The difference between the theory and practice of free trade - face masks edition

Free trade and comparative advantage have been articles of faith in Econ 101. 

Joe Nocera has an article about the fate of mask manufacturers in the US. The short story is that in the aftermath of the pandemic, several small businesses responded to the demand and calls for local manufacturing by establishing mask manufacturing facilities in the US. They flourished during the pandemic. Once the pandemic eased and prices fell, the Chinese competition returned and now threaten to drive them out of the market. 

This story repeated with Swine flu in 2009 and Covid 19 in 2020-21. 

Just weeks into the Covid-19 pandemic in 2020, the supply chain for protective equipment had broken down, creating severe shortages that cost lives. A black market emerged, full of con men and get-rich-quick schemers. A handful of U.S. entrepreneurs decided they would do their part by manufacturing masks... At first, customers who could no longer obtain masks through their normal supply channels were beating down their doors. The same was true during the Delta and Omicron waves, when masks were also scarce. But as soon as the waves crested, and Chinese companies, determined to regain their market share, began exporting masks below cost, the customers disappeared. “All the hospitals and government agencies and retailers that had been begging for American products suddenly said, ‘We’re good,’” said Mr. Hickey.

One important way to address this problem is by leveraging public procurement,

The government’s answer to this pattern is its own buying power. During his State of the Union address on Tuesday night, President Biden promised that the government would begin to rigorously enforce provisions in the law that call for the federal agencies to buy American-made goods whenever possible... resilience — that is, creating extra manufacturing capacity that can get the country through an emergency — is what the small mask makers say is their value to the country. Sure, they argue, a globalized, just-in-time supply chain for low-cost protective equipment is fine in ordinary times. But we’ve learned these past two years that the country needs domestic manufacturers if we hope to avoid terrible shortages during the next pandemic, and the one after that. But how do you create that resilience? The federal government spent $682 billion buying goods and services from contractors in 2020, according to Bloomberg Government. That’s the sum the Biden administration wants to use to buy American products.

This approach would stand in contradiction to the principles of Econ 101. 

The mask manufacturers are a microcosm of a larger problem. Today, there are shortages that go well beyond personal protective equipment. Things as diverse as semiconductors and garage doors are in short supply — all products whose manufacturing was offshored during the past decades as American companies embraced just-in-time supply chains and inexpensive foreign labor. Economists and corporate executives ignored resilience, and now the country doesn’t have a clear idea how to create it, even as its necessity has become obvious.

The idea and associated narrative around free trade endures despite very little evidence to support it. 

Some observations:

1. The theory of comparative advantage suggests that each country specialise in those goods and services in which they are best placed (compared to other things in the global consumption basket). But in reality, absolute advantage is what matters. A few countries are better placed than others in absolute terms to produce most goods better and cheaper. So these countries end up dominating the global production of most goods. 

2. In the globally integrated market, where the pool of consumption class is expanding continuously and will do so for a long time, the economies of scale just keep rising. This means that once a country entrenches itself in a few products it develops the backward and forward linkages to expand production and supply of the same goods and services as well as similar products at a far cheaper marginal price than any new entrant.

3. Such concentration of production trades-off against resilience and risk diversification, a point that became egregiously manifest during the Covid 19 pandemic. Overlooking all other factors, purely on resilience grounds alone, there is a strong case for ensuring at least a certain share of local production on many things. At the least, there should be an effort to diversify production across multiple locations. 

4. Amplifying all these trends is the dynamic of capitalism, which elevates profit maximisation above all else. Similarly, for the median (and vast majority of) consumers, price considerations trump all else. 

The net result of all this is an inexorable dynamic where the first mover who captures the market ends up keeping the market for a long time (till something unexpected happens and something shifts). 

Update 1 (23.07.2022)

A comparable story of mask manufacturers in India struggling to compete with Chinese competitors.