Specialization and Trade

by Don Boudreaux on July 27, 2011

in Adam Smith, Growth, Innovation, Myths and Fallacies, The Economy, Trade

Here’s the PowerPoint presentation that I used for my second lecture at the 2011 Cato University (held this year, btw, in one of my favorite towns: Annapolis, MD).

Because of several questions that I received after my first lecture, I began this second lecture with a brief review of the state of manufacturing in America.  I used several of the great graphs that Mark Perry made available over the past few years at Carpe Diem.  Of course, in my verbal remarks I explicitly acknowledged that these graphs are from Carpe Diem – and I encouraged the attendees to check out that indispensable blog.

Then I reviewed, first, Adam Smith’s explanation of the benefits of specialization, and, second, David Ricardo’s explanation (the principle of comparative advantage).  I also combined Smith with Ricardo.

I concluded – after some too-quick remarks on various theories of the industrial revolution – by encouraging the attendees to read Deirdre McCloskey’s Bourgeois Dignity.

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{ 86 comments }

Single Acts Of Tyranny July 27, 2011 at 4:08 pm

I have read McCloskey’s book and agree entirely with your recommendation.

Wow July 27, 2011 at 4:31 pm

Amazing. Spread these genious insights!

J Storrs Hall July 27, 2011 at 4:45 pm

Any chance you can put this up in PDF format? Ipads, macs, and Linux systems typically handle that natively but require extra (and expensive) apps to read ppt.

Scott Harrison July 27, 2011 at 4:54 pm

You might try Libre Office Impress. It handles ppt’s just fine and is free.

Stone Glasgow July 27, 2011 at 5:18 pm

You can also convert them for free using a website. Google it.

J Storrs Hall July 27, 2011 at 5:32 pm

None of which is worth my time, being a royal pain to do on an iPad. It would make more sense, and be a lot more efficient overall, if the conversion were done once rather than that each reader of the blog had to download a monstrous pile of developer droppings (I use OO on Linux when I’m home, I doubt libre is any better).

Economiser July 27, 2011 at 7:34 pm

> It would make more sense, and be a lot more efficient overall, if the conversion were done once….

Agreed. Perhaps you could do it once and post a link here for everyone else to use.

HaywoodU July 27, 2011 at 7:49 pm

Zing!

J Storrs Hall July 28, 2011 at 8:27 am

Reread my comment

Pom-Pom July 28, 2011 at 2:10 pm

I’m taking your side on this one. (not to be unappreciative, tho)

Portable Document Format
^^^^^^^^

J Storrs Hall July 28, 2011 at 9:11 am

For those on iPads, it turns out that Goodreader handles ppt fairly well. Copy the URL from the link above (hold your finger on it rather than tapping), switch to Goodreader, and paste it in.

muirgeo July 27, 2011 at 5:23 pm

If I was at that lecture I would have asked the following questions;

1) Can you discuss how manufacturing output is measured?
– Is it true that 40- 60% of our imports are actually American manufactured products made in other countries?
– If you cut the wages of all workers across the board by $1.00 per hour would that show up as an increase in manufacturing output as presently calculated?

2) What about a scenario where the cost of production is less for all products made by one side?

3) Can you redo the island scenario where Don produces pieces of paper that he writes word onto and tries to trade them for fish and bananas with Tom? How does that work out?

4) And finally how does trade work when neither trader is directly trading but in fact trading via a middle man say like maybe a huge multinational corporation that writes the trade laws for the WTO… did Ricardo cover that in his work?

Don Boudreaux July 27, 2011 at 6:08 pm

Here’s one of those rare occasions when I respond to Muirgeo – not because I have any hope that he’ll be persuaded by what I write; rather because the question of his to which I respond below is one that is typically asked by uninformed freshmen who either haven’t yet seen – or who fail to grasp – the principle of comparative advantage. By answering it I hope to explain to readers who haven’t yet been exposed to the principle of comparative advantage (or who’ve been exposed to it only poorly) why the possibility posed by the question is, in fact, an impossibility.

Muirgeo says that he would have asked me at my lecture: “What about a scenario where the cost of production is less for all products made by one side?”

