CIA – The World Factbook - Iceland

How did a barren rock in the middle of the North Atlantic Ocean become one of the richest countries in the world, where the average citizen earns $40,000 per year?

Iceland’s prosperity is a perfect example of how a country that participates in international trade based on the principal of comparative advantage can produce the goods for which it has a relatively low opportunity cost, export them to the rest of the world, and become rich. Listen to the podcast below, then complete the activity that follows.

Activity:

• Go to the CIA World Factbook online.
• Look up your home country from the drop down menu.
• Click on the “Economy” section and read the introduction to your nation’s economy.
• Look through the economy section and find information on your nation’s exports, then answer the questions that follow.

Other Media Download (41)

New York Manhole Covers, Forged Barefoot in India – New York Times

In the revealing story above, the NYT reports on the manufacture of the New York’s thousands of manhole covers, which it turns out come primarily from a foundry in the Indian state of West Bengal. An NYT photographer discovered the Indian factory, and his photos prompted the report here:

Eight thousand miles from Manhattan, barefoot, shirtless, whip-thin men rippled with muscle were forging prosaic pieces of the urban jigsaw puzzle: manhole covers.

Seemingly impervious to the heat from the metal, the workers at one of West Bengal’s many foundries relied on strength and bare hands rather than machinery. Safety precautions were barely in evidence; just a few pairs of eye goggles were seen in use on a recent visit.

In AP Economics, we have begun learning about resource markets, where firms hire the productive resources needed to produce their output. Land, labor, and capital are all needed to produce any output; the combination of these resources a firm will use depends on several factors, including the productivity and the prices of the resources. When the price of labor is low, firms tend to use more labor and less capital. In developing countries, especially those with a large, unskilled workforce (like India), firms are likely to specialize in the production of labor-intensive products, such as the manholes found in American cities like New York.

The scene at the Indian foundry sounds like something from the Middle Ages:

The temperature outside the factory yard was more than 100 degrees on a September visit. Several feet from where the metal was being poured, the area felt like an oven, and the workers were slick with sweat.

Often, sparks flew from pots of the molten metal. In one instance they ignited a worker’s lungi, a skirtlike cloth wrap that is common men’s wear in India. He quickly, reflexively, doused the flames by rubbing the burning part of the cloth against the rest of it with his hand, then continued to cart the metal to a nearby mold.

Once the metal solidified and cooled, workers removed the manhole cover casting from the mold and then, in the last step in the production process, ground and polished the rough edges. Finally, the men stacked the covers and bolted them together for shipping.

Why are New York’s manhole covers being made over 8,000 miles away, anyway? Wouldn’t it make more sense for American cities to buy such items from firms making them right here in the United States? To understand this question, we need to consider the principle of comparative advantage, which says that a nation should specialize in the production of the products for which it has the lowest opportunity costs.

Manhole covers manufactured in India can be anywhere from 20 to 60 percent cheaper than those made in the United States, said Alfred Spada, the editor and publisher of Modern Casting magazine and the spokesman for the American Foundry Society. Workers at foundries in India are paid the equivalent of a few dollars a day, while foundry workers in the United States earn about $25 an hour.

Bengali laborers working in India’s foundries most likely face the trade off of an agrarian existence or maybe another factory job in the pre-industrial economy of the impoverished region, alternatives presenting a much low opportunity cost than American workers whose alternatives include jobs offering much higher productivity. The productivity of a worker depends on the quality and quantity of capital available, the level of training and education of the worker himself. Clearly, Indian workers have less access to capital, lower quality capital, and much less training and education than their American counterparts.

The result is that jobs that require large inputs of low-skilled labor, such as the manufacture of manhole covers, end up being “off-shored” to remote corners of South Asia. The added cost of shipping thousands of ton of iron around the world is more than made up for by the lower resource prices (thus costs of production) in the West Bengali foundries.

