Is comparative advantage obsolete?

In a new interview with the FT, Hillary Clinton invokes Paul Samuelson and says we live in a brave new world:

We have benefited through most of the 20th century from trade. It has helped to raise American standards of living, it has helped to create jobs. And I agree with Paul Samuelson, the very famous economist, who has recently spoken and written about how comparative advantage as it is classically understood may not be descriptive of the 21st century economy in which we find ourselves.

I believe that Senator Clinton is referring to Paul's paper in the Journal of Economic Perspectives.

I am deeply impressed by the Senator's reading list, but I hope her advisers also give her some of the responses to the Samuelson piece. For example, here is an excerpt from Mankiw and Swagel (free version):

Paul Samuelson's (Misdirected) Salvo against Outsourcing

Outsourcing surged back into the news in the period just before the election [of 2004]. In part, this reflected the intense focus on the issue in democratic campaign ads in the battleground industrial states such as Ohio. An additional focus of coverage on outsourcing followed a September 9, 2004 article in the New York Times that reported on a remarkable new paper by Nobel Prize-winning economist Paul Samuelson that purported to cover outsourcing. The article in the Times informed readers that:

In an interview last week, Mr. Samuelson said he wrote the article to "set the record straight" because "the mainstream defenses of globalization were much too simple a statement of the problem." Mr. Samuelson, who calls himself a "centrist Democrat," said his analysis did not come with a recipe of policy steps, and he emphasized that it was not meant as a justification for protectionist measures.

BusinessWeek (December 6, 2004) well summarized many people’s (mis)interpretation of the Samuelson article:

So unprecedented, so colossal, and so fast is this change [in the world economy] that eminent economists such as Paul A. Samuelson are beginning to question the basic tenets of free-trade theory. Is it possible that David Ricardo's economic analysis doesn't work for the 21st century? Can the theory of comparative advantage operate when China and India compete not only with low-cost labor but also with highly educated, highly skilled workers who have access to broadband and the Internet? What is the U.S. supposed to specialize in when Asia competes across the board in manufacturing and services in both low-end and high-tech jobs? Is the future prosperity of America in jeopardy?

BusinessWeek answered the final question in the negative, but many with the opposite view embraced Samuelson’s contribution as intellectual support, without understanding what it really said. The headline of the Pittsburgh Post-Gazette on September 23, 2004 put the reaction succinctly: “Nobelist Samuelson says Outsourcing May Not Be a Plus.”

Samuelson’s paper, which was eventually published in the Summer 2004 issue of the Journal of Economic Perspectives, showed that technical progress in a developing country such as China had the potential to reduce welfare in the United States. As the above quotations illustrate, outside the economics profession, this work was viewed as providing a rebuttal to those who had claimed that trade, globalization, outsourcing, and related phenomena would benefit Americans. The idea that this was a rebuttal appears to have been spurred by Professor Samuelson himself in discussions with journalists (as recounted in turn to us). The actual point of the paper, however, was that changes in China that led to less trade would lower U.S. welfare—a development that came about because the United States was losing some of the benefits it derived from free trade in the first place!

As explained by Bhagwati, Panagariya, and Srinivasan (2004) and in more detail by Panagariya on his website, Samuelson’s paper involved three stages. First, starting from autarky, China and the United States open up to trade and experience the usual benefits of trade based on comparative advantage. Second, China has a productivity gain in its export good, which improves the U.S. terms of trade and further benefits the United States. Samuelson’s third stage (or second “Act” as he put it) involves a Chinese productivity gain in its import good. This narrows the differences between the countries and thus reduces the scope for trade, potentially so much that all trade disappears. As trade diminishes, so too do the gains from trade.

As Panagariya points out, the potential for productivity changes to reduce the gains from trade has long been understood (Panagariya has Harry Johnson teaching this at the University of Chicago in the 1950’s). The harm in Samuelson’s setup comes from having less trade, not more. This is light-years removed from the usual concerns of people about globalization giving rise to too much economic integration, not too little. Dixit and Grossman (2005) further point out that the U.S. terms of trade if anything have improved since 1990, rendering moot even Samuelson’s theoretical scenario. And in any case, all of this has nothing to do with outsourcing, despite strained interpretations of such by Samuelson.

The underlying substance was largely lost in media discussions of Samuelson’s paper. One possible reason is that the Journal of Economic Perspectives published Samuelson’s cryptic paper by itself and then the explanation and gentle rebuttal by Bhagwati, Panagariya, and Srinivasan only later, in the Fall 2004 issue. This issue of the journal, however, came out after the November election, when media attention to outsourcing had fallen off from the pre-election peak.