Asking this question is proof positive that Muirgeo does not understand comparative advantage. One of the key features of reality that a grasp of the principle of comparative advantage makes clear is that it is impossible – not unlikely, not highly unlikely, not astronomically unlikely, but utterly impossible – for one producer (one person, one firm, one region, one country, “one side” [to use Muirgeo's term]) to have a lower cost of producing all products.

For “side” A to produce more apples requires that side A produce less of other things (say, ball-bearings). Side A has a comparative advantage over side B in apple production if, as side A produces an additional bushel of apples, side A’s reduction in ball-bearing output is less than the reduction in side B’s ball-bearing output were side B to produce an additional bushel of apples.

So if side A can produce apples at a cost lower than can side B (in terms of foregone ball-bearing production), it MUST be the case that side B can produce ball-bearings at a cost lower than can side A (in terms of foregone apple production). (Take a look at panel 24 in the above PowerPoint presentation.)

And note that if side A – with a comparative advantage at producing apples – becomes even more efficient at producing apples (say, by figuring out how to get each tree to double its yield), side A thereby becomes even less efficient at producing ball-bearings. That is, by becoming an even better apple producer, the amount of apples that side A would forgo producing were side A to increase its output of ball-bearings would rise. Side A’s cost of producing ball-bearings rises as side A’s efficiency at producing apples rises; side A’s higher cost of producing ball-bearings is one of the unavoidable consequences of side A’s lower cost of producing apples.

Or, put differently, for side A to have a comparative advantage at producing X implies – by necessity – that side A has a comparative disadvantage at producing something else. It is impossible for any “side” to have a comparative advantage at producing everything.

Failure or inability to grasp this fact is failure or inability to understand the principle of comparative advantage.

Economiser July 27, 2011 at 6:23 pm

Thanks for the explanation, Don. People often get tripped up by the fact that a comparative advantage is not the same as an absolute advantage. It’s possible for one side to be better at making any given product or service (e.g., side A could be the cheapest producer of either apples or of ball bearings). It’s not possible for one side to be simultaneously the cheapest producer of every product or service for the reasons above.

Don Boudreaux July 27, 2011 at 9:14 pm

‘xactly!

Pom-Pom July 28, 2011 at 2:11 pm

I can still wish I was better than you at everything.

John Dewey July 27, 2011 at 6:36 pm

Comparative advantage is difficult for many people to understand. An example I read years ago explained how Shaquille O’Neal, a 7 foot world class athlete, would be more efficient at cleaning house than would be his housekeeper. But the opportunity cost for Shaq – the time taken away from basketball practice – would be very high. So Shaq’s housekeeper had a comparative advantage over Shaq in cleaning house.

Not sure why that example worked for me. Perhaps the mental image of Shaq in a French maid outfit complete with feather duster was just amusing for me.

Don Boudreaux July 27, 2011 at 9:15 pm

I agree. That is indeed a good example.

Krishnan July 27, 2011 at 11:24 pm

Russ Roberts has many excellent examples in the book “Choice” (I am sure this has been mentioned many times!) (I just finally got around to reading it …a terrific book indeed)

It is actually eerie to read that book written in 1994 (?) – because the same old same old is being trotted out today by Washington about how “we do not make anything” and that “China has an unfair advantage because they make shoes and we do not” (or some such) … and that “they have an advantage because they sell cheap and do not buy anything from us”…

Trade (and class) warriors simply do not understand OR refuse to understand OR worse – they simply do not care about comparative advantages – all they can do is say “Look, my friend Joe Blow lost his job making shirts because the business went to China” (they refuse to see the 100′s or thousands of others who now do things BECAUSE shirts are made in China)

Bill July 27, 2011 at 9:50 pm

And it is said that Pres. Woodrow Wilson was a faster and more accurate typist than were the clerical people in the White House. I liked using this example when I taught some years ago. But, alas, the more I learn about Wilson, the harder it is for me to defend the notion that the opportunity cost of Wilson’s typing his own correspondences, speeches, etc. was too high for him to devote any time to typing.

Pom-Pom July 28, 2011 at 2:15 pm

lol! The opportunity cost of him doing political work was too high compared to anything, including shoveling manure.

Of course, one could say he was shoveling metaphorical manure, and lots of it!

