers and 41 states. Why are these recalls so huge? Because one massive packing plant, specializing what it does best, sells beef to that many communities, which as a result have the luxury of not having to invest in individual packing plants of their own. A second problem: in neither of these recalls could the packing plant identify the herd, or even the slaughterhouse, that was the source of the E. coli contamination. Why? The animals come from everywhere from Brazil to Nebraska, and even the slaughterhouses are spread far and wide across the US. In either of these recalls, the problem could have come from just a couple of animals, but they are mixed in with so many others in the global production line that contamination is impossible to trace.

The elegant economics of comparative advantage leaves the world’s production systems teetering on the knife edge of efficiency. As long as no one messes up, we get lots of stuff on the cheap. But if something goes wrong, we all fall down. Is it worth it?

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Comments»

1. Tammy McLeod - February 5, 2010

I appreciate your post. I do advocate local but had never considered the argument that you present here – the effects of global scale in the case of a mishap. I tend to make my case on a micro level and you’ve opened my eyes to something broader. Thanks.

2. Eric C - February 9, 2010

Nice post, Angelique–it really got me thinking. I’ve long bemoaned the lack of understanding of comparative advantage too. Two comments:

(1) The scale of damage is certainly greater in a TRADE scenario than a LOCAL one. But conversely, and for the same reason, the scale of benefits is also greater in TRADE than in LOCAL. For example, if the beef distributor becomes slightly more efficient, it can pass those savings on to many, many more people if it trades than if it stays local. So maybe your question boils down to one of whether (or the extent to which) we should be risk-averse? And since risk aversion is a form of irrationality, my sense is we should try to limit it.

(2) There are lots of bad reasons for staying local, as you mention (ignorance of comparative advantage, prejudice against those far away, etc). But maybe one good one is the increased externalities typically involved in trade, namely through pollution. My company’s cost-benefit analysis of trade will of course have to account for my additional costs of things like renting trucks to distribute the traded items, but it won’t account at all for the cost to third parties of additional pollution. So yeah, I admit some hippy tree-huggers who blindly advocate LOCAL are just ignorant of comparative advantage, but it seems the best defense of LOCAL has nothing to do with that. It seems to have to do with externalities.

Angelique - February 9, 2010

Completely agreed – except for the point about risk aversion being irrational. From what I recall, psych research suggests that negative events impact people disproportionately to positive ones; e.g., the loss of $10 will make me more upset than the gain of $10 would make me happy. So, if I know that I share this psychology, isn’t it rational for me to guard against negative events (ie be risk-averse) rather than simply maximizing the expected value of my choices?

3. Eric C - February 9, 2010

I haven’t worked it out well in my own head, but it seems the thing to say there is that there is greater negative utility for a $10 loss than positive utility for a $10 gain. So that wouldn’t really be risk aversion.

But I guess in general any phenomenon which one person describes as risk aversion can be re-described by someone else as maximizing expected utility using a different utility function.

So maybe the concept of risk aversion is a red herring (my mistake), and really we want to know whether (why) we should assign more negative utility to the potential widespread harms that can arise from trade than positive utility to the potential widespread benefits.

I dunno…

4. jill g. - February 16, 2010

“Does a worker in Mankato deserve my dollar more than a worker in Bangalore just because he happened to be born in a place that’s driving distance from the place I happened to be born?” – This is a fantastic question and, as a long-time supporter of “local,” something that I’ve wrestled with a great deal. Thank you for this very thoughtful article.

5. Art C - May 9, 2010

The case made is class neo-classical econ thinking. The arguments presented are really those that created the global economy such as it is. It is truly a stawman argument to say that local economics is not compatible with trade. Visit the works of Jane Jacobs to understand how basic economics evolve and have for hundreds of years. Trade has always been a part, but not in the same way as we see it today as a “free trade” paradigm. The latter is deeply flawed. Created local economic centers that build from the inside-out is healthy. A balance of trade is central. We do NOT have that today; and the idea of specialization between nations is fragile and prone to a totally unregulated economic model. Self-regulation can be had at the local level, but size diminishes the ability to create the essential balance.

There is no perfect state, but what we have, it can be argued is not sustainable. It’s dependence on massive fossile energy based fuels is catestrophic and there is really no replacement for those energy sources in a global free trade economy. More recently, Michael Shuman has provided the data that empirically demonstrates how local outperformes globa transnationals on almost every important metric.

6. Matt - September 21, 2010

Let’s also remember that local agriculture promotes accountable agriculture. The miss deeds of big ag are under a watchful eye (or at least more likely to be) when they live by you. Also, specialization in ag has externalities that are sometime hard to quantify like crop rotation or millions tons of feces ruining a nearby lake because way too many animal were grown for cheap in way too small a space. You make important points to keep in mind though. Thanks for writing about it.

7. Not a nice guy Per Se « From Animal To Meat - May 21, 2012

[…] Mexico or a farmer from Malaysia just because he happens to live near you, as I’ve discussed in a past post. While you might enjoy keeping your money within your community, ethics doesn’t demand […]

8. Samdarshi Rana - July 9, 2012

This is an excellent post, I will definitely be sure to add this blog to my morning routine!

Angelique - July 9, 2012

Thank you!


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