Adam Smith on Science, Paul Krugman on intellectual charlatans: Speech to CSIRO science leaders

A few weeks ago, on the 30th of Sept to be precise, I gave a speech to ‘science leaders’ in CSIRO. Science leaders are early mid career scientists from around the world whom CSIRO have recruited. As the speech explains, Jim Peacock, the Chief Scientist whom I met when on the Innovation Review asked me to speak. I sent this to Don Arthur, who enjoyed it, so I thought I’d post it for those who might like to read it on Troppo.

I must confess to some trepidation as I stand before you.

Ive never thought of myself as an after dinner speaker. But there I was working away I was going to say innocently working away but some people who know me might find that unconvincing.

Anyway, at that point, the nations Chief Scientist rang.

He said that hed come to think of my contributions to the Innovation Review where we both sat as members as so witty that he thought that if I turned up here tonight everyone could have a good laugh.

I note he didnt say witty and wise, but then thats just as well as it halves the level of performance anxiety I might otherwise feel.

Now naturally enough, those on the Innovation Panel regard a gentle request from the Chief Scientist in the same way that members of the US Military regard a gentle request from the Commander in Chief. So I accepted his kind invitation.

Anyway, immediately I got off the phone the saying that came to my fevered and terrified mind was the one attributed to Abraham Lincoln. You can fool all of the people some of the time, and some of the people all of the time (I think in these circumstances thats a reference to the Chief Scientist), but you can’t fool all of the people all of the time.

On thinking about that I nearly rang back and cancelled, but then I realised, that from what the Chief Scientist had said, all I really needed to do was fool all of the people in this room for fifteen minutes or so.

So here I go. Please dont refrain from having a few more drinks as I speak. A couple of minutes already gone!

oooOOOooo

Economics is known as the dismal science.

Anyway, Im that saddest, most dismal of characters, the second generation economist. My father was an economist and my brother and I tried exceptionally hard not to become economists my brother trying physics and then mathematical physiology, and I tried law, school teaching, cartooning, consulting and working in the public sector. But in the end, we both failed miserably. A life in economics was the ultimate expression of that failure.

oooOOOooo

What might an economist have to say to such an impressive collection of scientists? Well I if you ask me whether you should have bought stocks last week, I can tell you that you shouldnt have.

Only marginally more usefully, let me tell you a secret. The last time there was large scale public excitement about innovation and science in public life or the last major time I remember was the time of the National Innovation Summit in 2000. This is how it happened. I was working at the Business Council of Australia and did the first survey which showed that R&D had plunged following the Howard Governments halving of the rate of concessionality of the R&D tax concession from 150 to 125 percent.

In preparing to release the survey I was asked What is our message for the Government. I said that the message was that the policy was a mistake and that it should be reversed. There was immediate agreement that of course that was correct but somehow I wasnt getting the point. The government wouldnt like us to say that. What else could we say I?

Somewhat nonplused I said half tongue in cheek we could have an R&D Summit.

Thats a great idea was the reply. Then I watched amazed as the scientific community praised the Business Council for its vision. How visionary can you get? Before I could whistle that old Bee Gees tune I started a joke swarms of scientists were appearing swamping the meager resources of the Business Council and setting up the National Innovation Summit.

Id never seen anything like it since Id worked for Senator John Button and watched automotive industry lobbyists swarming at the sound of a tariff review. The scientists said the same kinds of things as the component producers. That without them the country couldnt compete; that it would be flat on its back and, to mix a metaphor, up the creek without a paddle. It was not a pretty sight.

But there is a difference between scientists and car makers lobbying, about which Ill have a little more to say shortly.

oooOOOooo

Another thing that I can tell you as an economist is that, extraordinarily enough, one of the best theories of science produced before the twentieth century was produced by the father of modern economics Adam Smith.

In his early years in the middle of the eighteenth century, Adam Smith produced a history of astronomy. It is a remarkable document. Its long winded and rhetorical. But it has a remarkable modernity to it. Because long before it became commonplace amongst philosophers of science like Popper and Kuhn, Smith was there insisting that science wasnt some inevitable convergence to the truth.

Somewhat like Kuhns Structure of Scientific Revolutions, Smiths focus on the engine of science grew from a psychological portrait of what it was like to do science what drove scientists.

Smith concluded that surprise was the initial engine of science. This is like Kuhns idea that there are anomalies lurking, waiting to disrupt normal science which can eventually propagate the seismic shifts of scientific revolutions.

As Smith puts it, where things occur as expected they come to be so connected together in the fancy, that the idea of the one seems, of its own accord, to call up and introduce that of the other. But when we come upon the unexpected We are at first surprised by the unexpectedness of the new appearance, and when that momentary emotion is over, we still wonder how it came to occur in that place.

Wonder is the next part of the process, and wonder is The stop which is thereby given to the career of the imagination, the difficulty which it finds in passing along such disjointed objects, and the feeling of something like a gap or interval betwixt them.

I remind you again that this focus on incorporating anomalies is not the product of some philosophy of science graduate in the 1970s, were talking the mid 1700s here.

But the thing I admire about Smith is that he then goes on to argue that after this period of wonder, we seek to find patterns that restore our mental equilibrium, and the criteria we bring to that search are aesthetic ones. We are looking for the aha moment, a moment of pleasure in our contemplation of the object and of repose in our troubled minds. And this leads us more fully to admire the world we are investigating.

Like his contemporaries, Smith was entirely smitten with the scientific revolution that Sir Isaac Newton had pulled off in the previous century. And yet what is extraordinary is his very modern insistence that Newton might not be the last word. That Newtons system wasnt the truth, it was a system, a human contrivance which was more fully appreciated as that, than being confused with the truth.

Here is Smith:

And even we, while we have been endeavouring to represent all philosophical systems as mere inventions of the imagination, to connect together the otherwise disjointed and discordant phaenomena of nature, have insensibly been drawn in, to make use of language expressing the connecting principles of this one, as if they were the real chains which Nature makes use of to bind together her several operations. Can we wonder then, that it should have gained the general and complete approbation of mankind, and that it should now be considered, not as an attempt to connect in the imagination the phaenomena of the Heavens, but as the greatest discovery that ever was made by man, the discovery of an immense chain of the most important and sublime truths, all closely connected together, by one capital fact, of the reality of which we have daily experience.

oooOOOooo

And in the shadow of Newton, Adam Smith built his economics around just one idea. Just as Newton had built his system around the inverse square law of gravitational attraction and a few simple laws of motion thrown in, Smith proposed to build a system of understanding how economies work and can be made to work better around the innate tendency of people to truck, barter and exchange. Economics has been built on very simple foundations since that time. Of course thats a weakness if people dont proceed with proper understanding of the simplifications theyre making. But its also a great strength the strength of Ockhams razor.