MWG July 27, 2011 at 7:11 pm

Comparative advantage is one of the most basic principles in economics, but alas, is misunderstood by far too many in this country of all political persuasions.

Ironically, I first began to understand comparative advantage reading International Economics written by (GASP!) Paul Krugman.

Don Boudreaux July 27, 2011 at 8:58 pm

Prof. Krugman was a darn good economist.

MWG July 27, 2011 at 10:50 pm

Yes he was.

SheetWise July 27, 2011 at 10:52 pm

A well stated, if somewhat backhanded, response.

Dan J July 27, 2011 at 11:04 pm

Idealism can lead many astray. One had to wonder what led Krugman down his path of idealistic testing of theoretical economics or political posturing in economics.
Delusions of self grandeur lead him into the elitist rank and file.
Becoming an intellectual in the world of elitist intelligentsia can wreak havoc on one’s career.

Pom-Pom July 28, 2011 at 2:16 pm

RIP Prof. Krugman.

Dan J July 27, 2011 at 11:25 pm

May I suggest that Your response, Don, really needs fine tuning.
I only say this because I can see a persons eyes glaze over thru the explanation.
Your explanation is well written and understood by those past Econ 101, Macro and Micro.
But, we need an explanation tha is simpler and quicker for the less inclined to ‘want’ to sit thru that explanation.
Muirgeo, is not inclined, nor will he accept anything outside of protectionism and redistribution theories.
But, I am often in discussion of economics. I am not the most educated or best suited for correcting misinformed or those who have fallen into the fallacies put forth by MSM and self-interested union members, but I do well. Well enough, to make another think twice about their preconceptions or those mislead by incorrect information.
I enjoy this site, but post and discuss in attempts to get better and to find simpler ways to explain the importance of understanding economics and the impacts of particular policies.
All here are very helpful. Especially, the ridiculousness of muirgeo is helpful. Many are just as obstinate as muirgeo, misinformed, or just agenda driven.

vikingvista July 27, 2011 at 11:46 pm

Cax: Cost to person ‘a’ of producing x

Cax = (Cax/Cay)Cay
Cbx = (Cbx/Cby)Cby

(1) Person ‘a’ has a comparative advantage over ‘b’ in producing x relative to y when:

(Cax/Cay) < (Cbx/Cby)

(2) Person ‘a’ has a comparative advantage over ‘b’ in producing y relative to x when:

(Cay/Cax) (Cax/Cay) > (Cbx/Cby)

Therefore (1) and (2) can never both be true.

vikingvista July 27, 2011 at 11:50 pm

…weird HTML deletion due to angled brackets. Expression (2) should be:

(Cay/Cax) (Cbx/Cby)

vikingvista July 27, 2011 at 11:53 pm

…damn parser. Try again…

(Cay/Cax) (Cbx/Cby)

vikingvista July 27, 2011 at 11:53 pm

I give up.

Dan J July 27, 2011 at 11:58 pm

Very funny, VV.

Sarcasm at it’s best.

I was not joking.

People will listen if the argument is able to be simplified in discussion.

Most of you here are knowledgable enough to do so, just not inclined to do so.

America is unlikely to ever grow out of the teeter-tattering of more socialism or more individualism if some of the arguments are simplified for those who have never read ‘law of supply and demand’.
Progressives have slowly been winning. Enough people are pulling back on socialism, but the far left is not far from making am emotional pitch in response to a crisis.

vikingvista July 28, 2011 at 1:11 am

It makes for amusing sarcasm, but for the damned parser, it is also a sound proof.

DG Lesvic July 28, 2011 at 2:21 am

Dan

You’re a better man than I, for apparently you were able to extract some meaning from Vike’s cryptonomics, which I was not. So congratulations. I do hereby acknowledge that you and Viking too are my intellectual superiors.

But what was wrong with Don’s plain English? This dummy at least understood it. So why not stick with it, unless you smarter people are trying to exclude us from the conversation. But why would you want to do that? Don’t you want our support for freedom too? Whose side are you on?

