STAN ULAM’S CHALLENGE

Stanislas Ulam was a Polish mathematician and physicist, one of the co-inventors of modern thermonuclear weapons. He had a low opinion of economics, perhaps because he underestimated economists’ capacity to blow up the world, albeit in their own way.

Comparative advantage is the idea that countries should do what they are relatively best at doing. To understand how powerful the concept it, it is useful to contrast it to absolute advantage. Absolute advantage is simple. Grapes don’t grow in Scotland, and France does not have the peaty soil ideal for making scotch. Therefore, it makes sense that France should export wine to Scotland, and Scotland should export whisky to France. Where it gets confusing is when one country, like China today, looks like it’s pretty much better at producing everything than most other countries. Wouldn’t China simply swamp all markets with its products, leaving other countries with nothing to show for themselves?

David Ricardo argued in 1817 that even if China (or in his era, Portugal) was more productive at everything, it could not possibly sell everything, because then the buyer country would sell nothing and would have no money to buy anything from China or anywhere else.⁷ This implied that not all industries in nineteenth-century England would shrink if there was free trade.

Based on this argument, Ricardo concluded that even if Portugal was more productive than England at producing both wine and cloth, once trade between them opened up, they would nonetheless end up specializing in the product for which they had a comparative advantage (meaning where their productivity was high relative to their productivity in the other sector: wine for Portugal, cloth for England). And the fact that both countries make the goods they are relatively good at making and buy the rest (instead of wasting resources producing a product ineptly) must add to the gross national product (GNP), the total value of goods people in each country can consume.

Ricardo’s insight underlines why there is no way to think of trade without thinking about all the markets together. China could win in any single market and yet there is no way for it to win in every market.

Of course, the fact that GNP goes up (both in England and in Portugal) does not mean there are no losers. In fact, one of Paul Samuelson’s most famous papers purports to tell us exactly who the losers are. Ricardo’s entire discussion assumed production required only labor, and all workers were identical, so when the economy became richer everyone benefitted. Once there is capital as well as labor, things are not that simple. In a paper published in 1941, when he was just twenty-five, Samuelson set out the ideas that remain the basis of how we are taught to think about international trade.⁸ The logic, once you understand it, as is often the case with the best insights, is compellingly simple.

Some goods require relatively more labor than others to produce and relatively less capital; think of handmade carpets versus robot-made cars. If two countries have access to the same technologies of production for both goods, it should be obvious the country relatively abundant in labor will have comparative advantage in producing the labor-intensive product.

We would therefore expect a labor-rich country to specialize in labor-intensive products and move out of capital-intensive ones. This should raise the demand for labor compared to when there was no trade (or more restricted trade), and therefore wages. And, conversely, in a relatively capital-abundant country, we should expect instead that the price of capital goes up (and wages go down) when it trades with a more labor-abundant partner.

Since labor-abundant countries tend to be poor, and laborers are usually poorer than their employers, this implies freeing trade should help the poor in the poorer countries, and inequality should fall. The opposite would be true in rich countries. So opening trade between the United States and China should hurt US workers’ wages (and benefit Chinese workers).

That does not mean the workers in the United States must necessarily end up worse off. This is because, as Samuelson showed in a later paper, the fact that free trade raises GNP means there is more to go around for everybody, and therefore even workers in the United States can be made better off if society taxes the winners from free trade and distributes that money to the losers.⁹ The problem is that this is a big “if,” which leaves workers at the mercy of the political process.