Friday, April 16, 2010

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...


steven andresen said...

I'm for the state putting money into a lot of projects that would create out of thin air domestic industry.

This is how an economy is grown. You get someone to put in a little seed corn, and water the thing, then in awhile you have something that will produce something useful.

The alternative is, of course let the people who are already making money elsewhere keep on doing that because, well, you aren't any good.

Doug Gabbard said...

This is how I (a lowly finance guy!) would translate the Krugman thesis. Building a domestic streetcar is currently a negative-NPV project on its own. However, this project has high option value, at least some of which value is a social benefit external to the parties in the transaction.

If this is an acceptable translation, we are left with two questions:

(1) What is the value of the call option?
(2) How much of that value is social and therefore worthy of subsidy?

I don't have an answer to either, because I'm way out of my depth here. And there is a cynical part of me that says our policy is based more on flag-waving than Black-Scholes.

Praetor said...

A few things:
Firstly, the Czechoslovakia broke apart 17 years ago. I mean it is "business journal", they should know better - the country is world's No.2 in car production per capita (after Slovenia-1st, not Slovakia-3rd). And also leading country in machinery export per capita. And the only exporter of trams to US (Škoda, Inekon), as same as holder of the world largest tram order (Škoda 15T ForCity - 250 pieces for Prague). OK, so they know next to nothing, that makes it easy on the rest.
Secondly - the Oregon Iron Works made only one single tram and it took them more than a year. The tram is made under Škoda licence(with some small changes to be called "US developed", basically it is the Škoda 10T model). The Škoda went into the venture because Inekon was selling its product in US over them, and moreover with "Buy American" laws the federal money wouldn't go for imported trams. I would like to believe, that OIW have the skill to develop their own better product, but is it even possible, if only licenced streetcar with Škoda's imported motors took a year to build?
Thirdly, Škoda was founded in 1859 transportation stuff like locomotives was the main product for more than a century (apart from guns, power plat turbines, electromotors). They started makeing trams in 1990's, but they got whole development team from other Czech company ČKD, which, although bancrupt for more than 12 years now, still holds the title of the manufacturer of the most trams in world (one of reasons for bancrupcy is that Russians never paid for 2000 - two thousand - trams delivered to them just before the collaps of socialism). So you can say that Škoda inhereted 60 years of tram manufacture tradition. It started in 1952 with car based on US PCC streetcar, and the model 15T ForCity today is the best there is on the market (though Siemens may have similar technology in a couple of years too).

I understand the call to keep the jobs home, but hoping that it might also get you better product is just silly. Maybe in next 25 years (that's time ČKD needed to become world's leader, also thanks to fakt that US switched to buses).

Patrick Emerson said...


Thanks for the comment. I put you in the we should do what we do best and trade for streetcars made in the Czech Republic.

But you have plenty of good beer too, so what can we give you, iPhones?

I noticed the Czechoslovakia bit too, but decided not to point it out. What can you expect from a bunch of poorly educated Americans? We never know geography.

Praetor said...
This comment has been removed by the author.
Praetor said...

Patrick I don't say what is the best way. But here it seems that you can either import excelent product or invest a lot of money into domestic production of something that might turn also good in some 20 years.

Bringing beer into the debate may do no good, the original Budweiser and Pilsner are made in CzR, I'd rather avoid commenting on foreign (not-Czech) beer quality ;)

I am all the way for supporting domestic production, development and jobs, but in this case, giving the money to company which took 1 year to make a copy of a tram (and as far as I know the engineers from Škoda were there to assist) seems like quite a waste.

When it comes to public transportation Prague has the highest ratio of people using PT vs. cars in Europe, and streetcars are the backbone of it (together with subway and busses; they run on streets also in other smaller towns and cities). The competition on the streetcar market is really tough, not only domestic but especially with Polish manufacturers pushing the prices down. It works well for us, I am looking forward to see how the protectionism (buy american laws) will work for you, especially when it comes to streetcars, which are my favourite mode of city transport.

If you ever come to CzR we can discuss this kind of things over a mug of good old original Budweiser :)

Iphones are really popular here. I am thinking what else US product I could buy here, apart from a muscle car. Guns are produced locally (CZ or EU) on comparable level with US. We do import medicaments, but it is also Czech export article, so that would be null null. The hollywood production rules the local culture, but than if you check big movies made in last decade a lot of them were shot in CzR or Hungary. When it comes to software, my friends works here as Red Hat Linux developer and last year their team was named the most productive of the conglomerate, however Microsoft totally rules the market. Do they still make Windows in US? Ford is one of most sold cars, but they are all developed and made in Europe (I heard that also US market will now get European fords i.e. Fiesta) Still the statistics show that CzR imported more from US than exported there in 2009 (precrisis years were otherwise). We definitely couldn't import beer or streetcars, so what could it be? :)