Dan J July 28, 2011 at 2:47 am

Don’t talk much to non-college grads or union factory workers, do ya?
Many just want satisfaction, today. Had a house, now house is gone. Had a job, now job is gone. Easy and simple answers are provided via MSM and politicians, so they are accepted. The answers seem reasonable. Job was here, now India or China have the jobs.
Many people just want to work so they can buy things they want or ‘need’. Go bowling with guys, watch game on Sunday.
Not stupid or naive. Just prefer time for something entertaining or that which they can affect directly, right now.
This is why much of the Presidents drivel of populist ambiguity and class warfare as lasting effects.
I merely am looking for better arguments that does what the misleaders have done. Use quick quips and buzz words that the point across succinctly and have lasting effect.
Republican are overmatched in this category. While there is much to dislike about Republican party, the enemy of my enemy is my friend……. Or at least band together for now, till the enemy has been diminished enough to then duke it out later.
Some wind of luck, via innovation created despite the atmosphere, a type of crisis, or brilliant maneuvering and campaign advertisement combined with the opposition’s fallibility possible to give us 4 more years of Obama, now unencumbered by re-election hopes, assuming he is not following that part of the FDR playbook.
I am convinced of many of the mirror policies and positioning by this admin was after careful study of the ultimate progressive, FDR.

vikingvista July 28, 2011 at 2:59 am

DanJ,

I’m sorry the HTML parser screwed up the last expression, but if you had seen it, the whole post is quite simple. It just says what Don said, but with the frugality of symbols. The math is just high school algebra. I think the population of people in this country who graduated from high school is pretty substantial. What might be a little more difficult is translating from Don to algebra. Algebraic word problems are standard SAT fare, but many people do have difficulty with them.

vidyohs July 28, 2011 at 4:46 pm

@Dan J

Amigo, the simple answers are out there already, and any one wanting to know the real reason he lost his house or where the job went has that true hard factual information readily available, but the problem is that those explanations have no appealing emotion in them………that is why the looney left succeeds with their propaganda, their explanations tell the individual it wasn’t his fault and that he was screwed by an evil capitalist. Now isn’t that so much easier for the average man, Joe Sixpack to understand and run with?

You give a man a hard dose of reality and he doesn’t like it or you.

The looney left gives him lies and he loves them for it.

Dan J July 29, 2011 at 8:46 pm

@Vidyoh

I am not criticizing Don. I am only hoping the brains here might ponder on it a little and see what pops up. The war of propaganda gives the left the advantage due to what you mention.
Emotion is a huge driver, indeed.
But, Great quick quips must be a part of the game. Then, more info can be provided to satisfy the curiousity.

Ken July 28, 2011 at 12:42 am

Don,

How many topics are covered in Econ 101? How many do you think there should be? Is comparative advantage covered? Admittedly, I took econ 101 almost 20 years ago, but can honestly say I don’t remember anything from that course, except that I had to buy a subscription to the NYT and read the editorial section every day.

How in depth are topics covered or is the approach cover as many topics as possible? The latter seeming to guarantee no one remembers anything from the course.

Regards,
Ken

Kirby July 28, 2011 at 10:42 am

Let’s say that Don and Viking create Apples and Oranges (yes, create)

Don can create 25 apples OR 50 oranges a day
Viking can create 50 apples OR 25 oranges a day
Don and Viking both want an even number of apples and oranges, their products are identical, and they are both honest.

Now if Don and Viking work alone, they will work one day at what they produce best for every two days at what they have produce worst, and it will take 3 days to get 50 apples and 50 oranges each.

However, if Don only makes oranges and Viking only makes apples and they trade 25 apples for 25 oranges each day, Don and Viking only have to work 2 days to get 50 apples and 50 oranges each.

This is because for each apple Don makes, he gives up the opportunity to create two oranges, however, if he trades one orange for one apple with Viking, each apple he buys will only cost him one orange, and the reverse for Viking.

Dan J July 28, 2011 at 4:22 pm

That is getting simplified. I like it. Thanx!!

Kirby July 28, 2011 at 8:03 pm

you’re welcome

NotSure July 27, 2011 at 6:09 pm

The WTO laws are written by governments which make up the members of the WTO, there are no corporations as members last time I checked.

heart_of_flint July 27, 2011 at 5:29 pm

I suggest that in the future you make either Tom or Don (but not both) a woman. This will allow you to capitalize on the efficiencies of gendered pronouns.