Discussion Questions:

1. Why do the Indian foundries use such large inputs of labor, and relatively little machinery?
2. What factors might reduce the demand for labor in the Indian foundries?
3. How does a firm know if it’s using the right combination of capital and labor in its production?

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This past weekend, the Obama administration officially put an end to US combat in Iraq. Seven years after the invasion, both politicians and economists are looking back and asking themselves, was the invasion into Iraq and the ensuing occupation of coalition forces actually worth it. Or in economic terms, was the benefit of the war greater than the costs of fighting it.

What have been the benefits of the US being in Iraq? Have their indeed been any and if so how can we measure them? There are some clear explicit benefits that can be measured such as companies that have profited from the war as well as evidence of increased investment in the middle east due to the presence of the coalition forces. But there are also benefits that are hard to measure such as the creation of democracy, freedom or the removal of a ruthless dictator. On the cost side there are explicit costs for the war in Iraq such as the total amount currently spent by the US Government which is around 748 billion USD. Like the benefits there are also costs that are hard to place a number on such as  the human cost with an estimate of over 100,000 total deaths, close to 4400 of which were Americans. For a more detailed look at these costs you can view the American Progress web site.

But as you know, economists do not only look at the explicit or obvious costs. In order to get a better understanding of the true costs of a decision, economists must look at the “could have beens” or the opportunity costs. In their recent article “The true cost of the Iraq war: $3 trillion and beyond” Nobel Economics recipient Joseph Stiglitz and Harvard Professor Linda Bilmes do just this. They calculate the costs of the war not only based on the explicit costs, but on the hidden ones. Several years ago, the authors estimated that the costs of the war in Iraq would eventually reach 3 trillion USD. This week, they claim that they may have underestimated the amount. The article states ,

Moreover, two years on, it has become clear to us that our estimate did not capture what may have been the conflict’s most sobering expenses: those in the category of “might have beens,” or what economists call opportunity costs. For instance, many have wondered aloud whether, absent the Iraq invasion, we would still be stuck in Afghanistan. And this is not the only “what if” worth contemplating. We might also ask: If not for the war in Iraq, would oil prices have risen so rapidly? Would the federal debt be so high? Would the economic crisis have been so severe? The answer to all four of these questions is probably no. The central lesson of economics is that resources — including both money and attention — are scarce. What was devoted to one theater, Iraq, was not available elsewhere.

Economists believe that if we can get a sense of what the “true costs” of a decision are, then we can make a more rational choice when faced with a decision.  Read the following two articles, the one quoted above by Joseph Stiglitz and the other entitled Iraq: Weighing the Costs and Benefits by Tim Kane and answer the following questions:

Questions

1. Why is it important to look at the hidden costs when making a decision?
2. In your opinion, what would be some of the opportunity costs associated with not invading Iraq? What are some that are associated with invading Iraq?
3. In your opinion, is it possible to properly do a cost benefit analysis of a war? Are there some things that we cannot put a price on? Is it possible to use opportunity costs as “true costs” when they are essentially “could have beens”?

School kids feel the bite of high food prices – May. 5, 2008

A classic method of teaching the basic economic concept of the production possibilities curve is to illustrate the relationship between a nation’s decision to invest in military goods versus civilian goods. The model typically includes two “products” that a nation can choose to invest in: guns and butter. The specific goods themselves are not so important, rather what they are meant to represent: the tradeoff any nation faces between allocating more of its scarce resources towards national defense versus goods and services that benefit the nation’s consumers.

Today the United States faces a very real version of the old “guns vs. butter” model. Rising global food prices have put public school districts in a bind: how to feed kids nutritious meals as the prices ingredients has risen at unprecedented rates:

Rising food prices are making it harder for schools to cook up ways to give kids the nutrition they need.

Right now, they’re taking shortcuts and shuffling ingredients to make up the difference, but that’s only a short-term solution with long-term consequences on the horizon.