Smiths idea was that in the presence of certain conditions, the most efficient form of cooperation was competition. His idea has been refined, but Id say there is still a single idea at the foundation of economics. Today, Id say that the single idea in economics is opportunity cost. And that idea was being mulled around in Ricardos mind at the beginning of the nineteenth century during the Napoleonic wars. This was, by the way, around the time when Lord Wellington was reviewing his troops to go into battle and observed in his inimitably dry way, one feels after a long and tense sigh . . . well, they may not scare Napoleon, but by God they scare me.

It was Ricardos principle of comparative advantage that showed most clearly that countries that trade with each other dont compete in the way that firms do. I wont go into the idea here in much detail except to say that it reminds me of a joke that was circulating when I was a kid and circulates with different personnel today. On a church in Hawthorn the pastor had written the challenge What would you do if Jesus came to Hawthorn. Underneath in graffiti, someone had replied Move Peter Hudson to centre half forward.

You can get an intuition for Ricardos principle of comparative advantage if you understand how in the 1971 Grand Final Peter Hudson, the best full forward there was at the time, or Buddy Franklin in last Saturdays grandfinal likewise the best full forward there is now, spent quite a bit of time at centre half forward. Thats because what mattered for Hawthorn was not Buddy Franklins or Peter Hudsons absolute abilities, but their abilities relative to other Hawthorn players in the circumstances that presented themselves. Their absolute best position was full forward, but sometimes their comparative advantage comparative to the other players in the side was at centre half forward with other capable fellows filling in at full forward.

But a real understanding of comparative advantage of the fact that it makes more sense to say that our firms are competing against each other (for labour and cash and other resources) rather than against other countries is almost routinely ignored, including by people who present themselves as knowing, and indeed feel themselves to know the economic basics.

Heres the great Paul Krugman on the point:

Almost nobody in business or government would disagree with this statement: Today America is part of a truly global economy. To maintain our standard of living, we must learn to compete in an ever tougher world marketplace. . .

The problem is: Its baloney. In reality, there is almost nothing to our fixation with national competitiveness, or its central idea that every country is like a giant corporation slugging it out against rivals in global markets. The U.S. and Japan are simply not competitors in the same way that, say, Ford competes with Toyota. Any countrys standard of living depends almost entirely on its own domestic economic performance, and not on how it performs relative to other countries. . .

My advice is to consider a proper understanding of the real relationship between productivity and competitiveness as a kind of test of the reliability of supposed experts, in and out of government. The issues involved are not hard to sort out were not talking quantum mechanics here. So if you hear someone say something along the lines of America needs higher productivity so that it can compete in todays global economy, never mind who he is, or how plausible he sounds. He might as well be wearing a flashing neon sign that reads I DONT KNOW WHAT IM TALKING ABOUT.

oooOOOooo

But in case this talk about the single idea in economics sounds a little triumphant let me tell you a story. I attended the launch of the last book published by the Australias most distinguished public servant Nugget Coombs. Youll appreciate the prophetic topic of the book when I tell you that it was published eighteen years ago, yet was called The Return of Scarcity. Coombs was reviving a long dormant concern in economics that the world was running out of resources.

Anyway at the lunch after the launch I was sitting next to someone who claimed triumphantly that she really didnt understand economics. I said to her what Ive said to you that theres only one idea in economics and that it was simple commonsense. Nugget Coombs having overheard this, leaned over and added yes and its wrong!.

Because of the simplicity and the compelling nature of their logic, economists are constantly in danger of overreaching of thinking they know more about the world than they do. Thats something economists should have been reflecting on in recent months. This is what one US executive said in 2007.

It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.

The executive was Joseph J Cassano, and he was basing his comments on the analysis of risk quants who were sufficiently clever to build some mathematical contraptions that gave him these answers but not clever enough to notice that they were only valid for as long as the world remained as it was when they designed the model. Joseph Cassano by the way, was in charge of AIGs credit default swaps (CDS) operation which drove the company broke.

And theres an additional hazard. Though it is now infinitely more technical than it was in Smiths day, economics remains as Smith built it, one long diatribe against the fallacies of do-it-yourself economics. That is the economics which says that high tariffs create jobs when they typically destroy them, that technology will destroy jobs when it will more often create them. And added to the fools who seem hard wired to fall for this stuff, there are knaves who benefit from their doing so. Weve seen plenty of them on Wall St in the last week.

So economics comes with a strong sense of self righteousness against special pleading.

And thats a dilemma for science. Because there is very good economic evidence that a great deal of science needs to be supported by the public purse. The reason is simple enough. Science and R&D do much more good for the world than can ever be captured by anyone conducting it.

Now my idea of a true economic rationalist would be one that was aware of this problem and so in some sense welcomed lobbying for worthwhile uses of public money. But here I come back to Smiths great insight that aesthetics plays a big role in the thinking of disciplines. And like I said, economics is such a powerfully simple discipline, that it comes with a powerfully simple policy aesthetic. That aesthetic is to impose a heavy burden of proof against government funding of anything much and indeed to regard the process of lobbying as essentially distasteful.

But in a democracy you dont get money off the government without making it clear to the government which has no shortage of hungry snouts bustling at its trough that therell be a price to pay if they dont come good. There is nothing very pretty about this. But if there isnt a well organised lobby for science, science goes hungry and following it in a decade or sos time does Australias productivity growth.

Thats why Im very pleased that we included the Treasury in our deliberations on the R&D tax concession. And while they can speak for themselves, I think I am right in saying that they understand and are broadly sympathetic to the logic we pursued which called for more funding, and for a much smarter concession. In essence we proposed that the tax concession be increased and that the systematic bias built into it against tax loss firms be turned into a systematic bias in their favour.

oooOOOooo

Since Adam Smith tells us that surprise is the beginning of science, I thought Id end with a story about what was probably the most surprising thing Ive ever heard said in what is now quite a long history of policy making.

