Comparative Advantage and Increasing Returns

Busy, busy, busy Friday - jumping from one meeting to the next.  So a late post about this article in the Portland Business Journal:

TriMet has been awarded $2.4 million from the Federal Transit Administration to research a U.S.-produced streetcar propulsion system.

The work will be led by Clackamas-based Oregon Iron Works Inc., whose subsidiary, United Streetcar LLC, is the only U.S.-based manufacturer of streetcars.

In a news release Friday, the Federal Transit Administration said the funds represent its 80 percent share of a $3 million project in which $600,000 will come from a local match.
The goal of the project is to fill a major hole in the U.S. streetcar supply chain. Propulsion systems account for about 20 percent of a streetcar’s cost, but the only manufacturers are based outside the U.S.

United Streetcar, which last year unveiled the first U.S.-built streetcar in 58 years, uses a propulsion system made by Czechoslovakia-based Skoda Electric S.A.

Chandra Brown, United Streetcar’s president, said the federal funds will be used to test a propulsion system developed by Milwaukee, Wisc.-based Rockwell Automation.

Once installed, 90 percent of the streetcar’s components will be made domestically, up from 70 percent today, Brown said.

So I am going to sound like a typical economist here - but guess what I am a fairly typical economist (atypical in my wit, wisdom and good looks but that is another matter). Why do we care so much about having our streetcars totally made in the US? What if we are not terribly good at it? Perhaps the Czechs are real experts and can produce a more reliable propulsion system for less money. Wouldn't it be better to focus on what we are good at - like designing iPhones, making good beer (Pilsner - pah!), making Hollywood blockbusters - and then trading them to the Czechs for streetcar propulsion systems?

Almost 200 years of economic theory suggests that we should and that if we do we will be better off.

Is there a counter-argument? Actually yes, and it is essentially what Paul Krugman won the Nobel Prize for. If the source of the Czechs comparative advantage in streetcar engines is from economies of scale, or if the source of their comparative advantage is from having gotten really good at it through experience (i.e. that there is a strong learning curve effect) than this type of government intervention can actually help, over time, the US become better comparatively than the Czechs. In other words, no private firm would do it themselves because they could not compete at first, but over time would grow big enough or learn enough to be competitive if only they had the support to make it there.

Does this argument hold water in this case? Hard to say for sure, perhaps we have more skilled electrical engineers and manufacturers so that if we set our minds to it we would be better and more efficient at it - but we would also have to overcome our relatively expensive labor.

I am skeptical, but of streetcars become the rage in the US, perhaps...

Beeronomics: Krugman, the Nobel Prize and Beervana

So this blog post has been brewing in my head for a while now (rim-shot please), but now that Paul Krugman is in Sweden to collect his much-deserved Nobel, let's think about how his ideas explain Beervana.

[From Paul's NY Times page: The marquee for his talk at the Bagdad - Paul , Beer, Oregon - get it?]

Paul's most influential insights came from the idea that there may be increasing returns in trade. When applied to trade this insight helped explain why we see two-way trade in things like cars and was the principle reason he won the Nobel. But this insight quickly spilled over into other areas as well - for example, why is Silicon Valley still the center for high tech industry given that it is perhaps the most expensive place on earth to do business? Paul's answer has a lot to do with heads starts and learning curves: It may be cheaper to move Silicon Valley to Bangalore if you could do it overnight, but you can't - it takes time to build up the knowledge base and skilled work force and while that is happening, Silicon Valley can compete the nascent Bangalore away. This helps explain that while Bangalore has been able to chip away a little bit at Silicon Valley's dominance it hasn't done that much. This story is half trade and half economic geography. Economic geography talks about increasing returns that come from concentration: part of why Silicon Valley is so successful is because of the close connection inventors, entrepreneurs and venture capitalists have by virtue of being neighbors and part is the concentration of skilled workers to populate the firms.

So what does this have to do with Beervana - Portland (and Oregon's) disproportionate number of breweries and beer drinking? Well the same stories about Silicon Valley can be told here: brewing and beer drinking are both learning processes and ones that benefit from concentration. Brewing takes skill and practice and a there are a lot of knowledge spill-overs that comes from brewers talking and sampling each others products. Beer drinkers have to learn about the ingredients, how they taste and develop a palate and taste for the more robustly flavored beers. So the punchline is you tend to have concentration rather than dispersion and that places that get early starts tend to hold onto that advantage - familiar themes from Paul's work.

So really, beer drinkers of Oregon, this Nobel's all about you! Let's toast to that...

By the way, just to complete the circle - Beervana blogger Jeff Alworth left a comment on the same Krugman blog page that includes the picture above.