Don Boudreaux July 27, 2011 at 6:17 pm

Actually, I normally do so. But when preparing this particular presentation the only person who I knew would be in the audience – and who everyone in the room would know – is Tom Palmer (who organized Cato University). So I used Tom’s name.

Jaye Bass July 27, 2011 at 11:31 pm

These last few threads about trade and specialization reinforce authors like Matt Ridley who say the same sort of things but in a less rigorous fashion.

Kendall July 27, 2011 at 11:41 pm

I understand how the math works with comparative advantage in a two country, two product world but I assume the example gets much more complicated with a multi-country, multi-product world and non-economists have to accept by faith the principal still holds.

Also, it seems to me comparative advantage assumes a demand curve with an infinate y-intercept but in the real world supply can outpace supply even with a cost of zero. If Tom and Don can’t use more than 25 fish and 25 bananas then getting extra fish from trade really isn’t beneficial. In the real world are we assuming no country has the resources to produce all (or most of) the products demanded by the world at the lowest cost anyone can produce the products at?

vikingvista July 28, 2011 at 12:29 am

It readily holds for an arbitrary number of products for two traders. If one trader’s relative productivity between any two of his products differs from the other trader’s, there will always be comparative advantages, and a way for all to profit from trade. That is, the more products you add to the universe of products (i.e. the more realistic the scenario), the more likely there will be comparative advantages, because the less likely the two parties will have identical relative productivities in all things.

For an arbitrary number of traders, you can simply pair them off and isolate the pairs to show that trade is profitable for all. And it doesn’t even matter how you pair them off. That is sufficient to prove it holds for any number of traders. Of course the possible number of trade networks grows exponentially as the number of traders increases, and there may be arrangements that are even more profitable, but you don’t need to worry about that, since you’ve already found one arrangement that works, and that is sufficient.

I think what you might be thinking about is a situation where one universally beneficial trade network is changed into another universally beneficial trade network, but in the new network at least one of the traders has LESS benefit than he had with the other arrangement.

But that is a different issue than comparative advantage. In that scenario, you are adding another level of relative benefit beyond what c.a. deals with. Comparative advantage is simply true.

DG Lesvic July 28, 2011 at 2:27 am

Kendall,

What was wrong with Don’s plain English? How does your cryptonomics improve upon his presentation? Does it make it easier to understand? Does it make it any more convincing?

Kendall July 28, 2011 at 12:17 pm

DG,
If you don’t wish to try to answer an honest question like Vikingvista did (by the way, thanks to Vikingvista) then why spend the time making a comment?

Kendall July 28, 2011 at 12:49 pm

Vikingvista,
Excellent explanation on how comparative advantage extends to multiple products and/or people. I don’t think the second part of my question is clear enough to get an answer. Does adding money complicate matters? If country A can produce widgets for $12 and gadgets for $6 and country B can produce them for $10 and $2 and country B can produce enough gadgets and widgets for both countries why would any consumer from country A pay $12 for a widget when he can get it for $10? How does country A’s comparative advantage in widgets turn in to an advantage for the consumer making the purchase? Thanks!

Dan J July 28, 2011 at 1:27 am

One country can raise the sheep to shear due to open plains and abundance of grazing….. Region 2 spins the wool with their industrial know how and produces not clothing, yet lack the open space for the animals ……. Region 3, located in between the other two, imports some sheep to slaughter for food and distribution keeping meat fresh and does not spoil in long transit between regions…..
Sound good?

Dan J July 28, 2011 at 1:33 am

‘produces clothing (products packaged and distributed for sale)’

Kendall July 28, 2011 at 12:55 pm

Thanks!

Don Boudreaux July 28, 2011 at 6:07 am

No faith is required.

Comparative advantage is about opportunity cost. Only if the amounts of output of X or of Y or of Z that Jones sacrifices when he produces an extra unit of A are the same for Smith when Smith produces an extra unit of A will neither Jones nor Smith have a comparative advantage over the other at producing X,Y,Z, and A. (Another way to say this is “neither Jones nor Smith will have a comparative disadvantage, relative to the other, at producing X,Y,Z, and A.”)

Let’s extend the example to more than two persons.

Only if the amounts of output of X or of Y or of Z that Jones sacrifices when he produces an extra unit of A are the same for Smith when Smith produces an extra unit of A, and the same for when Williams produces an extra unit of A, will none of these three people have a comparative advantage over any of the other two at producing X,Y,Z, and A.

