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Some Surprises of Comparative Advantage

In my most-recent column for AIER I highlight some surprising insights conveyed by a correct understanding of the principle of comparative advantage. A slice:

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.