Some of you may recall the early years of Bob Hawkes excellent Prime Ministership for my money he was the only really good PM in my lifetime. Anyway in 1983 Japan was all the flavour in economic policy and particularly in what was then called industry policy and what is now called innovation policy.

Mr Hawke invited Mr Amaya who at least according to my memory had been the head of MITI in Japan to visit Australia. He was a very urbane man with a heavy shock of white hair and one of his most important visits was to the new Industry Minister my boss Senator John Button.

John Button was one of Australian politics least pompous politicians, but the occasion appeared to have got the better of him and he or someone else arranged chairs in his room so that there was a circle of chairs for officials around two chairs for the main conversation between Senator Button and his illustrious guest. Mr Amaya was asked about the secrets of MITI and he seemed to be stressing that there wasnt anything special to any of it that it was pretty much commonsense.

John Button then launched into a quite long monologue about national self-reliance. He said that he wondered whether it was the case that countries needed to go through some crisis in order for their populations to discover that no-one owed them a living, that they would sink or swim on their own efforts. I wonder if there are many countries that would even understand the idea of a countrys citizens thinking that others would look after them perhaps countries with a long history of benign colonisation. Anyway, I doubt it made much sense to Mr Amaya.

John Button expanded further. You see he said, the Americans had their war of independence. The British had the Battle of Britain and the Amada before that. And the Japanese had Commodore Perry and the black ships.

And, said Button finishing his peroration, I sometimes think that Australia has never had its own crisis of this kind which might lead it to take its destiny into its own hands.

Mr Amaya paused for a while in that inimitable Japanese way. I expect the amount of time he let pass was a grave courtesy in his own country, but in this country it was sufficiently long for the pause to become awkward. The officials were silent waiting for Mr Amaya to respond. And then he did.

Do you think we should have sent more submarines?

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54 Responses to Adam Smith on Science, Paul Krugman on intellectual charlatans: Speech to CSIRO science leaders

  1. Rafe Champion says:

    “Send more submarines!”
    I love it:)

    On the topic of being competetive to survive in the global community, a speaker on the radio was going on about the way that rapid growth in China and India will sooon challenge the supremacy of the US, as though the US would become a second rate power. But that looks like the “war by other means” theory of economics, with a hint of the zero sum mentality of exchange. Surely the growth of China and India (indeed the growth of any other nation) provides opportunities for the US (and everyone else), to gain from trade with them. Is that what Krugman was hinting at?

  2. SJ says:

    WTF is a “charlitan”?

    I think you’re a fraud, Nick. A quack. A charlatan. ;)

  3. Rafe Champion says:

    A great contribution to the debate on Australian innovation by Thomas Barlow.

  4. Patrick says:

    Nice speech and I also loved the punchline.

  5. Richard Green says:

    Additionally, a standard of living in a country isn’t a positional good. Having a fed, sheltered and educated population doesn’t become the worse off just because people in China are managing to achieve the same thing. Living standards aren’t national bling.

    And living standards are the purpose of the exercise, not a pissing contest of number size.

    On another note, the section break “oooOOOooo” is reminiscent of a live studio audience aknowledging a diss. This changes my vision of the CSIRO.

  6. Thanks Richard, but I’m afraid that last sentence completely escapes me – its meaning that is.

  7. NPOV says:

    “Today America is part of a truly global economy. To maintain our standard of living, we must learn to compete in an ever tougher world marketplace.”

    It is total baloney though? I mean, the U.S. must import goods to maintain its standard of living. To pay for those imports, it must also export them.
    To export goods, it has to produce them at a price that is competitive with producers in other countries. If the U.S. exporting sector didn’t improve its productivity, eventually there would be no-one to sell to, because there would be exporters elsewhere in the world capable of producing the same goods at a significantly lower price.

  8. NPOV says:

    BTW, having read the full article here, it would seem that Krugman was mainly arguing that it was in practice baloney because of how things actually are currently (i.e. only 10% of the county’s GDP is due to international trade, and because of current trading arrangements, when big overseas economies do better, the U.S. benefits because there is increased demand for the sorts of goods and services it currently exports very large quantities of). But it’s surely not in principle baloney – especially if applied to a smaller nation that, say, relied on imports for a very large percentage of its goods, and paid for this by exporting only a few products to lots of other countries, and they were products that many other nations also exported.

  9. FDB says:

    I got it Richard, and it was most amusing.

    For Nick:

    Jerry Springer Guest #1: “My momma tole me you wuz a good fer nuthin’ dawg. I shoulda listened to momma!”

    Jerry Springer Guest #2: “She never said that when I was bangin’ her big flabby ass!”

    Studio Audience: “oooOOOooo!”

  10. NPOV,

    Trust me, Krugman is not saying it’s baloney because the US’s trade share is low. He’s saying it’s baloney – baloney from start to finish. Countries don’t compete in the way that you’re suggesting they do.

    Ricardo’s proof in 1817 or thereabouts IIRC makes the point that trade would occur between Portugal and England even if one was more expensive at producing everything.

  11. NPOV says:

    Nick, from <a href=”http://www.pkarchive.org/global/pop.html”>another article (another article by Krugman on the same topic) he states:

    Consider, for a moment, what the definition would mean for an economy that conducted very little international trade, like the United States in the 1950s. For such an economy, the ability to balance its trade is mostly a matter of getting the exchange rate right. But because trade is such a small factor in the economy, the level of the exchange rate is a minor influence on the standard of living. So in an economy with very little international trade, the growth in living standards — and thus “competitiveness” according to Tyson’s definition — would be determined almost entirely by domestic factors, primarily the rate of productivity growth. That’s domestic productivity growth, period — not productivity growth relative to other countries. In other words, for an economy with very little international trade, “competitiveness” would turn out to be a funny way of saying “productivity” and would have nothing to do with international competition.

    But surely this changes when trade becomes more important, as indeed it has for all major economies? It certainly could change. Suppose that a country finds that although its productivity is steadily rising, it can succeed in exporting only if it repeatedly devalues its currency, selling its exports ever more cheaply on world markets. Then its standard of living, which depends on its purchasing power over imports as well as domestically produced goods, might actually decline. In the jargon of economists, domestic growth might be outweighed by deteriorating terms of trade. So “competitiveness” could turn out really to be about international competition after all.