Don Boudreaux July 28, 2011 at 7:00 am

At its foundation, the principle of comparative advantage is a proposition about the unavoidability and the unavoidable relevance – and the (sometimes counter-intuitive) consequences of differences in – opportunity costs. That’s all. But that’s also quite a lot given the widespread misunderstanding of trade and what drives trade.

Because it enlightens our understanding of trade, comparative advantage enlightens our understanding of trade that occurs across political boundaries. But despite first being explained as a proposition in international trade, comparative advantage is not simply about trade that occurs across international borders. And despite typically (and usefully) being explained in terms of production (how many fish Jones does not produce as a result of his producing more bananas) – and despite the fact that understanding the principle of comparative advantage enlightenes our understanding of just how patterns of specialization in production evolve – the principle of comparative advantage is not a proposition limited to production.

Indeed, the principle of comparative advantage applies to – helps to explain – how each of us allocates our own time even when such allocation decisions have no bearing on interpersonal trade. Comparative advantage explains how Jones allocates his time between fishing and banana-gathering (and all other possible uses of his time) on a desert island even if Jones is the only resident of that island.

The principle of comparative advantage is a proposition about what Jones sacrifices, ultimately in subjective utility, by doing more of activity A and less of activities B, C,….Z. Because the same proposition applies to Smith – and because Jones and Smith each can regard trading with the other as one of their individual activities – the principle of comparative advantage illuminates a major driving force behind interpersonal trade (regardless of whether or how much of that trade occurs between people separated by political borders).

Kendall July 28, 2011 at 12:50 pm

Don,
Thanks for the reply. Does adding money complicate matters? (I asked this above but I didn’t know if you would read it) If country A can produce widgets for $12 and gadgets for $6 and country B can produce them for $10 and $2 and country B can produce enough gadgets and widgets for both countries why would any consumer from country A pay $12 for a widget when he can get it for $10? How does country A’s comparative advantage in widgets turn in to an advantage for the consumer making the purchase? Thanks!

Kendall July 27, 2011 at 11:46 pm

It seems to me the housekeeper has a comparitive advantage over Shaq only if Shaq practices/plays basketball 24 hours a day. If Shaq watches Gunsmoke every Saturday and replaces that activity with cleaning then he can keep the money he formerly paid the housekeeper for the price of missing Gunsmoke.

vikingvista July 28, 2011 at 12:35 am

Yes, to know the opportunity cost, you have to identify the correct opportunity.

But the NBA is hard work. If Shaq deprives himself of relaxation by cleaning house when he should be resting, it may very well cut into his basketball productivity. The housework may not pay off.

It makes most sense to define a reasonable period of time that a person works, and then determine what the most productive way is for him to spend that time. 24 hours isn’t reasonable.

Kendall July 28, 2011 at 12:27 pm

Vikingvista,
I agree with you, in fact that is the point of my comment. I read a lot of examples which illustrate the idea of opportunity cost but they assume the person involved can always spend the time at their primary profession. Such as a lawyer spending an hour picking strawberries who could have made $400 an hour as a lawyer so the strawberries cost him $400. That would only be true if he left the office early to pick the strawberries.

Pom-Pom July 28, 2011 at 2:31 pm

Let’s not pettifog on examples that are necessarily stripped down to highlight the essential features of the underlying principle.

Pom-Pom July 28, 2011 at 2:28 pm

Relaxation time is a valued luxury good. Money is a valued good whose value lies in eliminating the otherwise required coincidence of wants that are barter. A clean house is a valued good. Values are subjective.

Shaq values money and relaxation time more than housecleaning. His productive advantage in playing ball is high enough such that he values relaxation more than producing a clean house.

Ron H July 28, 2011 at 4:38 am

I think you have to ask whether Shaq values watching Gunsmoke more than he values the money he pays for housekeeping.

Kendall July 28, 2011 at 12:28 pm

I agree with you.

SheetWise July 27, 2011 at 11:57 pm

Let me see if I understand you correctly.

I need to fix an old foundation that was added to my house, and I need the skills of a mason. I know that because it would take me at least twelve trips to the hardware store just to screw it up.

