Comparative Advantage

2013-05-26

I recently reread the book The Bottom Billion. For those of you who have not heard of it (probably most people), it is a (well-researched) analysis of global poverty and how it could be fixed. His take on the problem is quite different than you normally hear, and actually makes a lot of sense.

The main idea of the book is that the standard approach of dividing the world into 1 billion rich people people (probably includes everyone on Facebook) and 5 billion poor people is flawed. Instead, there are 1 billion rich people, 4 billion people who are well on their way to being rich (they started behind and are catching up), and 1 billion who are staying poor. I am not sure what happened to the other 1/2 billion people that were in the world at the time - maybe they didn't fill in their census forms).

The world systems (free markets, trade, international aid, etc.) work pretty well for the 4 billion, but the bottom 1 billion are losing out. He has a bunch of ideas on how to fix this, ranging from practical to unlikely. On the sensible end, many poor countries have no idea what sort of laws they should have for foreign oil companies, so some respected world group (e.g. the World Trade Organization) could issue a suggested set.

One thing that stuck with me is the idea of comparative advantage (which is only tangentially related to the book). This is a very important idea from economics that most people do not understand, but is actually not that complicated. I am going to make an attempt at explaining it here. I think spreading knowledge is something you can do with Facebook that actually helps the world.

We will need three people for this explanation, two from a movie (Wreck-It Ralph) I recently saw:
  1. Ralph: A big guy who is very good at destroying thing. For all practical purposes, he can't fix anything.
  2. Felix: A little guy who can instantly fix things with his magic hammer. This prevents him from ever breaking anything, even if he desperately needs to.
  3. Stephen Hawking: A genius-level physicist. Unfortunately, he is in a wheelchair, so he is even worse at both smashing and fixing things than either of Ralph or Felix. However, his knowledge of entropy (things falling apart over time) will make him better at smashing than fixing.
We also have two tasks that need to be done:
  1. Destroy Voldemort's horcrux (Slytherin's locket, in this case): Our order of preference for this is: Ralph, Felix, Stephen Hawking
  2. Repair the bridge of Khazad-dum (which Gandalf smashed in The Fellowship of the Ring): Here, our order is: Felix, Ralph, Stephen Hawking
Now obviously, if we have Ralph and Felix working for us, it is easy to see where to send them: Ralph takes smashes the horcrux (skill 100) while Felix fixes the bridge (skill 100).

However, let us imaging that Felix has been thrown in the dungeon, so we only have Ralph and Stephen Hawking. It is clear that Ralph would be the best person to destroy the horcrux. Unfortunately, he is also the best choice to fix the bridge. Since we can only set him one task, Stephen Hawking will have to do the other one.

There are two ways this could go:
  1. Ralph destroys the horcrux (skill 100), and Stephen Hawking fixes the bridge (skill 5).
  2. Stephen Hawking destroys the horcrux (skill 10), and Ralph fixes the bridge (skill 25).
Because he is better at smashing things, Ralph has an absolute advantage at destroying the horcrux of 90. He also has an absolute advantage at fixing the bridge, although it is only 20. If there was only one task to do, we would choose Ralph every time.

In this case, however, we need to do both. Ralph has a bigger advantage at destroying the horcrux than fixing the bridge, while Stephen Hawking has a smaller disadvantage with the bridge than with the horcrux. This means that Ralph as a comparative advantage at smashing things, while Stephen Hawking has a comparative advantage at fixing them. The important point here is that Stephen Hawking's comparative advantage is in the thing that he is worse at. Even though there are things he is better at, it is still the best thing for him to do.

The same thing happens in the world economy. The rich 1 billion have a comparative advantage in things that need lots of knowledge and technology (e.g. writing computer programs). Everyone else has a comparative advantage in labor-intensive work (e.g. making clothes). If we try to spread everything out evenly, we just end up making everyone poorer. If, on the other hand, we let the free market work (it is very good at finding comparative advantages), we can make everyone better off. The poor will still be poorer than that rich, but they will be richer than they would be otherwise. That is a good thing.

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