    (my emphasis)

  12. OK – so terms of trade are deteriorating and they’re deteriorating so badly that this depresses your standard of living more than productivity improvements increase it. There’s pretty clearly a ceteris paribus clause in what I’m talking about. If you were hit by a meteor and that wouldn’t do much for your standard of living either.

    But I’m being flippant and I may have misunderstood you. If so I apologise. I took you to be suggesting that to be ‘competitive’ a country has to produce some good at a lower cost than some other country. That’s not right. It only has to be able to gain by exporting one product to pay for imports of another – with the transaction lowering its domestic costs. This was Ricardo’s idea.

  13. pedro says:

    NPOV, here is Krugman’s article on Ricardo’s difficult idea.
    http://web.mit.edu/krugman/www/ricardo.htm

    I can’t see how your quote is relevant to the comparitive advantage question. but clearly it is true that declining competitiveness would have an impact on the growth of living standards.

    If national productivity is rising then living standards should also rise, unless it’s like north korea and the productivity is only in AF47s. But you might have a relative decline in living standards. Which I dare say happened in Australia during the 20th century, at least relative to some developed countries.

  14. pedro says:

    Whoops AK47s

  15. NPOV says:

    “I took you to be suggesting that to be competitive a country has to produce some good at a lower cost than some other country”

    Well, no, but it surely at least has to be producing goods that can be exported competitively – if almost every product that a country produces can be purchased cheaper and more conveniently from elsewhere, then it’s hard to see how it can maintain much of an export trade.

    For instance, it’s surely conceivable that, if say, a huge carbon tax was imposed in Australia that applied to export coal and value-added mineral and agricultural products that involved CO2 production, it would seriously reduce the competitiveness of enough of Australia’s export products that at some point the terms of trade would become bad enough that we would no longer be able to afford the imports that are needed to maintain our standard of living.

  16. pedro says:

    I expect it is hard to sell things overseas unless you are value competitive. And if you can’t be value competitive then you must have a productivity problem. Your coal tax example is a productivity problem because you are increasing the cost of production through the tax. The living standard decline would happen, but because of the productivity decline.

  17. Well that sounds far fetched to me. The image is like putting a brick in Thorpie’s cozzie and expecting him to beat Phelps. It’s the wrong image. If we impose a carbon tax then it will change the things that we’re relatively good at exporting. So it won’t make ‘us’ uncompetitive. It will change the constellation of firms that are internationally competitive in Australia and produce a different trade pattern.

    There are some costs involved in making the switch and some (probably pretty minor) loss of purchasing power because the economy is bearing some new costs (though this should be thought about as mainly borne through redistributing the pattern of activity rather than as a ‘weight’ on every firm trading in the international marketplace – because of course nearly as many firms will be relatively advantaged in international trade by the policy as will be disadvantaged – pretty much by definition.

    But in so far as we are able to sell resource rents to the rest of the world, presumably there’s some hit to our standard of living ceteris paribus.

  18. NPOV says:

    Although I read the Krugman article you referred to Pedro, it wasn’t until I read the wikipedia article on comparative advantage that I actually properly understood what it was about.
    However it seems to me to that even taken the simplified case of two nations trading two goods, then wouldn’t a scenario whereby one nation’s productive capacity was expanded so that it could produce sufficient of both goods to satisfy its entire domestic demand more cheaply than its trading partner cause a drop in living standards in that other nation, if it wasn’t able to also increase its productive capacity? Or is the assumption that “entire domestic demand” is infinitely expandable, because there’s no upper limit on potential living standards?

  19. NPOV says:

    Also pedro, I meant to be more explicit – the carbon tax is ONLY on exports, not on production. So domestic productivity should not be affected by such a tax.

    But I can at least now see while even if the cost of all Australia’s exported goods increased relative to the cost other nations could export them, then there’s no real reason to suppose our living standards would necessarily drop. But would they not increase less quickly than would have without such a tax…?

  20. Now we’re getting somewhere.

    Now take the situation in which we have two countries each producing and trading happily. Then one ends up producing all goods more cheaply. I presume that means it got some productivity kick from somewhere.

    Does that leave the other one worse off? Can’t see it. Of course one could always pull some special assumption out of the hat but without it, the productivity kick in the cheap country just gives the more expensive country different options as to what it wants to buy from the cheap one doesn’t it? In most circumstances one would imagine that both countries share the benefits of the productivity gain in the cheap country. Of course they may not, but it looks quite difficult to me to get the expensive country to do worse out of a productivity kick in the cheap country.

  21. Well if it’s a silly inefficient tax then pretty much by definition living standards will drop. But it’s not a lot to do with exports. If you taxed some other part of the economy – put on a 100% tax on the sale of all liquids for instance – then you’ll do some nasty things to the economy.

    If the liquids are imposing some externality then the tax might improve things – so that’s the argument for a tax on carbon. But it’s an international externality, so that Australia gets next to no benefit from it (unless it’s part of some global deal).

    I once heard an eminent economist (a trade economist actually) defending the GST on the grounds that it would make us more competitive. I asked him to tell me what would be wrong with imposing GST on exports. He thought about it for a while and realised that it wasn’t at all trivially obvious that that would be a bad thing (I’m not recommending it by the way, but you can go through the exercise). The main point is that doing this would not necessarily make us less ‘competitive’. It would reduce the extent to which we trade (fewer exports and imports) and that would probably end up giving us a worse allocation of resources. But it could conceivably improve it.

  22. SJ says:

    NPOV says “Or is the assumption that entire domestic demand is infinitely expandable, because theres no upper limit on potential living standards?”

    Well, sort of. There’s an assumption that demand is expandable, but it’s not necessary to assume that it’s to infinity for the model to work. The model breaks down when pushed to infinity. Most other models of anything do likewise, but that doesn’t imply that the model is wrong when used for the purpose for which it was designed.

  23. Rafe Champion says:

    How to make scientific research pay – the lessons to be learned from the success of rural research in Australia.

  24. SJ says:

    Thanks for that irrelevant Catallaxy spam, Rafe.

    (Insert “roll eyes so far back in the head I can see my adrenal cortex” emoticon here)

  25. pedro says:

    NPOV, sorry if the Krugman piece disappointed, I thought it interesting in the context of a discussion about the understanding of comparative advantage, but wikipedia would probably have provided a better explanation of the principle.