“I’ve been in school service for 27 years and this is the worst it’s ever been,” said Sara Gasiorowski, food service director for Wayne Township Schools in Indianapolis. “I have never seen food prices jump up so far…”

Food prices nationwide have risen 4.5% between March 2007 and March 2008, according to the Bureau of Labor Statistics’ Consumer Price Index, with flour and eggs rising even more dramatically than milk. Grumbles said milk prices in her district are up 22% from last year, which means an increase of 3.5 cents for each of the federally required 16,000 half-pints she provides every day.

“For every penny on a carton of milk, it costs me $30,000 a year,” she said. “That’s $105,000 extra on my food bill.”

Flour prices have roughly doubled over the last year, according to Grumbles, to $19 per 50-pound bag. To make up for the difference, she substitutes canned peaches for fresh apples “to save a couple pennies” per meal, or she uses ground beef in place of chicken.

Unfortunately, federal funding for school lunches has increased at a much slower rate than cost to districts of providing those meals:

Federal reimbursement programs cover all or part of school districts’ lunch tabs. Congress lifts reimbursement rates every year, but Gasiorowski said it hasn’t been enough: “We need to be looking at an increase of 12% to 15%, instead of our usual annual increase of 2 or 3%.”

The current federal reimbursement program is based on household incomes; the poorest American students receive $2.47 of federal funding towards their “free lunches”, while students from the highest income bracket only receive $0.23 per meal. The problem is, the average school lunch now costs $3.10, so these days no one is actually receiving a “free lunch”, not even the poorest American students.

This article struck me in that is truly does illustrate the concept of tradeoffs as illustrated in the production possibilities curve. Society must allocate its scarce resources towards the goods and services it deems most desirable based on the needs of its citizens. Complications arise in this basic model, however, when government is involved.

The commitment to subsidizing school lunches is based on the idea that if the responsibility of feeding American school children were left to the free market, resources would surely be underallocated towards nutritious meals, representing a market failure. School lunches are a merit good, meaning they would be underprovided by the free market, since without public provision and support, millions of American children would come to school every day without nutritious meals to get them through the day.

National defense is another service that governments find it necessary to provide.  If it were left completely up to the free market, national defense would probably not be provided at all. Instead, only individuals who could afford it would hire private security forces to protect their property. To protect a whole nation, however, government provision of defense is a necessity.

Clearly, both “guns” and “butter” create benefits for society. Among the countless other goods and services the government provides or supports the provision of, the United States faces a tradeoff arising from the scarce resources at the government’s disposal. Currently, the US government spends far more on  its military ($660 billion in 2010!) than it does on lunches for American school children. Clearly, military spending is necessary, but it may be that in the tradeoff between these two important services more resources should be allocated towards “butter” at a period in the US economy when low income households are finding it harder than ever to provide their children with one of life’s most basic necessities, nutritious food.

Discussion Questions:

1. What do “guns and butter” represent on the PPC above? Why have economists found it useful to use these two goods on their analysis of the tradeoffs faced by nations?
2. Why doesn’t the United States just make all school lunches FREE for all American school children? Wouldn’t that make sense? Give an economic argument against this suggestion.
3. Why does the government feel it necessary to allocate any resources towards school lunches? Shouldn’t the government just let American families provide their own children with lunch?
4. Say the US government decided to increase its provision of both national defense and school lunches, without reducing its provision of some other good or service. How would it do this? Why wouldn’t the government do this?

Update: I received an email message from a reader about the above blog post:

I have to say that your “guns and butter” diagram is “interesting.” I am not clear on why the United States should spend vastly more on school lunches than on defending the free world While government provided school lunches may have a place, most Americans feed their own children and do not depend on Federal financing.

Where did you get the notion that feeding our children would be “under-provided by the free market”

Here was my reply to this reader. I’m posting it here because I want to make it clear the the diagram above is not meant to make any political statement about US military spending:

Hello,

Actually, the PPC was included simply to illustrate the basic tradeoff that society faces when it chooses how to allocate its scarce resources.

