Mankiw’s Principles of Economics Part 5: Trade Can Make Everyone Better Off

The introduction to this series is here.
Part 1 is here.
Part 2 is here.
Part 3 is here.
Part 4 is here.

Mankiw’s fifth principle is: Trade Can Make Everyone Better Off. He says that that my family competes with other families for jobs, and when we shop, we compete with others to find the best prices. But if we cut ourselves off from the market, we would have to grow our own food, make our own clothes, and build our own houses. “Trade allows each person to specialize at what he or she does best, whether it’s farming, sewing, or home building.” In the same way, nations can specialize in what they do best. In both cases, people get a wider range of choices at lower prices.

It’s obvious that there are too many humans for us to exist on this planet without the kind of trade Mankiw is talking about. There isn’t enough arable land to support the huge number of tiny farms we would need to set this up, even if we wanted to, and I don’t think that’s what people want. And the way Mankiw explains it, it all seems so natural, probably because we’ve been hearing it all our lives. Everyone knows people like to trade for things. Our most ancient ancestors traveled to trade goods, and to party and marry across groups. Codification of this idea goes back at least as far as Adam Smith.

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy…What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.
The Wealth Of Nations, Book IV Chapter II, pp. 456-7, paras. 11-12.

As long as you have lots of money and better things to do, that makes sense. If you have spare time and the means, why not grow your own food and make your own cloth, and save your money for things you can’t make? I assume that was the case for many Britons of Smith’s day. As a maxim, I assume it has much older roots. It’s easy to see why people who live in Whitby, England are specialists in making jet jewelry: the jet there is perhaps the finest in the world, and people have been working it into jewelry for centuries. In the same way, it’s easy to understand that a small town in 18th C. England is better off with a professional blacksmith than with a forge in every home.

People in India have been making beautiful cotton textiles for centuries, as I learned from Empire of Cotton by Sven Beckert. Those textiles were shipped around the world for most of recorded history, until what Beckert calls War Capitalism began to take control of it in the 17th Century. For a very brief discussion of the role of cotton in Gandhi’s India, see this.

What we now know is that owners of capital decide where investments are made. With low transportation costs globally, capitalists are able to locate businesses anywhere. The point is that when specialization reaches a certain level, the role of the craftsman comes to a bitter end, replaced by selling fast food or tending children. This is precisely what happened with cotton. Rich merchants stopped importing finished goods, and stopped using independent weavers in distant parts of the world, and built plants with capital intensive machines in Northern England. The price of cotton textiles went down, but millions of India’s workers lost their incomes, and millions of Africans were sold into slavery to raise cheap cotton for shipment to England. Trade didn’t make them better off.

Of course, it happens all the time. One excellent example is aircraft manufacture. Boeing’s principle resource was once its amazing workers, especially its engineers and assembly line workers in northwestern Washington. But its executives wanted the big bucks, so when it came time to build the Dreamliner, they broke that system to replace those skilled workers with cheaper unskilled labor all around the world, and increased their own salaries. Then the entire system broke down. Here’s a timeline of the known failures of the Dreamliner. Currently, Boeing estimates it is losing $23.2 million on each sold aircraft. Much of this can be blamed on stupid management decisions about production. Boeing CEO James McInerny got about $29 million in 2014 compensation, and the chief of commercial aircraft, Ray Connor, got $16 million. This is payment for abject failure. I guess they benefited from trade.

Maybe that’s why Mankiw’s fifth principle is couched in such weak language. Here’s a better statement: trade can make some people better off, especially if we ignore all the people it makes worse off.

We also see how beautifully this principle supports Mirowski’s Eighth Commandment of Neoliberalism: Thou Shalt Keep Thy Cronyism Cosmopolitan, which teaches the importance of free flows of capital. The capital needed to make aircraft and textiles can be sent wherever labor is cheapest, including South Carolina. That’s neoliberal freedom. You will recall that most of the British assault on India was led by the East India Trading Company, an early corporation. These stories tell us that Mankiw’s fifth principle works well with Mirowski’s Tenth Commandment: Thou Shalt Not Blame Monopolies and Corporations. They are simply not responsible for any of the misery their trade policies hurt. And finally, see how Smith’s maxim works with the average person’s understanding of economics, that what is good for the household is good for the nation.

