Value is in the eye of the beholder

This post is written in reply to Tim Worstall's criticism of this paragraph in my post "The intergalactic trade frontier":
"It is true that export success depends on comparative advantage and international competitiveness, but these are relative terms: international competitiveness is bought at the expense of the competitiveness of others, and comparative advantage implies a near-monopoly position in the provision of some good or service."
Tim correctly pointed out that comparative advantage is not relative to others, but relative to oneself:
"Comparative advantage is not about what you are better at compared to other people. That is absolute advantage. Comparative advantage is what you are better at doing relative to the other things that you could be doing. And as such it greatly strengthens the case for trade."
I take issue with two points here. The first is, as I shall explain shortly, that what I am "better at doing" may not be what I am best at doing. (Yes, I know that sounds odd - but bear with me.) And the second is that I was never, ever arguing against trade. On the contrary, I am a big fan of trade. I want lots of it, both international and domestic. And that is why I criticise trade policies that are designed to create trade surpluses. Because as I've explained here, persistent trade surpluses do not increase trade. They may even reduce it.

But to return to the first point. If demand for all products and services is constant, then I am of course going to achieve the greatest profit by concentrating on the thing that I do best, because in a market with constant demand price differentiation is a function of product quality. In my case, what I do best is singing. So if there is constant demand for classically-trained mezzo-sopranos, and no-one is better than me, my most profitable activity is also what I do best.

But suppose that demand is not constant? Suppose that the fashion in music has moved away from classical music into pop and musical theatre, neither of which I can sing convincingly? I may be the best classically-trained mezzo-soprano in the world, but no-one will pay me to sing. Actually this isn't happening - classical music is holding up pretty well. But it's not beyond the bounds of possibility. Markets can, and do, die. And when they do, the producers of those goods and services go out of business.

Alternatively, suppose that there is a vast increase in supply. The market is swamped with hundreds of classically-trained mezzo-sopranos with wonderful voices. Indeed, this is pretty much the case, world-wide. The classical singing marketplace is saturated. So even though I am a very good singer, there are a lot of mezzos out there who are even better than me. Concert promoters are not going to prefer me to them. So although singing is my best skill, it isn't good enough to succeed in a highly competitive marketplace. Concentrating on it is not going to pay my bills.

As it happens, I can play the piano. Not well - I'm certainly not concert pianist standard - but enough to accompany exams and ballet classes, that sort of thing. And there is something of a shortage of half decent pianists. So I could make some sort of living from bad accompanying, whereas I can't make any sort of living from very good singing. Would I be doing what I am "best at", by any reasonably objective measure? No. But I would be doing what I am "better at" in comparative advantage terms.

You see, in comparative advantage terms, what is "better" is whatever generates more profit, and that is determined by the market. The value of my singing is not determined by my ability but by how much people will pay to hear me sing. So although I am objectively a much better singer than pianist, if people will pay me to accompany exams but won't pay me to sing in concerts, my piano playing is more valuable than my singing.  Value, like beauty, is in the eye of the beholder.

And the fact that there is a mismatch between my objective ability (what I am "best at") and what I am "better off doing" is a function of demand and competition. If there weren't so many brilliant mezzos out there, or there were more musical events requiring mezzo-sopranos, I could make a living from singing and would not need to concentrate on a lesser skill in order to pay the bills. Comparative advantage therefore has nothing much to do with what people, or businesses, or countries are "good at". It has everything to do with what opportunities exist in the marketplace and what the competition is like. This even applies when a business creates a completely new product or service that does not exist in the marketplace (and therefore initially has neither demand nor competition): they have to create demand for it, and if they fail to do so then the product or service is worthless, however "good" it is. And if they do create demand for it, they may later be overtaken by competitors who force them out of the market they have created.