Having taught at least for a short while in public schools, I can say that nutritious lunches are definitely “underprovided” by the free market, that is, many students in poor communities in America depend on the “free and reduced” lunches that are provided through federal and state funding programs… I once volunteer taught in a poor Elementary School in Spokane, Washington where 40% of the students ate only two meals a day, both provided free by the school district: one at 8 in the morning, one at noon. Many of these children had parents who were poor, unemployed, often addicted to drugs, who failed to put any food on the table whatsoever.

In other words, I do think that nutritious meals are a “merit good” which by definition is one that is underprovided by the free market, therefore requires subsidies from the government. Otherwise, why would the government offer such subsidies at all, if these meals were something the free market could adequately provide on its own?

Again, I was not making any political statement with the graph, only pointing out the basic economic concept of tradeoffs and the idea that society must allocate its scarce resources towards an “optimal” combination of goods and services. The article indicates that in this time of rising food prices, not enough of America’s resources are going towards providing nutritious meals for school children, indicating that a movement along the PPC might be in order. The degree of such a move is irrelevant, only the fact that a movement must occur if nutritious meals are to continue to be provided. In fact, the x-axis could have represented any other public good the government provides for society, I chose “military spending” so that the current example was consistent with the classic example of “guns vs. butter”.

Hope that clears things up… Best regards,

Jason

Freakonomics – Laid-Back Labor – New York Times

If you’ve spent much time on this blog, you know that I’m a fan of the boys at Freakonomics, the book that so aptly applies economic theory to the seemingly benign happenings of everyday life. In the article above the Freakonomists examine the difference between labor and leisure. I thought this article did a good job of introducing some of the basic concepts behind how economists think about the world.

As this year’s AP students begin to delve into the world of economics, one of the early topics they study will be the concept of humans as rational beings engaged in the constant pursuit of utility (the economist’s word for happiness). According to our text, “Economics assumes that human behavior reflects ‘rational self-interest.’ Individuals look for and pursue opportunities to increase their utility.”

If, as economists say, the purpose of life it the pursuit of utility, then presumably work is only a tedious but necessary means to an end, which we assume to be leisure. So why, as pointed out in the article above, do so many people willingly choose to spend so much time and money doing things like cooking, knitting, gardening, working in the yard, and other tasks that appear to be work, when they could easily pay others to do these menial chores for them, thus giving them more time for leisure? As the authors say, “Isn’t it puzzling that so many middle-aged Americans are spending so much of their time and money performing menial labors when they don’t have to?”

Where exists the line between work and leisure? This seems like an apt question to explore from an economic perspective. Here’s the author’s view:

“Economists have been trying for decades to measure how much leisure time people have and how they spend it, but there has been precious little consensus. This is in part because it’s hard to say what constitutes leisure and in part because measurements of leisure over the years have not been very consistent.

Economists typically separate our daily activities into three categories: market work (which produces income), home production (unpaid chores) and pure leisure. How, then, are we to categorize knitting, gardening and cooking? While preparing meals at home can certainly be much cheaper than dining out and therefore viewed as home production, what about the ‘cooking for fun’ factor?”

Why a professional (let’s say a lawyer) who spends 50 hours a week in his office, earning somewhere in the range of $100 an hour for his labor, would choose to spend two hours mowing his lawn on a Saturday, rather than hiring the neighbor boy to do it for him, truly poses an economic paradox.

Let’s see why: If this man’s labor is worth $100 and hour, then we can calculate the opportunity cost of mowing his own lawn as $200 plus the value to this man of the leisure he could have enjoyed by not mowing his lawn. The man probably could have hired the neighbor boy to mow his lawn for $20, which would have then freed him up to pursue his own leisure activities (reading, working out, watching a movie, etc.) during those two hours, and compared to the $200 value of his own labor the $20 seems like a bargain. So is a lawyer who mows his own lawn acting irrationally?