19 replies
  1. wallace says:

    quote”These stories tell us that Mankiw’s fifth principle works well with Mirowski’s Tenth Commandment: Thou Shalt Not Blame Monopolies and Corporations. They are simply not responsible for any of the misery their trade policies hurt. And finally, see how Smith’s maxim works with the average person’s understanding of economics, that what is good for the household is good for the nation. “unquote
    Well halalulla!!
    I would expect that your insights fall on deaf ears of those who are the recipients of the very subjects of your analysis. Get a grip. Economists don’t really have a clue. EVER. After all…look around pal.

  2. Pacanukeha says:

    Interesting – I had not realized that the Household=SovereignNation lie was started so long ago, good archaeological find!

    • SomeCallMeTim says:

      That false equivalence mostly arises in macro, as an argument against Keynesian fiscal policy in response to aggregate demand fall off in recessions, countercyclical social welfare policies benefiting the wrong people (highlighted by racial dog whistling, but poor whites are wrong and undeserving too).

      On.the micro side it doesn’t seem as egregious, at least at the small merchant rather than EIC level of power disparity.

  3. Alan says:

    Mankiw get’s Adam Smith all wrong. More on this when we get to the next Principle.
    Several things to note:
    The term capitalism didn’t come into usage until around 1840. Lots of people speak anachronistically about capitalism in the 18th centuries (e.g Beckert) and sometimes earlier. Wealth of Nations (WoN) was published in 1775 and is a critique of Mercantilist economics, the dominant economic system of the 18th C.
    Adam Smith is very critical of the East India Company (EIC) in WoN for the same reasons someone such as Mirowski might criticize modern neoliberal corporations: croynism, collusion between the wealthy and government, monopoly, incompetence and gross negligence resulting in human suffering, etc.
    Your point about Smith’s focus on the household is well taken. Many economists like to interpret Smith as a critic of government (selective) and a proponent of laissez faire (wrong). Smith is very skeptical of government but understands it to have a necessary role (i.e. there are common projects such as defense, infrastructure etc. that are poorly served by market relationships). He is even more skeptical of large corporations (e.g. EIC) and large institutions (e.g. Catholic Church) than he is of government but for the much the reasons: large institutions have limited knowledge of the particular and the local and are therefore very bad at planning. When Smith is talking about trade he’s talking about individuals, small merchants, and what have you (much more common in the 18th C.); not large corporations such as the EIC. Large corporations are just a different form of government –really bad at serving the public interest, even worse than government because they are in essence just a form of government in the service of private interests.

    • Ed Walker says:

      Let me clarify Beckert’s point about War Capitalism. I am enamored of the phrase, and didn’t think to add sufficient explanation. Beckert explicitly recognizes that what we call capitalism emerged in the 19th C. See page 18. War capitalism is the name he gives to the preceding period of international business activity. It consisted of a strong state in the home country that encouraged colonial activity, and wealthy companies which used armed force to insert themselves into the production systems of other countries which were not strong enough to fight off the privateers or the armies of the home state as the case may be. Here’s a description from Beckert. He says that colonial areas:

      … were characterized by imperial domination, the expropriation of vast territories, decimation of indigenous peoples, theft of their resources, enslavement, and the domination of vast tracts of land by private capitalists with little effective oversight by distant European states. … [M]asters trumped states, violence defied the law, and bold physical coercion by private actors remade markets. P. 38.

      War capitalism could not be imposed in Europe, where social structures were comparatively integrated with the government, but as the industrial revolution was getting underway, in the late 1700s it was the dominant mode of expansion of cotton growing. It worked in the Americas, especially in the US South, in the Carribbean, and in India, but was less successful in areas with stronger local governments, including the Ottoman Empire.

  4. jonf says:

    Obviously not all that is good for the household is good for the nation. We can’t all decide to save at the same time unless the government is passing out money. Money is what is needed for production and consumption. If not enough is spent we have a recession. So as Bush suggested, everyone go to the store and buy something.

    In your example, Boeing seems to have carried out the specialization maxim a little too far and were unable to control it. I think though that the idea is right. We may not like cheap goods made with cheap labor, but we buy them nonetheless. And if Japan makes better quality cars, (as they did for a time) people figure that out. So GM with an insular management lost out.
    So if trade is good why not the TPP? Because it goes beyond fair trade and into cronyism and monopoly and loss of sovereignty. But it sounds good.

    Executive salaries are a whole nother issue. Can’t regulate them. So tax them away.

  5. galljdaj says:

    I come from an age of import and export licenses, And they both make sense to me. Also there is a license to form a corporation. Then the governing laws come forth from Constitution(s). At this starting point; One set of Peoples cannot force on another set of Peoples, Laws.