    The ricardo explanation always uses a simple model, but the underlying point is that if you concentrate on where you are most productive and trade for the balance then you are better off simply because you have maximised your production. That does presuppose that other people want to buy the things you are making. I suppose what is most importantly unsaid in the simple model is that, where trade is possible, market forces will over time direct resources to the production of those valued goods and services that can be most productively produced. Sorry for the clumsy sentence. The deep point of ricardo is that trade works to improve living standards and governments should not fret too much about the death of industries. It is not a principle to assist governments to pick winners.

    A tax on exports will make the relevant producers less competitive for those exports to the extend that the tax raises their sale prices relative to their competitors overseas, but you have exchange rate effects and so forth too.

  26. NPOV says:

    “trade works to improve living standards and governments should not fret too much about the death of industries”

    No real dispute there, but I think governments have some reason to fret if it’s becoming clear that, for instance, no new industries are developing that are capable of generating suitable employment for displaced workers. There’s also the age-old argument that maintaining at least some basic manufacturing capacity is necessary for security purposes (I suppose the important thing here is to maintain the human capital necessary for building defence equipment – providing you have that human capital, constructing factories can be done pretty quickly).
    I can also understand why governments would be concerned about the ease with which corporations based in wealthy western nations can largely keep all the benefits they’ve gained from being located in such nations, but then transfer capital/labor/technology to developing nations to take advantage of conditions in a country that most likely could never have been able to enable to the company to develop to its present condition in the first place. I don’t necessarily know what the best solution to this is, but it seems like if we were able to better recognise the degree to which a corporation relies on infrastructure and human capital provided by the nation it initially develops in, then there’s argument that representatives of that nation (i.e. the government) should be able to benefit more directly from a company’s decision to pick up shop and move it elsewhere than the questionable advantage of cheaper consumables.

  27. pedro says:

    NPOV, I think that the armaments industry has moved beyond our reach now. But there will always be work for low skilled workers, particularly if we do not put up artificial barriers, like over doing the training for child care workers. There has been an explosion in domestic help industries and god only knows what a struggle it is to get a decent cleaner for home.

    People do fret about replacement industries, but they seem to come along anyway, the invisible hand at work I suppose.

    Cheaper consumable are unquestionable advantage. Would you prefer the lifestyle of the 50s? The difference between now and then is better and cheaper consumables.

    The other thing to remember is that people in developing countries start up the wealth ladder when the low silled jobs move there. Unless they’re run as kleptocracies you get malaysia.

    The point Nick made earlier is that you should not think about countries competing. Better to think about people and companies trading across the world and all of us benefiting from the division of labour.

  28. NPOV says:

    “Cheaper consumable are unquestionable advantage. Would you prefer the lifestyle of the 50s?”

    I don’t think that’s an entirely fair comparison – I’d suggest that one outcome of items like electronics, clothes and toys becoming cheaper because they’re made in China (or wherever) is that we simply buy a lot more of them, without them necessarily adding much to our quality of living. And the people who have benefitted the most from cheaper consumables (i.e. those with the least income) often aren’t the ones that have had their incomes reduced by the tendency of manufacturers to move offshore (and were often the ones that enabled the company to become successful in the first palace).

  29. pedro says:

    I think the problem with that argument is that the claimed problem does not appear to exist. Since the big reduction in trade barriers by Hawke, things have gotten better in this country as a direct result.

    Real wealth is valued (desired) land, goods and services, so we only get richer through productivity increases. I guess you could easily enough find supporters for the idea that the world is not made better by more plastic toys. But more toys comes along with more medicine, food, housing, education etc etc.

    I suspect it would be hard to find many examples of people who have in the long run had their income reduced because an industry migrates to China. I’m sure some exist, but unemployment has been going down and so those guys not making plastic toys are probably doing something better. No question there are dislocations that need to be worked out. Plenty of that happened when the tariff wall came down.

  30. NPOV says:

    “Since the big reduction in trade barriers by Hawke, things have gotten better in this country as a direct result.”

    I wouldn’t dispute that, and I’m not proposing that the correct way to address the issue of any reduction of medium-paying jobs is to re-erect trade barriers.

    “I suspect it would be hard to find many examples of people who have in the long run had their income reduced because an industry migrates to China.”

    I agree that in Australia at least the extent of this problem has been overstated by many. But there is considerable evidence of it in the U.S., where middle class income have been stagnant or falling for some time.

  31. pedro says:

    If the wages outcome is different in the US then maybe the cause is different. But let me address the concern another way. If t-shirts have to be $30 instead of $5 to keep local workers employed making t-shirts, then everyone is $25 worse off every time they buy a t-shirt (even the t-shirt workers if they could get the same or better pay in another industry). That $25 a shirt is supporting more than nust the workers. It is keeping a company going and paying for the running of a factory and replacing capital equipment and so on. Better to give those guys welfare/NIT and get them working somewhere else.

  32. pedro says:

    PS, Krugman says that the US has insufficient redistribution, so maybe that is the problem for middle class incomes. Certainly Howard was a famous for his middle class welfare.

  33. NPOV says:

    And if the differential was really that much ($5 vs $30) then pretty obviously there’s not a lot you could do to sustain a local t-shirt making industry.
    But let’s say it was $5 vs $10, and locally made t-shirts lasted on average almost twice as long (mainly because of better quality, but also because you’re more likely to look after something that you’ve paid more for). I’d argue that even if this case, a local t-shirt factory would go out of business because too many consumers will tend to buy 2 t-shirts knowing they won’t last so long than pay twice as much for a better locally-made one. In such a case, it’s not so clear that any sort of government intervention designed to help the local t-shirt industry would have a net negative effect.

  34. conrad says:

    “But there is considerable evidence of it in the U.S., where middle class income have been stagnant or falling for some time.”

    Here’s an alternative way to think about it NPOV. Lets say the US had 100% barriers against all Chinese products.

    (a) Would middle class income still have been stagnant?
    (b) Would the middle class be better off without Chinese products?

    I’ll assume the answer to (a) is yes, since some other country would have filled the gap if China didn’t exist, and the answer to (b) is certainly yes. Even if the US had tariffs against everyone, you’d still have to convince me that the middle class income would have risen rather than stagnated. This seems to me a function of the fact that going from rich to exceptionally rich is hard (especially with a fairly average education system).