My neighbor is a mason, and has a totally screwed-up web site that he paid dearly for — but the vendor never did make it work. He wants to get it fixed.

Over a pitcher of beer and a bowl of pretzels the two of us agree to solve each others problem — he fixes my foundation, and I fix his website. Nobody was “hired” …

Because we did not use dollars — is this a market transaction?

Yes. My understanding is, had we exchanged dollars, the government was a legitimate partner. Because we did not exchange dollars, there was no “taxable event” and the government did not get their “cut” …

My gut tells me this is where we are headed. The government is being “cut out” of transactions because their expanding and incomprehensible regulations imply that “hiring” somebody is the equivalent of adopting them. Consequently the government is “cut out” of a lot of seemingly innocuous transactions, and the “shadow economy” is strengthened.

This would be a good time to insert a quote by Hayek about the limits of economic thought.

The “Socialists” and the “Greens” success at recruiting the emotionally dysfunctional, impoverished, and uneducated to populate “the left” is an Orwellian newthink/newspeak revelation that should scare anyone who identifies with the rhetoric (as well as those who don’t). And assuming this is an accepted identity on the “left” — understand that there is no similar refuge on the “right”. Any absence of anger or display of harmony from the “right” is discounted as a non-event.

I’m ashamed at myself for spending as much time as I did writing this.

vikingvista July 28, 2011 at 1:25 am

You are wrong that it isn’t taxable. The IRS hasn’t the incentive to care about the countless examples of a single transaction like the one you mention. But establish a barter house trading in substantial value, they WILL get interested, and will demand you determine fair market value of those trades (in dollars) and pay taxes on it.

And what is worse, the taxes will be double. Both trading partners have to calculate their equivalent income in dollars and pay tax on it. When you ACTUALLY trade dollars, only the receiver of the dollars pays the tax.

So the army of gun-toting G-men give us a substantial incentive to use dollars over barter (or other currencies), unless we think we can elude them.

Dan J July 28, 2011 at 1:40 am

Bartered exchanges are taxable. Govt will place value on bartered products or services for you, in court, should one fail to comply.

I believe a sales tax and income tax are required.

Dan J July 28, 2011 at 1:42 am

Sorry, meant that govt has instituted a sales tax and subsequent income tax….. Not that I think those should be required.

vikingvista July 28, 2011 at 2:47 am

Yep. And its a double tax, right? That is, if I trade my x for your y, and x is dollars, then only you pay a tax on x. But if neither x nor y are dollars, then you pay a tax on x AND I pay a tax on y.

Dan J July 28, 2011 at 2:52 am

Triple tax if you include a property tax on some particular items….. Taxed at receiving of compensation for my labors…. Taxed at using same taxed monies for purchase of products or services ( in some cases on the very product or service I labored to assist in producing)…….. And taxed year over year on the property or else forfeit use or possession.
And, possibly taxed at point of exchanging the taxed item for another item I find of more value to trade with.

Pom-Pom July 28, 2011 at 2:34 pm

They get you coming, going, and in-between.

DG Lesvic July 28, 2011 at 2:31 am

Now you see, Vike, you can actually talk sense about economics without math? What was difference about this problem, that didn’t need your math, from the others, that did?

When do we need it and when don’t we?

And where you did it use it above, could you tell us, in plain English, what was your point of departure from plain English, and why it was necessary?

Another of my infallible predictions:

You will never do so. You’ll just revert to the same old personal attacks to avoid the actual philosophic issues.

DG Lesvic July 28, 2011 at 2:33 am

And by the way, hasn’t anyone but myself noticed that the personal attacks upon me have been upon Ludwig von Mises and Don Boudreaux as well.

That’s pretty good company, and I don’t mind being it it at all.

SheetWise July 29, 2011 at 1:33 am

My understanding of the tax code is that if you trade “hours-for-hours” and never establish a dollar value for those hours — or even if you casually agree that they are equal — there is no taxable event. As soon as you create an exchange and begin banking credits, you may have problems (unless you all treat each members hour of labor as an equal unit of exchange).

Bartered exchanges are taxable, but only if negotiated in dollars or dissimilar (dollar) values placed on time.

SheetWise July 30, 2011 at 4:20 am

I hate to add this to my post — but I can’t figure out who to respond to directly.

