Pulling out the comparative advantage card

Since everyone is talking about the drop in manufacturing output and employment and trying to figure out “how to fix it” I thought I’d pull out the old comparative advantage card to show why it may not be a problem.   In case you are wondering what it is, Wikipedia is always rock and roll.

New Zealand is a sparsely populated country that is far away from most large international markets. With fuel prices going up, increasing vertical integration (when different aspects of the production process are joined together in the same firm) and the rise of just-in-time inventory management, more and more manufacturers are positioning themselves “close” to market.

This trend, combined with the benefits of agglomeration in production and the improving use of technology overseas, has made manufacturing in countries like New Zealand less and less competitive.

This is tough for people who have invested time and skills in specific forms of manufacturing, but in so far as these changes are the result of changes in technology and the habits of global consumers, we cannot stand in the way of them.

And this is the flipside – although New Zealand is comparatively bad at manufacturing things that require large scale (such as say cars) it is comparatively good at other things (producing milk).

Other countries having become more productive in the export manufacturing space it actually a good thing for New Zealand as a whole – as it has driven down the price of what we buy from overseas relative to the price of what we sell.

This can be seen in our terms of trade (the ratio of export prices to import prices), which has risen 10% since manufacturing activity peaked.

No doubt my article may overstate the case – I would prefer not to make a policy based conclusion until there is some data heavy analysis of the issue.  However, given that changing technology and production patterns around the world will be a major driver of what is going on I felt that the argument actually needed to get some air.  I have noticed that it is popular to focus on esoteric issues when looking at what is going on – among both economists and non-economists.  However, doing so often leads us to lose sight of some of the most important issues!

As people who have done training in economics we have covered this issue a number of times on the blog (eg *,*,*,*,*) – the key point is that we need to understand “why” something is going on before we can truly define whether it is good or bad, change in itself is not bad.  Some people may not like the “descriptive” vs “prescriptive” split economics pushes, but it is the most transparent and honest, and dare I say it scientific, way of doing things.

  • http://offsettingbehaviour.blogspot.com/ Eric Crampton

    And note too that RBNZ piece by Gael showing that much of the drop in manufacturing is explained by reduced demand in the domestic construction industry. Again, building consents and local councils….

    • http://tvhe.co.nz/ Matt Nolan

      Was close to putting that in – but figured I’d need to add a relatively large section discussing how much of the slowdown was to do with cyclical factors, both globally and domestically. From there, I became concerned that if I covered that I would end up crowding out my point – so I purposefully didn’t.

      However, when it comes to looking at what is going on right now it is a good point.

  • boristhefrog

    Its a complex business this manufacturing gig… have a look at this website – sourcemap.com which focuses on location of components for various final products – for an iPhone the countries involved are… USA, Costa Rica, Congo, Malta, Italy, France, India, Singapore, Malaysia, Japan, South Korea, Taiwan, Vietnam, Philippines and of course China, where the final assembly is done…. so components from 14 countries….

    Now if your the Greens/NZ First/Labour/Mana it probably hasn’t occurred to you that comparative advantage is real and that the production of manufactured exports necessarily includes the purchase of a lot of imported components…

    Thinks of a can of infant formula – sure the milk powder comes from NZ, but that is only about 40% of the final product, excluding the can… wonder where the rest comes from? How much is imported? Might that not be important?

    • http://tvhe.co.nz/ Matt Nolan

      Indeed.

      Funny fact, Mana and to a lesser extent the Greens want to support manufacturing and introduce a financial transactions tax. A financial transactions tax will tax products with a “longer supply chain” more – as the type of tax that has been mentioned is a GST without rebates. As a result, they want to tax manufacturing more than other industries and then support it somehow.