  35. NPOV says:

    conrad, I never supposed that trade barriers were likely to solve the problem of stagnant middle class incomes. But I do wonder what might have happened if some more of the external costs associated with offshoring labour were properly built into the price of imported goods.

  36. pedro says:

    Well that’s the thing about external costs, they can’t be built into a price except by a tax. But how do you identify the cost of losing the t-shirt industry? I don’t think you can even find one. Nick Gruen believes that the removal of low levels of protection can be a negative, but low levels of protection are not distorting. I don’t think too many economists are in favour of substantial levels of protection. The basic argument is that factors of production move from a protected, and therefore relatively unproductive, industry to a productive industry.

    We have traditionally had adjustment programs for workers and industries affected by reductions in protection. From memory the milk levy to pay for the dairy industry adjustment program has only just been cancelled. Whether those programs do much good is a question that is beyond me. I prefer the idea of longish but fixed lead times for the reduction and then relying on welfare to cover the dislocation.

  37. NPOV says:

    “But how do you identify the cost of losing the t-shirt industry?”

    Well one might be any increase environmental impacts that occur by moving a clean modern factory in Australia to a dirty polluting one in China. Now sure you could argue that it’s not up to Australians to pay for the environmental damage being done by factories in China, but ultimately somebody has to pay for it, and probably better us than future generations of Chinese that are still not as wealthy as present-day Australian taxpayers.

    One other issue that has always concerned me is the degree to which sweatshops get away with maintaining pretty rotten labor conditions largely because the consumers they sell to simply don’t see what’s going on. If we had to walk through the factory that produced some of the goods we bought, we’d almost certainly think twice about it. Now if China can produce t-shirts more productively than Australia simply because of economies of scale or because there’s far more lower skilled workers there for whom the pay rates being offered (which might seem extremely low to us) are still a significant step up from what else is available to them, then fine, I don’t have an issue with it. But if they are producing t-shirts more “productively” because they are getting away with rubbishing the environment or obviously exploiting workers in ways that there really is no excusing, then it’s not clear to me that the human race as a whole is better off from such an arrangement.

  38. pedro says:

    All right, 2 good questions. With the manufacturing externality, if we restrict purchases from China as our contribution to minimising their pollution then we will probably make no difference because we are too small a market to much affect total production schedules. But we would still pay a cost. This is the exact problem with the proposed ETS. Cost without gain. But, we could affect somewhere like Fiji, which also is into TCF. So let’s use that as an example. We have cleanish factories here because we both want and can afford them. The Fijians might not be able to afford them yet, and if we refuse to trade with them, they might never afford cleanish factories. I believe you can trust that fijians will want clean factories and thus will require them when affordable. I think there are already signs the Chinese know they need to clean up their act.

    I think the best answer to the exploited worker argument is that as productivity increases the wages go up too. In my lifetime I’ve seen the source of clothing move around the world. That’s just from looking at the labels. Some industries have moved from country to country chasing cheap wages. The good point to note is that every move is evidence that the wages have gone up where they were operating.

    Japan and Hong Kong is where the cheap toys came from when I was a kid.

  39. Patrick says:

    One answer to the exploited worker problem is to realise that probably more than 90% of the time it is a vicious confluence of protectionism and soft-left paternalism.

    The protectionism is obvious. The soft-left paternalism (SLP) is, I suspect, basically NPOV’s view: those conditions appear intolerable to me they must be intolerable.

    The catch is that we don’t have either formal or practical open movement of labour, so even if the SLP is well-founded, it is irrelevant to the question: what is in the best interests of the labourer?

    To my mind the best interests of the labourer are the proliferation of sweatshops and other labour-intensive industries. In the first place s/he is employed, which for present purposes may be assumed to be better than subsistence without employment. Secondly, the growth of these industries will push wages up, and stimulate broader growth as those wages translate into consumption, in addition to the original constructions, visits from middle management and concerned NGOs, etc.

    After all the industrial revolution is not such a distant stage of our own path to luxurious comfort.

    And Pedro is spot-on when he points out that only thing that really correlates with environmental consciousness is wealth. Soft-lefties like to think that some kind of ‘original’ or tribal state correlates with environmental consciousness, but in fact the correlation is only to the degree that not having any alcohol correlates with sobriety.

  40. NPOV says:

    “To my mind the best interests of the labourer are the proliferation of sweatshops and other labour-intensive industries. In the first place s/he is employed, which for present purposes may be assumed to be better than subsistence without employment. Secondly, the growth of these industries will push wages up, and stimulate broader growth as those wages translate into consumption, in addition to the original constructions, visits from middle management and concerned NGOs, etc.”

    But that assumes that no better path is possible! My point is that we’ve already been through the hardship of fighting for decent working conditions in Western nations – but suddenly we’ve decided it’s OK to buy products produced under conditions that are often not even close to something that we would tolerate here.
    And it’s NOT about the pay – of course it’s not going to be possible to pay the sort of wages we enjoy in Western nations. But the cost of providing decent and safe working conditions is not only not that high – I would suggest that in the long term there’s a significant net cost in exploitative and unsafe working conditions. But we in developed countries, who are the ones who can most afford to, are by and large not going to be the ones to pay those costs.

    Likewise, we’ve already learnt the lessons of what happens when industries are free to ignore externalities associated with environmental damage. Why on earth should we suddenly decide that it makes sense to go back ignoring them just because the factories are now in a distant country? It’s of course especially the case as we realise the extent to which environmental damage that might appear local often ends up having global effects – and I’m not just talking about global warming here, but e.g. the huge dust and smog clouds that blow across the Pacific from China.

  41. Patrick says:

    My first response would be that if we don’t to at least some extent ignore all that then we simply don’t have any reason to manufacture shirts in the third world, and that is a very poor outcome for the third world.

    My second response is that I am not sure what better outcome is being proposed – the most reasonable interpretation of your comments meets my first response. If however you are proposing that in effect we practise a form of charity, paying more than we need to for goods in order to provide for better social and environmental conditions for their producers, then I have a third response.

    My third response is that if what you are proposing is the charity described then why don’t you give the difference to World Vision or a similar organisation? That way you would simultaneously achieve the presumably desirable ends of
    – not giving the middle-men a cut of your charity,
    – a tax deduction, saving you cash and enabling you to give even more to charity,
    – reduced distortions in the market for t-shirts creating more reliable demand fostering greater production in third world countries, with the benefits discussed above, and
    – a warm fuzzy feeling inside.