It would seem the line separating leisure from work has blurred in modern times. A hundred years ago an activity such as sewing or caring for a lawn would certainly have been viewed as work, but today the behavior of millions of Americans would indicate otherwise. As a science rooted in the belief that humans are rational pursuers of their own happiness and leisure, the paradox of the lawn mowing lawyer poses several interesting questions for students of economics.

Discussion Questions:

According to chapter one of our text (McConnell and Brue’s Economics, 17th Edition), “Purposeful (rational) behavior does not assume that people and institutions are immune from faulty logic and therefore are perfect decision makers. They sometimes make mistakes.”

1. Is the lawyer who mows his own lawn defying a fundamental rule of economics, that people act rationally? Is he making a mistake by not hiring the neighbor boy to do it for him?
2. What is meant by opportunity cost? Give an example of a decision you have made recently that involved an opportunity cost.
3. How is the lawyer’s decision whether or not to mow his lawn rooted in marginal analysis? Describe a choice you’ve made recently that involved marginal analysis.

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Shop Talk – Buying local, good idea?

I live two lives. In one, I’m an international school teacher who has lived and taught in three countries, travels around the world for work and play and flies 50,000 miles a year to and from the US, Europe and Asia. In my other life, I am a small town guy, who enjoys working in his yard in his mountain cabin tucked back in the woods of remote Northern Idaho, which is not so much a state as a “state of mind”, as the locals like to say.

When I’m in my “other” life as a small town homeowner, i.e. during my long summer breaks, I like to slow things down and reflect on the state of the world around me. I start to notice things about the local economy that seem so minute in the world of international travel that occupies 10 months of my year. I notice that twice a week farmers come to my small town of Sandpoint, Idaho, to sell their produce, bread, honey, arts and crafts, eggs and even meat. I notice that the buffalo, elk and cattle roaming the valley below my mountain cabin can be bought ready to grill and eat from the local butcher shop. I notice the local brewery, Laughing Dog, where I can buy my home town brew. I notice the natural foods market, where my wife and I do all of our shopping, and where many of the items for sale were grown locally or in the greater Pacific Northwest region.

I notice that, if one so wished to do so, one could sustain oneself almost entirely on locally or regionally grown food items. Compared to the lives of so many Americans, whose foods are so heavily processed, often times shipped from around the country or even the world, the choices available to those who chose to “buy local” seem so simple and straightforward, the benefits so obvious.

So the question is, why don’t more people eat locally? According to economist Russell Roberts, the reason we don’t all survive entirely on locally grown food is that, simply stated, the cost of doing so is too high.

In the article below, a Vermont magazine discusses he “buy-local” movement going on in communities across America today with Russ Roberts, whose enthusiasm for buying local is tempered by his economic rationale rooted in the basic economic principles of opportunity cost, specialization, and the gains from trade.

SEVEN DAYS: You’ve said that the buy-local movement has a “superficial appeal.”

RUSSELL ROBERTS: The emotional, nonmonetary appeal of “buy local” is very clear. It’s nice to buy things from people you know, and often that interaction of shopping and trading with people you know enhances the quality of life.

But there’s a cost to it, and when we say, “Let’s buy the local apples rather than the apples from New Zealand,” the cost is hidden, because apples are only a very small part of our economic life. If we tried to replicate that strategy over a wide range of products, the cost would be much more apparent.

SD: Environmentalists like Bill McKibben say the cost of some products doesn’t reflect their true environmental cost -

RR: And I think that’s true, by the way -

SD: But a lot of people would say the idea of “true environmental cost” is diametrically opposed to your idea about true cost.

RR: It’s a good observation. Rather than saying the true cost, it would have been better for me to say the full cost. Right now, if you buy local produce instead of produce that comes from across the country or across the ocean, the cost is pretty clear: It’s a little more expensive, usually. Sometimes the quality is higher, so you say, “Well, I think it’s a bargain after all.” Sometimes it’s not, so you say, “Well, it’s worth it, ’cause it’s local.”