So comparative advantage is subjective: the value of the goods and services produced is determined by the market, not the producer. It depends on demand: if no-one wants to buy the product, it is worthless, however "good" it is. And it is determined by competition: however good someone is at producing the product, if others are better, they cannot compete and must produce something else instead - or die.*

Singing is, of course, a difficult thing to value. My singing may be of little pecuniary value. But it is valuable to me, because I get pleasure from it. And to the extent that I am prepared to sing for others without payment, it may also give pleasure to others. Judge for yourselves.



*If they are a business, dying may be the right solution, of course. But this can never be true for people. So people whose skills are obsolete, or who simply are not good enough at a particular job to compete in a saturated market, need support and help to enable them to develop new skills. I am fortunate: I can play the piano (and as it happens, I can teach and write, too). Not everyone has alternative skills. Really, that's the problem that the long-term unemployed have. And they need time, opportunity and financial support to enable them to develop new skills.


Comments

  1. Frances, you have nicely illustrated two of the chief objections to the comparative advantage model: that it is not robust to change of any kind (consumer tastes, competition, input scarcity, technology, etc.), and that it ignores real option value. The latter point is not well appreciated even by economists, I think.

    In an uncertain world, the _possibility_ of being able to do something else has value. If I am choosing an occupation now, and acquiring skills and assets for it, I need to take account of whether I'm going to be locked in to a single way of making money, or whether I can change. Having the option to do different things has value, even if, as it turns out, I never do them. For an infinitely lived entity such as a country, that goes double.

    (Oh, and you are right. The theory of comparative advantage DOES imply the existence of monopolies. That is one of the chief objections that economists made to it, and why it was replaced with Hecksher-Ohlin and then the New Trade Theory.)

    Comparative advantage has got to be the worst-named idea in all of economics. People universally come to discussions of trade with the idea that it is a competition, so using the words "comparative" and "advantage" is just going to lead to permanent confusion. It's almost as though economists don't want to be understood...

    For economists, such as Mr Worstall, there is only one objective measure of advantage: money--or more technically, the magnitude of the stream of benefits you can receive for your work, suitably time discounted. Not for nothing has the label "the dismal science" stuck for so long.

    Now I'm going to listen to your YouTube piece, and have my soul enlightened.

    ReplyDelete
    Replies
    1. Thanks Greg. I was surprised by Tim's criticism - I didn't think my description of comparative advantage was so controversial. Hope you enjoyed the clip, anyway!

      Delete
  2. Thank you Frances for clear writing. Can you write about persistent and large trade deficits as well...ie. the current experience of the US.

    ReplyDelete
    Replies
    1. I've focused on trade surpluses because of people's tendency to regard them as a good thing. But that doesn't mean I am I favour of trade deficits either. Persistent large trade deficits reduce trade in exactly the same way as persistent large surpluses - not surprisingly, because they are the flip side of the same coin. So countries that persistently run trade deficits also need structural reforms. But it's very difficult for them to undertake the necessary reforms while they have low cost producers elsewhere with large persistent trade surpluses. Therefore reforms are needed in both deficit and surplus countries at the same time.

      Delete
  3. http://www.social-europe.eu/2013/11/northern-europes-drag-world-economy/

    It then seems reasonable to explore policy matters...

    ReplyDelete
  4. Frances, Can we have some singing to accompany each of your posts? I prefer popular bits of Mozart, Bach and Handel (my tastes are limited).

    BTW that wasn’t Salman Rushdie introducing you was it..:-)

    ReplyDelete
  5. You have an absolute advantage at brilliance. And a lovely voice!

    ReplyDelete
  6. Comparative advantage is apparent in trade on a daily basis.

    The first step is when a high productivity country buys something, that they could alternatively make in a shorter amount of time themselves, from a low productivity country.

    The second step is when the low productivity country buys something, that would take a very long time to make themselves, from the high productivity country.


    That is the comparative advantage principle realized in trade.

    ReplyDelete

Post a Comment

Popular posts from this blog

The Amazing Conversion of Sir James Dyson

Calculus for journalists

Game theory in Brexitland