  42. NPOV says:

    “My first response would be that if we dont to at least some extent ignore all that then we simply dont have any reason to manufacture shirts in the third world, and that is a very poor outcome for the third world.”

    I don’t believe that’s true at all. There’s still two big advantages that developing countries have over developed ones, and that’s huge pool of relatively unskilled labor available, and the fact that relative living standards and costs means that their wages will always be substantially lower.
    Even if factories were required to comply to the same level of environmental, health & safety regulations that apply in developed nations, they’d still be able to produce inexpensive items in very large quantities in a way that developed nations couldn’t expect to compete with.

    As far as considering it a charity – yes it would be wonderful if everyone voluntarily saw that because what they’re paying for inexpensive oversea-made goods doesn’t properly capture the longer term environmental and social costs involved in their manner of production, they should give a little bit extra to groups committed to improving conditions in such countries. But people by and large *don’t* see that, and I suspect the groups that do such work rarely operate as international charities anyway. I know myself I’ve bought plenty of cheap toys from China, largely because I have no choice – if I had the choice of buying the toys that my son wants more expensively from manufacturers that did adhere to better environmental and labour standards then I probably would. But worse, there’s not really anyway for me to determine exactly what are the environmental and labour standards that the manufacturers are maintaining, and further there’s no good way for me determine just what is the right price to pay to ensure good standards are maintained.

    As far as your “reduced distortions in the market” claim goes – it strikes me that the market is currently highly distorted anyway, because the people who will ultimately pay for the costs associated with poor labour and environmental standards are not, by and large, the ones paying for the products being produced.

  43. pedro says:

    NPOV, I understand what you mean about the safe working conditions and so forth. If Nike builds a factory in china then it should at least be safe. But those costs are not necessarily cheap. There is a capital cost to moving from a shed full of sewing machines to a western-style safe facility, with first aid, staff rooms and so on.

    I think there are 3 things we need to investigate/take into account:

    1 the type of factories we have here also require capital accumulation from earlier profits and while Nike has those, local manufacturers that supply to Nike might not;

    2 if nike builds a factory in china I would be surprised if it was a dingy sweatshop because nike would probably prefer not to have such a thing;

    3 but nike is more likely to use contract manufacture and if the US, say, mandates safe working conditions for all imported garment manufacture then factories will not get moved to cheaper labour until the labour cost difference justifies the capital cost, which would slow the opportunity for the poorest to get on the work ladder.

    I’m not saying your are definitely wrong, but I think there is a lot to it. The fair trade mantra often enough hides real problems for the people supposed to be benefited. But, if, as Patrick says, you let the sweatshops get on with things then the vast majority of the workers in them are starting on the ladder up. Trying to regulate from here, Europe or the US by fair trade controls will most likely substantially delay that process at the cost of the poor buggers who want the work.

  44. NPOV says:

    I’m sorry, but it’s nonsense to suggest that insisting on some basis set of working conditions and environmental standards is going to make it impossible for industrialisation to get off the ground: you say “those costs are not necessarily cheap”, but again I would suggest it’s far more likely that the costs of NOT implementing such standards are actually considerable – you can read of cases in China where factories that are permitted to pollute freely have been responsible for significantly impacting the health of those living around it, often resulting in premature deaths etc. Or of workers being maimed and killed, or of the social costs that stem from imposing unrealistic expectations on the number of hours worked per day, or of the costs from child labour, where children miss out on important educational opportunities etc. etc.

    I’m sounding like a broken record now, so I suspect this argument has run its course. If you honestly believe that you are doing the best you can for citizens in third world countries by turning a blind to what often goes on in factories there, then fine. But the reality is that such conditions are allowed to prevail only because for the vast majority of consumers in Western nations it’s “out of sight and out of mind”.

  45. Tel_ says:

    There is only a finite volume of oil in the world, a finite volume of natural gas and a finite volume of gold and silver. Based on the observation that humans find these commodities desirable (and I’m willing to listen to any arguments that they might be undesirable, but not seriously), the desirable commodities will end up sitting in someone’s country. Might be worth considering ways to make that your country.

    Another thing to consider is human talent. Of course, this is not a finite resource: we seem to have no difficulty making more humans, some percentage of those will have natural talent, a good education system can assist in this area as well. However, at any given moment, the nett supply of human talent will not change quickly so it is always faster to import skilled labour than to attempt to foster local talent. A fair chunk of the population of Silicon Valley were imported direct from India (and don’t forget Bangladesh) and to some extent from China too. The importer gets to be selective in these situations and the logical thing is to give preference to the best quality imports.

    A nation that can gather both human talent and desirable commodities will improve all of its industries, deliver more luxury items to its population, and put itself into a superior position to make war as well (or at very least give it a better defense against the next guy out there making war). If they choose to spend this boon on education, research and other future-seeking investments, they will also be in a better position next generation.

  46. NPOV says:

    Not entirely how your post fits with the preceding discussion Tel, but I will dispute that oil/gas/gold/silver are in themselves desirable commodities that will “end up sitting in someone’s country”.

    Oil and gas are energy sources that largely get burned away, so don’t “sit” anywhere – and while oil and gas have properties that make them especially attractive as energy sources, ultimately what we want is the energy supply, not the actual commodities themselves. To maintain a prosperous economy, it’s simply necessary to have a reliable and inexpensive energy supply – it doesn’t really matter too much where it comes from (though the current near ubiquity of the internal combustion engine does make compatible fuel sources particularly valuable).

    Gold and silver are not that different to other elemental resources whose value is primarily in a combination of their scarcity, convenience and what they can be used for. There doesn’t seem to be any particular advantage in “gathering” them, with the possible exception of using gold reserves as a form of ultra-secure monetary saving: generally the most worth you’ll get out of a commodities is by adding value to it by converting into a product that large numbers of people desire.
    And there’s not really much reason to be concerned about the world running out of gold and silver, given that if we ever were to reach a point where all naturally occurring gold or silver was all locked up in artefacts so desired by their owners that they weren’t prepared to trade them with others who wanted them for their metallic content then there’s reason to suppose it would be by then technically possible to create such metals artificially via nuclear fusion (just as it was created initially).

    Having said that, I do think there’s good reason to suppose that this century will be marked by the impact of energy and resource shortages, that while technically may well be temporary, will have lasting effects on global development.

