Econ 101: Dynamic Comparative Advantage

This past weekend, the Oregonian reported on something that has been fueling the rumor mill in Corvallis for a few months: HP is most likely scaling down its Corvallis operations.  A few weeks ago they also reported on the shuttering of the Hynix plant in Eugene.  What gives in the Willamette valley?

Well, as a friend who works for HP in Corvallis explained to me, HPs printer business is not growing and in modern business you have to grow revenues.  So without growth in sales, you need to cut costs and a big cost savings is to employ engineers in Asia rather than in the US.

When I teach comparative advantage, the relative productivity advantage that leads to gains from trade, I try to stress that though in the classical Ricardian example there exist static differences in productivity, such productivity differences evolve through time.  Countries like India and China for a long time had a major comparative advantage relative to the US in light manufacturing and other labor intensive activities that came from an abundance of unskilled labor and a relative paucity of skilled labor.  But over the last ten to twenty years, this has begun to change quite dramatically.  India and China have begun to produce more and more skilled engineers, to use but one example.  Thus the relative productivity advantage that the US used to enjoy in engineering is disappearing fast.

Why has the US lost this advantage?  One need only look at the sorry state of the US higher education system to figure this out.  Federal funding for basic research is almost non-existant, states support for public higher education is drying up and the K-12 system is sending (and not sending) kids to college without proper preparation.  From my vantage point it is not hard to feel pretty pessimistic about the future.  Our best hope is to try and hold on to all of the incredibly talented foreigners that come to get advanced degrees (for the time being at least) in the US.  But with stricter immigration policies and ever improving opportunities at home, many foreign students are choosing to return, leaving the US talent-poor and loosing more and more industry.  

So back to Oregon.  What can a state do to combat these job losses?  Produce skilled individuals who have the ability to be high productivity participants in the 21st century.  This takes time and resources for the entire educational system.  Failure to do so will leave us in the unfortunate position of having a comparative advantage in low value-added activities.   

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...