I don’t know if people think through how those costs would add up if you tried to buy more locally than just food . . . I think it’s a question of magnitudes. There’s no doubt that when you make economic decisions based just on price, you’re not getting the full picture, which is the environmental critique. But I think it’s also true that when you purchase one item or category of items, such as food, locally, you don’t think about what the full cost would be if you did that more aggressively across a wider range of products.

SD: You’ve said self-sufficiency is the “road to poverty.” Does that relate to this discussion?

RR: Absolutely. That’s a quote from my first book, The Choice: A Fable of Free Trade and Protectionism . . . I think the word self-sufficiency has an emotionally attractive ring to it: We don’t want to depend on others; we want to be self-sufficient; we certainly want our children at some point to grow up and become self-sufficient, rather than depending on us as parents. So self-sufficiency is generally seen as a goal, but in economic activity and in trade generally, no one really has self-sufficiency as a goal.

Discussion Questions:

1. Why does self-sufficiency lead to poverty?
2. What is the “true environmental cost” of buying certain products, namely cheap, imported food and consumer goods?
3. What is the opportunity cost of “buying local”, whether it be food or other consumer items?

Economists see financial bailout as necessary – Yahoo! News

Economists in the US are calling this week’s bailout of numerous US companies a necessary step in ensuring that no permanent harm is caused to the financial system and that we do not head into a deep recession.

The Treasury Department under the leadership of Henry Paulson is currently asking congress to move quickly on a bill that would provide $700 billion to the Department to buy up much of the bad debt that many financial institutions have incurred over the past years. Where’s this money going to come from? Since it doesnt look like the Bush Administration will be pushing for increased taxes anythime soon, Congress will have to borrow the money. 

Though most economists are agreeing that this is a necessary step in ensuring the integrity of the economy, I believe that it is important to look at how this additional debt may effect our government and economy in the future. So lets start with some numbers. The following statisitics are taken from the above article.

The deficit for this budget year, which ends on Sept. 30, is expected to rise to $407 billion, a figure that is more than double the $161.5 billion imbalance for 2007, reflecting what the economic slowdown and this year’s $168 billion economic stimulus program are already doing to the government’s books.

The Bush administration is estimating that the deficit for the budget year that begins Oct. 1, which will cover the new president’s first year in office, will hit $482 billion, a record in dollar terms.

And that forecast doesn’t include the $200 billion the administration committed to spending two weeks ago when it took over the nation’s two biggest mortgage companies, Fannie Mae and Freddie Mac.

And it doesn’t have any of the $700 billion the administration is seeking to soak up the bad mortgage-backed securities that have been at the heart of the severe credit crisis the country has been struggling with since August 2007.

The legislation the administration is now seeking to authorize the financial system bailout, according to a draft obtained by The Associated Press, would boost that debt limit to $11.3 trillion, up another $700 billion.

It is the rapidly rising debt that is cause for concern. The government is already spending more than $400 billion a year just to pay interest on the national debt. The higher that debt goes, the higher the government’s borrowing costs and the less it has to spend on other programs.

Discussion Questions:

1. What impact does the knoweldge that the government will bailout struggling financial firms have on investors willingness to take risks?
2. Should the government intervene in these finacial markets or leave the “invisble hand” to its own devices?
3. What are the opportunity costs associated with this decision?
4. What are some short term and long term implications of this bailout?

Bush, Democrats point fingers over energy crisis – Jul. 12, 2008

…apparently just over $4.00 per gallon of gasoline; at least according to the article above:

With gasoline prices above $4 a gallon, Bush and his Republican allies think Americans are more willing to allow drilling offshore and in an Alaska wildlife refuge that environmentalists have fought successfully for decades to protect.

Nearly half the people surveyed by the Pew Research Center in late June said they now consider energy exploration and drilling more important than conservation, compared with a little over a third who felt that way only five months ago. The sharpest shift in attitude came among political liberals.