    We seem to be getting desperately off topic now…

  47. Tel_ says:

    Not entirely how your post fits with the preceding discussion Tel,

    There was some suggestion that nations do not compete with one another. I was bringing up a few counter-examples demonstrating that not only do nations compete, but that being the “loser” in such competition will leave a nation with a poor economy, unhappy people (who emigrate where possible) and probably a weak military as well.

    Oil and gas are energy sources that largely get burned away, so dont sit anywhere – and while oil and gas have properties that make them especially attractive as energy sources, ultimately what we want is the energy supply, not the actual commodities themselves. To maintain a prosperous economy, its simply necessary to have a reliable and inexpensive energy supply – it doesnt really matter too much where it comes from (though the current near ubiquity of the internal combustion engine does make compatible fuel sources particularly valuable).

    There’s a lot more you can do with oil than just burn it, indeed some would say that burning oil is a singularly stupid waste of an excellent chemical resource. At any rate, people have demonstrated a desire for oil, presumably they want it for a reason, someone will get the stuff, thus others will miss out because no new oil is being created.

    In the future, with new technology, alternative energy (for argument’s sake, let’s say solar) will no doubt be available and then some other resource will become greatly desirable (e.g. zinc and bromine for batteries to store that solar energy). Same principle will apply with those materials. Krugman’s “no competition” principle is based on the presumption that physical-world material resource bottlenecks are never significant, which is quite frankly a total crock.

    Gold and silver are not that different to other elemental resources whose value is primarily in a combination of their scarcity, convenience and what they can be used for.

    The point is that if the resource can be used for something, and you have access to the resource and some other guy does NOT have access to the resource then you get to do cool stuff, and he gets to come to you asking for some. Gold and silver are primarily useful for electronics and for jewelery, both of which are desirable and make people happier. Electronics also have secondary uses improving the nation’s technology, productivity and infrastructure. Copper supply is so tight that people will steal live cables for the metal value, and in some parts of the world they won’t even try laying down twisted pair communications cable because the theft is too high to make such things economically viable.

    Krugman claims “Any countrys standard of living depends almost entirely on its own domestic economic performance, and not on how it performs relative to other countries”.

    So let us presume that China has huge reserves of US dollars and China happens to need a lot of copper, so they buy whatever they can get. Result is that the international copper price goes up, industries in poorer countries simply cannot make the electronic devices that require copper because it is out of their price range. If you want another example, most of the world’s Neodymium supply is controlled by China, if you want to make high power magnets, you have to buy the stuff.

    … it would be by then technically possible to create such metals artificially via nuclear fusion (just as it was created initially).

    The availability of energy sources many orders of magnitude cheaper and more powerful than what we have now would change so many things. I will say that whoever has access to the best tools and best research equipment now will probably be the first to gain access to the next generation of hyper energy supply and they may decide that it is more efficient to use this to conquer other nations rather than sharing the secret of how it works.

  48. NPOV says:

    “Krugmans no competition principle is based on the presumption that physical-world material resource bottlenecks are never significant, which is quite frankly a total crock”

    Fair enough, that’s definitely a valid criticism of his point, but I suspect you overstate the extent to which it’s a problem when looking at anything other than the poorest nations today. Krugman was primarily criticising those who claim that the U.S. must remain competitive with other large economies. I’d agree that if the U.S.’s ability to import oil shrivels because its spending power grows less rapidly than other net importers this has the potential to significantly affect living standards – but only if the U.S. does nothing to reduce its dependence on oil. In principle, even with current technology, the U.S. could use half the oil it does and still maintain very high living standards, so it’s still largely an issue of domestic productivity.

  49. pedro says:

    Tel, have a look at the per capita incomes and see if you can pick a relationship based on having resources. Note holland compared to saudi arabia, say.

    Countries don’t compete because businesses do. Businesses in some countries have advantages because of the economic and social development of those countries.

  50. Tel_ says:

    Dunno how the table is going to come across through the web munge but here’s a list of the nations of the Arab League (as taken from Wikipedia) with the controversial Israel and Palestine removed and I’m not counting the “observer” nations either. Countries listed have approximately similar culture, are located around the same area of the world and have somewhat parallel history.

    Qatar 5 — — OPEC
    United Arab Emirates — — 22 OPEC #8
    Kuwait 29 4 24 OPEC #11
    Bahrain 47 20 33
    Saudi Arabia 54 52 41 OPEC #1
    Oman 61 59 48
    Libya 72 72 170 OPEC
    Lebanon 94 87 50
    Algeria 108 103 89 OPEC #14
    Tunisia 117 109 74
    Jordan 121 124 90
    Morocco 134 138 101
    Syria 138 134 105
    Egypt 144 121 —
    Djibouti 155 159 97
    Mauritania 167 163 138
    Yemen 163 161 —
    Sudan 159 167 145
    Comoros 173 184 137
    Iraq — — 171 OPEC #15
    Somalia — — 172
    Western Sahara — — —

    I’ve ranked them partly from your list (as above) and partly from the Nationmaster figures (mostly CIA fact book). The three columns are the ranking (1 is good)

    http://www.nationmaster.com/graph/eco_gro_nat_inc_percap-gross-national-income-per-capita

    Also, note the flag for OPEC members and an additional flag for the top few oil producers in the world (2006 figures): http://tonto.eia.doe.gov/country/index.cfm

    The only one that substantially bucks the trend is Iraq, and they are under foreign occupation after losing two recent wars and many years of economic blockade. Bahrain is not an OPEC member but it is a major oil producer. Oman’s oil production has been winding down but still it is significant.

    If you really want to look at Europe, then compare Norway to Sweden — both doing well, similar technology levels, similar education and culture, but Norway’s high oil production makes a clear difference.

    There’s a lot more to it than just where the resources COME FROM, consider carefully where these resources ARE GOING TO. The guy who sells a resource does well while stocks last, but the guy who buys the resource uses it to stoke industry and build the next generation of technology. I think you will find that USA, Europe and Japan are huge consumers of resources and I would argue that this is both the cause and the effect of their internationally competitive economies. The US will no doubt drop a peg or two after recent efforts and they will feel the pinch when they are no longer able to easily obtain vast quantities of oil.

  51. pedro says:

    Tel, my point is that there is way more to wealth than resources, which are not a necessary precondition to wealth.

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