    So, to keep ‘peace’ each set of Peoples make laws rules for themselves and they are those Peoples Laws.

    My belief is that; No corporation should be allowed to export. Each corporation is governed by the Laws of the Peoples that issue the corporation license. Such, limits the corporation to the ‘land’ of the issuers. I.E., No exporting. Importing means going out side your land , buying, obtaining licenses, shipping, and being responsible for what you purchased.

    Under these conditions competition has the rights of economics!

  6. TarheelDem says:

    I’m having difficulty trying to figure out exactly what Mankiw means by “better off” and “worse off”. Are these vague waves at Pareto optimality? His principles of economics seem to be such a diversion from thinking and into a formulaic foundation for a particular set of policies–a political set-up for belief instead of a framework for inquiry. None seems quite as blatant as this “better off” “worse off” explanation of all trade all the time.

    What happens for those goods and services (some services can be exported now, call centers for example) that are in fact every country’s relatively equal advantage? And where is the race to the bottom for occupations like Mankiw’s own? It seems that one element of comparative advantage for individuals is patronage. Show me how the results of patronage always and forever makes the world better off. It seems to be that that is a fundamental element of what we instictively consider corruption of competitive markets and competitive democratic politics. Not to mention the corruption of ideas. There is something a little bit unseemly in the assertion that Kuhn’s process of scientific revolutions reveals the “truths of science”. And that is part of why the Enlightenment project of empiricism as a check against religious bloodshed ran aground at the height of 20th century scientism in the enthusiasm about Atoms for Peace and the Space Race. And why we have the chaotic form of post-modernist thinking that allows the silliness of the US 2016 primary system in which saying something makes it true in some significant publics’ minds.

    What does trade actually do? It brings Americans chocolate, coffee, tea, coconut oil, spices, and exotic woods at cut-rate prices. Has anyone ever analyzed the externalized costs that we export when we import these items? That analysis certainly has been done for oil, and it includes huge military expenditures and the cost of war. And for some exported goods, there has been an analysis of some of the externalized costs that the importing countries import, the unemployment in Mexico from the dumping of US agriculture products (still subsidized production in the US seeking entry into Asian-Pacific markets) and the consequential political instability and growth in the informal market for drugs and transport of people to the US.

    What exactly is “better off” and “worse off” in asserting that trade is the universal nostrum?

    • Ed Walker says:

      This whole exercise is an effort on my part to extract substance from very mushy prose. I don’t think Mankiw means more than this: if I don’t have to make my own sheets, but can buy them, I’m better off. But the mushy language means people can apply the words to support their view that trade deals are good, and those of us who oppose them are standing in front of the steamroller of history.
      For my part, I think having a very heavy cable-knit sweater from Ireland is a great thing for a Chicago winter. At that level of trade, there is still some reason to think comparative advantage works, as it probably does with jet jewelry and similar small goods. Beyond that, the only interesting thing is cheap labor. Beckert makes that point. Because British capitalists wanted the security of investing within the walls of their home nation, they were early to adopt machine manufacture, and even though their workers were paid 6 times as much as Indian workers, the machines gave them a huge edge in overall productivity.

  7. orionATL says:

    mankiw’s homilitic #5: trade can make everyone better off
    corollary 1 to assumption #5 : unless it doesn’t

  8. orionATL says:

    the principle of comparative advantage applies in the same way at all levels of scale – individual, household, community, state/province/department, nation ?

    isn’t there an ecological fallacy here ?

    no, no, not possible.

  9. orionATL says:

    “… Free mobility of capital in a globalized world
    (david) Ricardo explicitly bases his argument on an assumed immobility of capital: ” … if capital freely flowed towards those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labor price of commodities, than the additional quantity of labor required to convey them to the various markets where they were to be sold.”[31]

    He explains why, from his point of view (anno 1817), this is a reasonable assumption: “Experience, however, shows, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and entrust himself with all his habits fixed, to a strange government and new laws, checks the emigration of capital.”[31]…”

    • Ed Walker says:

      Riccardo agrees with those early British capitalists on the immobility of capital. Adam Smith makes a similar point. Beckert makes a stronger point. He argues that the power of the British state was harnessed to producing the social changes necessary to provide a docile workforce and to building out the infrastructure necessary to support the trade in cotton.