The travesty of Americans’ attitude in favor of drilling and against conservation is the shortsightedness of it. Regardless of how many millions of acres of wilderness the government opens to drilling, gas and energy prices will only continue to rise over the long-run as emerging market economies like China’s will continually drive demand for energy higher and higher as growth rates remain above 8%.

America, in the mean time, with the largest per capita levels of energy consumption in the world (and some of the lowest gas prices), turns its back on conservation just when it is needed most. The cost to the environment, society and the bounteous wildlife that inhabit the vast tracts of land and sea that Congress is considering opening to exploitation by energy companies will create a permanent scar in one of the most valuable (and simultaneously undervalued) resources, its wilderness.

As my summer vacation approaches its end and I begin to think about another year of teaching Economics in international schools, I find myself reflecting on what’s most important in the world: to me, to my home country, to my fellow Americans, to the kids I teach and the students I will teach 10, 20, 30 years from now. I spend my summers in one of the most beautiful parts of this great country, the Pacific Northwest, where despite over a century of logging, mining, hunting and trapping, beautiful wilderness still remains. Only 2% of America’s original forests remain standing today. Countless species of predator and prey have been wiped out. There are around 300 wolves running wild here in Idaho, and thousands of citizens here are campaigning for a hunting season that will threaten to wipe out that great species once again. Clearcuts dot the landscape, proposed mines threaten watersheds and the wild Bull trout, an endangered species in the lakes and streams of Northern Idaho. Bears are put to death when the stumble into our yards, yet we turn more and more of their habitat into housing tracts every year.

Conservation is on my mind, and the news from Washington saddens me today, as I read that Americans concern themselves less and less with what I consider this country’s greatest resource, its wilderness, when times get the slightest bit difficult economically. As I prepare for another year of teaching Economics, this year at a new school in a new country, one where conservation is of the utmost importance, I will think about ways to incorporate more of an environmental economics perspective into this blog and my own teaching. As I prepare to leave my home in the mountains of Northern Idaho once again, I will cherish what little wilderness remains in this beautiful country, and try to make as little impact as I can on an individual level towards the continued destruction and exploitation of nature that characterizes the path that Americans seem to be choosing in this time of economic hardship.

FT.com / World / Americas – US economy threatens Dominican Republic

Trade based on comparative advantage… the theory originally articulated by Adam Smith, later fine-tuned by David Ricardo, the theory that suggests that if each nation specializes its economic activity on the products for which it faces the lowest opportunity cost, then trades with its neighbors, total world output and efficiency can be maximized: today this theory represents the philosophical underpinning of all free trade agreements signed between and among the nations of the world.

Through trade, countries can exchange their extra output with other nations for the goods specialized in by others, enabling all nations to enjoy a level of consumption beyond what they’d be able to achieve if they tried to produce all goods domestically.

For many developing countries, with their abundance of either land or labor, comparative advantages tend to lie in either agricultural goods or low-skilled manufactured goods. Since global prices for food are highly unstable and dependency on healthy harvests, good weather, and stable rainfall are all highly risky endeavors for a poor country, developing nations prefer to foster the growth of manufacturing sectors in their path towards economic development.

Strategies for economic growth available to developing nations include export-oriented and inward-oriented growth. A country like the Dominican Republic, the largest economy in the Caribbean, has pursued a predominantly export-oriented growth strategy, promoting through “free zones” the growth of a textile industry aimed at producing goods for consumers in developed countries, primarily the US.

To the Domincans, producing textiles for export to America has successfully given the people of this poor nation a grip on a rung of the ladder towards economic development. The import of capital has taken previously unproductive workers out of agriculture and put them into an industry where productivity, thus income, has risen, leading to improvements in living standards. Export-led growth, however, runs some serious risks of its own, as is being realized by the people of the Dominican Republic today.

It had been clear for some time that Luis Caraballo’s textile factory, in one of the Dominican Republic’s largest “free zones”, was struggling.

