The Wonderful Surprises of Comparative Advantage

Human society is permeated with comparative advantage. When each person specializes in performing that task, or small set of tasks, for which he or she has a comparative advantage — and then exchanges the fruits of this labor for goods and services produced by others — everyone who participates in this system of specialization and exchange is enriched. Even those individuals whose economic fortunes dip with a change in the pattern of consumer spending remain vastly wealthier than they would be were they not part of this catallaxy of specialized production and trade.

No adequate understanding of the economy is possible without an understanding of comparative advantage. Fortunately, to obtain this understanding isn’t very difficult. And this understanding is filled with interesting surprises.

Surprise #1

In my previous column I explained surprise number one: your technical superiority over Jones at producing some good or service does not imply that you are economically more efficient than Jones at producing that good or service. Your comparative advantage might well be in the production of some other output.

For example, you might be able to build backyard decks faster than Jones can. But if you’re an even better physician than is Jones, your comparative advantage will be in working at supplying medical care rather than in building decks. You will gain by specializing in supplying medical care and buying deck-building services from Jones.

Surprise #2

Here’s surprise number two: if you further improve your skills at doing the task for which you have a comparative advantage, you thereby make yourself an economically even worse performer of other tasks.

Using an example from my earlier column, your cost of building a deck with your own hands is $6,000 higher than is Jones’s cost of building the deck for you, despite the fact that you could build the deck in a mere one month while the time required for Jones to build it is two months. The reason is straightforward. Because you earn $240,000 annually by working as a physician, the amount of income you would forgo by taking one month off from your job to build the deck is $20,000. Jones, in contrast, earns an annual salary of only $84,000 — meaning that, while he must take two months off of work to build your deck, the total amount of income that he sacrifices by doing so is only $14,000.

It pays you to hire Jones, at any price less than $20,000, to build your deck.

But suppose that your skills as a physician improve so much that your annual income rises from $240,000 to $252,000. Were you now to take off from your job the one month necessary for you to build the deck, you would forgo income of $21,000 — a sum $1,000 more than you would forgo if your income remained at $240,000. The cost to you of building your deck personally has risen by $1,000. Your improved skills as a physician make it even more inefficient — more costly — for you to build the deck yourself.

Even though your technical skills as a carpenter haven’t at all changed, by becoming a better physician, you thereby become — economically — a worse deck builder!

Surprise #3

Grasping this interesting fact reveals yet a third, and perhaps even more startling, surprise: Your becoming a better physician makes Jones, compared to you, economically an even better deck builder even if his carpentry skills do not improve. Before you became a better physician, Jones’s cost of building a deck was lower than your cost of doing so by $6,000. But once you become a better physician, Jones’s cost of building the deck — while still $14,000 — is lower than your cost of doing so by $7,000.

Put differently, your increased comparative advantage at supplying medical care increased Jones’s comparative advantage at building decks. Jones potentially benefits from you becoming a better doctor!

Why only “potentially”? By becoming a better physician you do not automatically increase the amount you pay to Jones to build your deck. In my earlier example — when your annual pay as a physician was $240,000 — you paid Jones $17,000 to build the deck. If with an income of $252,000 you still pay Jones $17,000, he doesn’t gain from your having become a better doctor.

But if your and other homeowners’ demands for Jones’s deck-building services are sufficiently intense, you will offer to pay him an amount close to what it would cost you to build the deck yourself. Before your annual income as a physician rose from $240,000 to $252,000, you would have paid Jones to build your deck an amount up to, but not more than, $20,000. But now that you’re earning $252,000 each year, you’re willing to pay Jones up to $21,000, for this amount would be your cost of building the deck yourself.

Your becoming a better physician raises not only your income, but potentially raises also the incomes of your trading partners. This consequence of comparative advantage helps to explain why in wealthy countries, it’s not only skilled workers, such as engineers and lawyers, but also low-skilled workers, such as janitors and hotel maids, who earn higher real incomes than do their counterparts in poor countries.

Thus, it’s in each of our interests to applaud the improved skills and productivity of the vast majority of our fellow human beings even when our own skills and productivity remain unchanged. To understand comparative advantage is to understand why we should celebrate rather than fear the economic growth of other countries.

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