  10. orionATL says:

    [… the overwhelming consensus of the economics profession remains that while these arguments are theoretically valid under certain assumptions, these assumptions do not usually hold and should not be used to guide trade policy.[33] Gregory Mankiw, chairman of the Harvard Economics Department, has said: ″Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards.″[34]

    Economist James K. Galbraith refutes these claims of the benefit of comparative advantage. He states that “free trade has attained the status of a god” and that “. . . none of the world’s most successful trading regions, including Japan, Korea, Taiwan, and now mainland China, reached their current status by adopting neoliberal trading rules.” He argues that “. . . comparative advantage is based upon the concept of constant returns: the idea that you can double or triple the output of any good simply by doubling or tripling the inputs. But this is not generally the case. For manufactured products, increasing returns, learning, and technical change are the rule, not the exception; the cost of production falls with experience. With increasing returns, the lowest cost will be incurred by the country that starts earliest and moves fastest on any particular line. Potential competitors have to protect their own industries if they wish them to survive long enough to achieve competitive scale.”[35]

    Galbraith also contends that “For most other commodities, where land or ecology places limits on the expansion of capacity, the opposite condition – diminishing returns – is the rule. In this situation, there can be no guarantee that an advantage of relative cost will persist once specialization and the resultant expansion of production take place. A classic and tragic example, studied by Erik Reinert, is transitional Mongolia, a vast grassland with a tiny population and no industry that could compete on world markets. To the World Bank, Mongolia seemed a classic case of comparative advantage in animal husbandry, which in Mongolia consisted of vast herds of cattle, camels, sheep, and goats. Opening of industrial markets collapsed domestic industry, while privatization of the herds prompted the herders to increase their size. This led, within just a few years in the early 1990s, to overgrazing and permanent desertification of the subarctic steppe and, with a slightly colder than normal winter, a massive famine in the herds.”

    “Countries doomed by climate and history to produce bananas, coffee, or cocoa and little else are invariably poor. Why? First, the demand for their products is inelastic: when supply increases worldwide, the price falls, and with it national income. Second, they suffer from diminishing returns. Contrary to Ricardo, it is generally impossible to expand agriculture indefinitely at a constant unit cost: good land and water are in limited supply. Third, a country with just one major cash export will lack a cushion in other products when fashion or technology turns against their specialty. Conversely, diversification pays. Countries with the capacity to diversify across multiple industries are far more likely to weather export demand shocks or insurgent competition from (say) China than those that commit themselves to a single industry or product line. Diversifiers are also better placed to take advantage of new technical opportunities, since by diversification they develop expertise in a range of products and processes.”[36]

    Ireland during the 1800s gives a tragic example of the dangers of specialization. When the union with Great Britain was formed in 1800, Irish textile industries protected by tariffs were exposed to world markets where England had a comparative advantage in technology, experience and scale of operation which devastated the Irish industry. Ireland was forced to specialize in the export of grain while the displaced Irish labor was forced into subsistence farming and relying on the potato for survival. When the potato blight occurred the resulting famine killed at least one million Irish in the worse famine in European history. As Cecil Woodham-Smith would later comment,”the Irish peasant was told to replace the potato by eating his grain, but Trevelyan once again refused to take any steps to curb the export of food from Ireland. “Do not encourage the idea of prohibiting exports,” he wrote, on September 3, (1846) “perfect free trade is the right course”.[37]… ]

  11. orionATL says:

    a british austerian before there were any austetians :

    “..As Cecil Woodham-Smith would later comment,”the Irish peasant was told to replace the potato by eating his grain, but Trevelyan once again refused to take any steps to curb the export of food from Ireland. “Do not encourage the idea of prohibiting exports,” he wrote, on September 3, (1846) “perfect free trade is the right course”.[37]…”

  12. wayoutwest says:

    The only positive reaction to this propagandist Mankiw was a few years ago when some of his subjects walked out of and boycotted his indoctrination sessions, demanding to be educated not manipulated. They were ignored or mocked by the majority of compradors in training that Harvard supplies to the Ruling Class.

    Civilization has depended on trade for its existence since the first city-states were formed just as it depends on its armies to enforce the direction of that trade and its benefits, to the State. If the ‘suppliers’ of commodities, local or foreign, are so bold or needy to refuse this trade they are crushed, killed or displaced to guarantee continued penetration and extraction, We are still using the Carter Doctrine with military and economic hit-men to guarantee this trade and its benefits are never shared equally.

  13. galljdaj says:

    No one else cares about how the Peoples of each and every country are made to pay for the whims, lies and crimes of the few that horde the ‘pie’? All done in the Peoples Name!

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