Skip to main content

The russian economic crisis and comparative advantage

As the Russian economy heads towards tough times Putin seems to be pulling up the drawbridge. If Russia is going to prosper then, so the logic goes, it needs to rely less on foreigners and more on itself. This is a familiar nationalist argument that long pre-dates Putin. But it is one that economists have long tried to counter with the logic of comparative advantage.
        Simply put comparative advantage says that a country should produce what it is relatively good at. To give an example suppose that both a barrel of oil and a tablet computer sell for $100 on international markets. If it costs Russia $40 to produce a barrel of oil and $100 to produce a tablet then Russia should produce oil because this is where it has a comparative advantage. Crucially this logic holds even if Russians only want tablets. For instance, with $400 of cash they can produce 10 barrels of oil and trade these on the market for 10 tablets. Or, they can produce 4 tablets themselves. Clearly 10 tablets is better than 4. And pulling up the drawbridge is a bad idea.
        Analysts have also been quick, however, to criticise Russia for becoming too reliant on oil. And this does seem to make for an inconsistent argument. Comparative advantage says that a country should specialize, but then we criticize Russia for becoming over specialized! So, is there a flaw in the logic of comparative advantage?
        Comparative advantage says what a country should produce, not how well it will do producing it. The recent dramatic fall in the price of oil is clearly bad news for any country that specialized in oil. But the logic of comparative advantage still holds firm. To illustrate, let us return to the example above and say the oil price is $60 per barrel. With $400 Russia still produces 10 barrels of oil, which sells for $600 and buys 6 tablets. The purchasing power of Russians has dropped from 10 to 6 tablets but this is still better than the 4 tablets they can make on their own. There is no flaw in the logic of comparative advantage.
         So, where does the call for diversification come from? As far as I know there is no strong economic argument for diversification. The popular argument essentially seems to be specializing is 'too risky' because a country becomes vulnerable to shock. Many, for instance, worry that the UK is over-reliant on the financial services sector. But, risk is something that could be insured against, as evidenced by Norway's wealth fund. 
         I'm not convinced, therefore, that Russia's 'over-reliance' on oil deserves the criticism it gets. Specialising in oil is fine if that is where Russia has comparative advantage. For comparative advantage to really benefit Russians, though, the Russian economy needs a big scale market liberalization and associated reduction in corruption. There is not much sign of that happening any time soon! 

Comments

Post a Comment

Popular posts from this blog

Revealed preference, WARP, SARP and GARP

The basic idea behind revealed preference is incredibly simple: we try to infer something useful about a person's preferences by observing the choices they make. The topic, however, confuses many a student and academic alike, particularly when we get on to WARP, SARP and GARP. So, let us see if we can make some sense of it all.           In trying to explain revealed preference I want to draw on a  study  by James Andreoni and John Miller published in Econometrica . They look at people's willingness to share money with another person. Specifically subjects were given questions like:  Q1. Divide 60 tokens: Hold _____ at $1 each and Pass _____ at $1 each.  In this case there were 60 tokens to split and each token was worth $1. So, for example, if they held 40 tokens and passed 20 then they would get $40 and the other person $20. Consider another question: Q2. D...
Post a Comment
Read more

Nash bargaining solution

Following the tragic death of John Nash in May I thought it would be good to explain some of his main contributions to game theory. Where better to start than the Nash bargaining solution. This is surely one of the most beautiful results in game theory and was completely unprecedented. All the more remarkable that Nash came up with the idea at the start of his graduate studies!          The Nash solution is a 'solution' to a two-person bargaining problem . To illustrate, suppose we have Adam and Beth bargaining over how to split some surplus. If they fail to reach agreement they get payoffs €a and €b respectively. The pair (a, b) is called the disagreement point . If they agree then they can achieve any pair of payoffs within some set F of feasible payoff points . I'll give some examples later. For the problem to be interesting we need there to be some point (A, B) in F such that A > a and B > b. In...
Post a Comment
Read more

Prisoners dilemma or stag hunt

Over Christmas I had chance to read The Stag Hunt and the Evolution of Social Structure by Brian Skyrms. A nice read, very interesting and thought provoking. There’s a couple of things in the book that prompt further discussion. The one I want to focus on in this post is the distinction between the stag hunt game and the prisoners dilemma game.    To be sure what we are talking about, here is a specific version of both type of game. Adam and Eve independently need to decide whether to cooperate or defect. The payoff matrix details their payoff for any combination of choices, where the first number is the payoff of Adam and the second number the payoff of Eve. For example, in the Prisoners Dilemma, if Adam cooperates and Eve defects then Adam gets 65 and Eve gets 165. Prisoners Dilemma Eve Cooperate Defect Adam Cooperate 140, 140 65, 165 Defect 165,...
Post a Comment
Read more