Finally, last December, he closed the factory gates for the last time: cut-throat competition from China and Vietnam, a weakening US dollar and unsustainable costs had become too much.

Once a hot destination for American companies looking for a cheap place to “off-shore” production of labor intensive textiles, the Dominican Republic today faces new competition, and is finding its comparative advantage slip slowly away from textiles…

The Dominican Republic depends heavily on the US, which is the destination of more than 85 per cent of exports. But textile exports – these days accounting for less than a third of total exports – fell by 32 per cent over 2007.

Although other countries in the Caribbean are also suffering from Asian competition – with Chinese textile exports to the US tripling between 2000 and 2005, while Vietnam’s multiplied almost 117 times – the Dominican Republic has been worst hit.

Here’s the thing: a nation’s comparative advantage may shift over time (from land to labor to capital intensive goods) as the structure of the global economy evolves. Once an economy like the Dominican Republic’s has undergone a period of structural adjustment, away from agriculture and towards industry, the flow of low wage workers from farm to factory begins to slow to a trickle, leading to rising wages and increased competition from countries with more abundant supplies of cheap labor.

The challenge for policy makers is to manage the structural changes as they come, minimizing the deleterious impact such global shifts of productive resources has on the citizens of a country like the D.R. Clearly, it is in the country’s interest to prepare its citizens for a “new economy”, one in which skilled labor will play a larger role. The problem is, this requires a solid education system, which the D.R., it turns out, does not yet have:

There is widespread acceptance of the need to develop a better-educated workforce, but so far education spending has been inadequate.

“The government simply doesn’t have enough resources,” said Mr Montás. About 40 per cent of its budget goes on debt obligations and another 15 per cent is dished out through subsidies. Just 1.5 per cent goes towards education.

It also turns out that this is a balance of payments story:

Mr Montás calculated that for every percentage point the US economy contracted, the Dominican Republic’s GDP would shrink by 0.4 per cent.

Not only will exporters be hit, but also the huge tourism sector and remittance flows…

One possible result of the decline in exports and flows of remittances from the US will be a depreciation of the D.R. peso, as demand for pesos by Americans falls. A weaker peso might make the country’s exports attractive once again, assuming the exchange rate is allowed to adjust on foreign exchange markets. A weaker peso should help slow the decline in the D.R.’s exports to the US, at least until new competition emerges, perhaps elsewhere in Asia, maybe even from Africa or other Latin American countries.

In all likelihood, given the increased competition from Asian textile manufacturers, continued economic growth in the Dominican Republic will depend on the country’s ability to educate and train its workforce to adapt to a more capital, technology and information-based economy, which, if successful, will eventually lead to rising incomes and higher standards of living for the people of the this rising Caribbean nation.

Comparative advantages evolve with the emergence of new competition among developing and developed countries. The negative impacts this evolution has on a particular economy can be managed if wise policy actions are taken to assure a country’s workforce is educated and trained to participate in tomorrow’s economy, rather than yesterday’s or today’s.

Shanghai American School Habitat for Humanity – Lucena City, Philippines. October 2007

This afternoon my wife and I returned to Shanghai after an amazing week in the Philippinese where we led 16 students on a Habitat for Humanity house building project on the island of Luzon (see map here). While this experience is still fresh in my mind, I wanted to share a few comments about how my thinking about Habitat for Humanity evolved over the last eight days.

A week ago right now, the 18 of us from SAS were bouncing scarily southward along Luzon’s main north-south highway, which is only a highway in the western sense for about 30 km outside of Manila, beyond which it turns to a two-lane, pot-holed, multi-use thoroughfare shared by buses, three-wheeled motorcycle taxis, lorries, a handful of personal automobiles and thousands of jeepneys. Three hours of nerve and bone rattling travel brought us to our lovely guest house near the southern Luzon city of Lucena, where we would spend five days building a house in a community on the outskirts of the city. Continue Reading »