Did it ever appear to you that the government has evolved into a protection racket? The only way government can make money is by making people LESS self sufficient. The MORE self-sufficient people are, the less their economic transactions pay tribute to the anointed.

If graft is your game, this makes a great argument for single family homes and two-earner households. If people actually take care of themselves, the wiseguys will lose their vig.

I know that’s simple — but it makes sense. What if the “economic collapse” is simply a change in lifestyle that has no economic impact on the populace actually supporting this country — it only has an impact on the wiseguys who have made promises (and those who believed them).

Daniel Shapiro July 28, 2011 at 12:11 am

Thanks, Don, this was great, as was your reply to Muirego. I hope to be able to explain comparative advantage to students in my social and political philosophy class, who know no economics.

J. W. July 28, 2011 at 1:30 am

Daniel,

I had a bit of trouble explaining it to one of my classes. I think it helped when I showed them Art Carden’s “Trade is Made of Win” videos at learnliberty.org:

http://www.learnliberty.org/content/trade-made-win-part-1-wealth-creation

Richard W. Fulmer July 28, 2011 at 9:12 am

Good presentation, Don. Years ago, I heard an intro to comparative advantage that made the basic concept clear at a “gut level.” The speaker talked about going camping with his family when he was young. He recalled that his father was far more competent at the various camping skills – clearing a campsite, pitching the tent, collecting firewood, starting a fire – than was any other member of the family.

He then asked if the family would, therefore, have been better off had his father done all of the work. Clearly not. The work was done far more quickly if his father did those things that only he could do and everyone else did tasks, like collecting firewood, that they could do well enough.

Don’s melding of the division of labor with comparative advantage works well with this example. By distributing the work, the other family members would learn how to do the tasks more efficiently, and each subsequent camping trip would go more smoothly.

Don’s example using numbers of bananas and fish would build on this example to make the undertanding of comparative advantage more concrete.

Bruce Fancher July 28, 2011 at 1:02 pm

Thanks for posting this. Suggestion: how about uploading it to a site like http://www.slideshare.net so people don’t need to download it and open it in PowerPoint (which some people might not even have on their computer)? You can sign up for an account on slideshare for free and it only takes a few seconds to upload a PowerPoint and have the site automatically convert it into a web slideshow.

geoge July 28, 2011 at 1:35 pm
Dan J July 28, 2011 at 4:31 pm

Comparative advantage and opportunity costs would seem to have an important role in discussion with all of the complaints (issues) around ‘jobs’, China, trade, etc.,….

muirgeo July 28, 2011 at 4:50 pm

And then there are always real world results for those to which it matters;

American Household Net Worth

Before free trade;
1980 to 1995 Net worth ~tripled from $9.5 trillion to $27.9 trillion

After Free Trade;
1995 to 2010 Net worth ~doubled from $27.9 trillion to $57.1 trillion

I suspect that there is some sort of neat fancy thing none of use have that never was developed because of the current global neoliberal economic stagnatory inefficiency.

So when you say its cool because everyone has a internet cell phone that looks like we are doing better then before but the question is could we have been doing even better. I suspect if progressive policies had dominated these last 25 years or so our cell phones would be Star Trek like transporters by now. Oh well… civilization progresses in spite of neoliberal drag so produced.

Kirby July 28, 2011 at 9:47 pm

Sure, communism brings massive advances in technology. Look at China, they are just now discovering oil.

Not going to bother to copy/paste my wikipedia response, as you have obviously done

VPrime July 28, 2011 at 7:25 pm

Thanks very much for sharing, Don. I wish I had been there!

The graphs are, as you stated, brilliant.

With permission–and with due credit given to you, of course!–I’d like to use both of the presentations in my intro to econ courses.

And, thanks for the inspiration. Your intellectual steadfastness and determination to stand up for sound economic thought-as exemplified in this blog, your other writings, and on EconTalk-are truly energizing.

Cheers!

BTW I’ve never ceased to be amazed by how well you and Russ deal with the internet cranks and the incensed-at-birth. I would find it draining…

VPrime

Don Boudreaux July 28, 2011 at 7:45 pm

Permission granted, VPrime. (The ideas are not mine; they belong to common sense.)

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