Celebrating or regretting 200th anniversary of Ricardo’s idea of comparative advantage?

It was on 19 April 1817, Ricardo proposed the idea of comparative advantage.

Prof Douglas Irwin pays a tribute:

No extension of foreign trade will immediately increase the amount of value in a country, although it will very powerfully contribute to increase the mass of commodities, and therefore the sum of enjoyments.” With these words, David Ricardo opened his famous chapter on Foreign Trade in his book On the Principles of Political Economy and Taxation, published two hundred years ago on 19 April 1817.

The publication of Ricardo’s book deserves special notice because in it he set out, for the first time, the theory of comparative advantage. Ever since, the idea of comparative advantage has been an essential part of every economists’ intellectual toolkit.

The key idea behind comparative advantage is that every country, no matter how advanced or behind it might be in the productivity of its labour compared to other countries, would be able to engage in beneficial trade with others. A country with a productivity advantage over other countries would not export everything, but only those goods in which it had a comparative advantage. Thus, paradoxically, an advanced country would find it advantageous to import goods even if it could produce those goods more efficiently than other countries. Conversely, countries behind the technological frontier without an ‘absolute’ productivity advantage in anything (in comparison with others) could still export goods in which its comparative disadvantage was the least and import goods in which its comparative disadvantage was the greatest – and benefit from doing so.

Ricardo was deeply insightful in making this point, but his way of explaining the idea was not exactly lucid and easy to understand. Using a somewhat convoluted numerical example, Ricardo described how England and Portugal, producing cloth and wine, could both gain from exchange because it takes 100 workers to produce cloth in England and 120 workers to produce wine, and … well, you get the picture.1 In trying to keep track of all the labour requirements and exchange ratios, any layperson reading Ricardo would more likely come away more confused than convinced about the merits of trade. As George Stigler (1982: 58) once quipped: “The import this layman is likely to embrace is not the English theory of free trade but a bottle of Portuguese wine.”

🙂

However, I don’t agree with this bit. Prof Irwin says this idea is difficult to understand for non-economists:

While often explained in a two-country, two-good context, comparative advantage is not just a very deep idea but one that is often difficult to understand. It was for this reason that Paul Samuelson (1972: 683), when challenged by the eminent mathematician Stanislaw Ulam to name one proposition in the social sciences that was both true and non-trivial, thought of the theory of comparative advantage. In a beautiful essay “Ricardo’s Difficult Idea”, Paul Krugman examined why non-economists have such a hard time grasping the implications of trade based on comparative advantage, aside from the inherent difficulty of the concept. The reason, he concluded, is not just that many people fail to understand the positive-sum nature of trade, wanting instead to view it in the context of an international rivalry based on zero-sum competition. Equally important is that many ancillary assumptions that economists take for granted (labour mobility, full employment, flexible wages and prices, balanced trade, and so forth) are needed for it to fully make sense.

Actually trade is something so fundamental to us. The other day I heard a beautiful story about how my nephew trades with fellow students in his class. He is just 9 year old and the word economics is far away from him. But trade isn’t. Infact the blame is on economists for complicating the idea of trade to such an extent that we don’t understand something so close to our existence.

Infact, David Bordaueax of Cafe Hayek Blog says it is regrettable that Ricardo introduced comparative advantage using example of international trade:

It’s regrettable that David Ricardo introduced the principle of comparative advantage in the chapter of his Principles titled “On Foreign Trade” and used for his illustrative example two countries – England and Portugal – as the two trading parties. In fact, comparative advantage exists at the level of the individual producer – worker or firm – and not originally or in any unique way at the level of the country. Whatever comparative advantage we might sensibly speak of a country having is nothing other than the composite comparative advantages of the producers within its borders. (When I teach economic principles, the very first piece of formal economic analysis that I share with my students is the principle of comparative advantage. I use this principle to reveal an essential part of the reason why individuals specialize and trade – and, so, in my example the two specialists are individuals, not countries.)

As I’ve argued before, I suspect that the world would be a better place had there never been a specialty in economics called “international trade.” The existence of such a specialty conveys the mistaken impression that there is something unique about the essentials of international trade compared to purely domestic trade. But no such uniqueness exists.

For another example, consider that the same reciprocal demand, or “offer,” curves that every student of international trade encounters can be used with no less validity and good effect to explain trade between blue-eyed people and brown-eyed people of the same country as they can be used to explain trade between the people of the United States and the people of Guatemala.

Alternate views on economics are so important. We just know and follow Ricardo side of the story but seldom discuss its limitations. Blame it on utter neglect of history of economic thought.

In sum, we can appreciate Ricardo’s effort and contribution to economics for suggesting the concept/idea of comparative advantage. But at the same time Ricardo and the subsequent followers have made the idea so complicated that we don’t understand that all we are talking about is trade…

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One Response to “Celebrating or regretting 200th anniversary of Ricardo’s idea of comparative advantage?”

  1. Jorge Morales Meoqui (@MoralesMeoqui) Says:

    Ricardo’s numerical example is not that hard to understand, once one leaves behind most of the wrong things that have been said about it, and reads it without prejudgement:

    https://www.worldeconomicsassociation.org/files/journals/economicthought/WEA-ET-6-1-MoralesMeoqui.pdf

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