New Definition of Comparative Advantage

by BILL WADDELL

The explanation from those on high for throwing American manufacturing – as well as manufacturing in western Europe and Australia – under the bus is the Theory of Comparative Advantage.  Even Barack Obama cited it in his "Economic Report of the President" sent to Congress last month.  The definition of the theory he provided, however, while right down the line consistent with how the economists and academics describe it to everyone these days, is a tad off from how the guy who thought it up described it.

Our President – who most assuredly did not write his report, or probably even read it; that work was left to the big brained economists who are steering the economic ship of state so masterfully for him these days – defined comparative advantage as the idea, "that nations specialize in producing the goods that they can produce cheaply relative to other goods."  David Ricardo, an English guy who actually thought up the theory and wrote about it in a book back in 1817 never used the word "cheap".  He made it pretty clear that the theory was all about productivity.  His big idea was that there is greater economy for everyone by finding the best combination of making stuff here, there and everywhere that creates the greatest overall output of stuff relative to the total labor hours everyone is expending.  He said every country should do what they do best – best meaning most productively – and then swap stuff back and forth, instead of each country trying to do everything.  That way the whole world gets the most stuff for the least work.

The idea that the theory is about productivity, rather than "cheap" is not buried in some obscure passage in the book.  It is front and center – Chapter 1, Section 1, page 1, paragraph 1, sentence 1:

"The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that labour."  When an economist – or a President – defines the theory as having to do with "cheap" rather than "the quantity of labour" – productivity – it is kind of like a kid doing a book report on Tom Sawyer, and not knowing Tom was an orphan.  Pretty strong evidence he didn't actually read the book.

I suspect what happened is this:

About twenty five years ago, a bunch of Harvard and Yale grads were crying in their single malt scotch at a Wall Street watering hole bemoaning the explosion of Toyota on the economic scene, seeing the future and realizing that it looked pretty grim for Wall Street.  While good old Ford and GM operated wildly out of control with great profits one year and deep losses the next, Toyota was like the proverbial tortoise – making a lot of money but doing it slowly and consistently, growing both the top line and the bottom line every year at a very steady rate.  The thought that everyone might become lean and operate like Toyota was their worst nightmare.  "Toyota stockholders buy and sell their stock every fifteen years," they cried, "compared to every few months for the out of control companies.  How can we make any money when the stock doesn't churn?"   "And what good is inside information about a company that is completely transparent, and whose strategy never changes, having no surprises?"  They looked at lean manufacturing and saw their impending doom – the worst of fates – the possibility that they would actually have to go to work in order to make any money - a fate worse than death itself.

But help was on the horizon.  Not every Harvard and Yale grad went to Wall Street.  A few stayed behind in the ivy covered halls because, darn it, college was just too much fun to leave.  So the boys on the Street called their friends back on campus and asked if they had any good ideas to solve this looming crisis – after all, their old college buddies were the idea men.  And one of them vaguely remembered Ricardo and Comparative Advantage.  He hadn't read it – there was a big polo match that weekend so he just used the Cliff Notes – but it seemed appropriate because what the guys on Wall Street needed was a comparative advantage over lean thinking.

That a comparative advantage was needed was just common sense, so the boys ordered up another round of drinks, started brainstorming and came up with a few common sense thoughts:

Compared to complying with environmental regulations in the United States, there is an advantage to making stuff where they don't care about the environment.

Compared to complying with occupational health and safety regulations, there is an advantage to making stuff where workers can be treated like animals.

Compared to American productivity and wages, there is an advantage to making stuff in countries where the pay is so dismal that it more than makes up for the fact that productivity is much worse.

Compared to the transparency requirements in the United States there is a big advantage to making stuff in countries where no one can know what is really going on.

Compared to being responsible for people being hurt by the products they make, there is an advantage to making stuff in a country where American consumers can't touch them.

Mostly, compared to investors making a lot of money in a long-term secure manner, there is a great big advantage for us on the Street to buying up every small manufacturer we can get our hands on and moving them to such a place that these advantage can be realized, then selling them before the rubes out shopping in Walmart figure out that the products are no good any more.

Best of all, compared to accepting any responsibility for employees, customers, communities, the country or anyone else, there is a huge advantage for us in just grabbing as much cash as we can as fast as we can and buying as many toys as we can.

They scribbled on the back of a linen bar napkin, which they sent off to their buddies back at school to polish up into academic language.  It was subsequently sent off to their old fraternity brothers holding down the top jobs in the White House, Treasury, the SEC and the Fed; and the rest is history.

Now I can't prove it, but I am pretty sure that is how it happened.

The best evidence I can cite is the recent news involving Apple and Steve Jobs.  The richest man from Steve's innovations is not Steve, but a fellow by the name of Terry Tai-Ming Gou, who controls a company called Hon Hai Precision, which owns Foxconn, which is the maker of just about everything Apple – as well as a lot of stuff for Dell, HP, Intel, Play Station and Cisco.  He is the big money maker in the innovation-comparative advantage engine because he is the guy who brings this scotch-induced new theory of comparative advantage to life.  Terry is worth about $5.5 billion has some 450,000 employees – the overwhelming majority of them in places where people have to put up with just about anything Terry tells them to. He rules his comparative advantage empire form a castle in Europe, rather than his flagship 270,000 employee operation in Shenzhen – or Vietnam, Mexico or the other places where he provides a comparative advantage over ethical, decent management.

In recent weeks, Terry's plant in Mexico was lit on fire– some say by disgruntled current employees, Terry says by 30 disgruntled ex-employees - over a brouhaha over late buses and overtime pay.  One disgruntled ex-employee coming back for vengeance is the American way – I can't imagine how you can disgruntle 30 people from a Mexican minimum wage job to the point that they come back en-masse to burn the place down, but that appears to be just another day in the life at Foxconn.

A Reuters photographer was kicked, beaten and dragged  by Foxconn security folks for having the audacity to take a picture of a Foxconn factory from the public street in front of the plant.  And, of course, most folks have heard of the Foxconn employee who either lost or stole a prototype iPhone who made the strange decision to jump from his 12th floor apartment window as he was being searched, interrogated and assaulted by Foxconn security.

Now Apple has released its audit of Foxconn – a litany of acknowledgments of employee abuse, child labor, making folks pay for the privilege of dollar a day jobs and on and on – 17 'core violations' in Terry's factories.  Foxconn has admitted to them, with a 'but hey, we've only been working on these violations since 2006 and we're getting better'. 

On the home front, Steve took a bit of a setback when a federal appeals court ruled that Apple shareholders can refile their lawsuit to get what Steve thinks is so unreasonable – access to the books of the company they own so they can get to the bottom of the  back-dated stock options scheme.

It seems to me that Apple – and many, many others – are living the dream under this new definition of comparative advantage.  The boys on the Street have averted catastrophe, and named Steve (and by proxy his partner Terry) the CEO of the decade for his masterful job of turning their creative economics into a most impressive financial advantage for them compared to managers who engage in constructive work for a living, and do so with integrity, love for their community and their country, and respect for the people who work for them. 

And Barack Obama has educated Congress – and the American people – that this is just how comparative advantage is supposed to work.