Adam Smith, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, comparative advantage, David Ricardo, economics, economy, free trade, global economy, Ha-Joon Chang, innovation, On the Principles of Political Economy and Taxation, taxation, taxes, The Wealth of Nations, trade
“The same rule which regulates the relative value of commodities in one country, does not regulate the relative value of the commodities exchanged between two or more countries.
Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically: while, by increasing the general mass of productions, it diffuses general benefit, and binds together by one common tie of interest and intercourse, the universal society of nations throughout the civilized world. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England.
In one and the same country, profits are, generally speaking, always on the same level; or differ only as the employment of capital may be more or less secure and agreeable. It is not so between different countries. If the profits of capital employed in Yorkshire, should exceed those of capital employed in London, capital would speedily move from London to Yorkshire, and an equality of profits would be effected; but if in consequence of the diminished rate of production in the lands of England, from the increase of capital and population, wages should rise, and profits fall, it would not follow that capital and population would necessarily move from England to Holland, or Spain, or Russia, where profits might be higher.”
David Ricardo, writing in chapter seven of his seminal 1817 work The Principles of Political Economy and Taxation.
As is the case with many great scientific and philosophical theories, the law of comparative advantage looks so self-evident in retrospect. How did no one come up with this sooner?
Adam Smith was the first to roughly outline the notion of comparative advantage in international trade, writing in The Wealth of Nations, “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.” But Ricardo shaped Smith’s idea into a nuanced and workable economic model.
Using the example of England and Portugal, Ricardo situated the law in a practical context. In Portugal, Ricardo wrote, production of wine and cloth requires less labor than in England; however, clearly the relative cost of producing those two goods differ in each of the two nations. In Portugal, both are possible to produce, and produce with ease. In England, it is extremely difficult if not impossible to produce wine, but not so difficult to produce cloth. Thus while it is easier to produce cloth in Portugal than in England, it is more sensible for Portugal to produce excess wine, and hence trade it for a surplus of English cloth. This becomes a mutually beneficial relationship, given that England benefits from the trade as well. The price it requires to produce cloth has not risen, while it has gained the ability to procure a coveted staple (wine) which cannot grow from Anglo-soil.
The Korean development economist Ha-Joon Chang, in his book Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, explains Ricardo’s brilliance but also how Ricardian-style free trade negatively impacts economies which are, unlike the cases of Portugal and England, underdeveloped or relatively undeveloped in our modern world:
Before Ricardo, people thought foreign trade makes sense only when a country can make something more cheaply than its trading partner. Ricardo, in a brilliant inversion of this commonsensical observation, argued that trade between two countries makes sense even when one country can produce everything more cheaply than another. Although this country is more efficient in producing everything than the other, it can still gain by specializing in things in which it has the greatest cost advantage over its trading partner. Conversely, even a country that has no cost advantage over its trading partner in producing any product can gain from free trade if it specializes in products in which it has the least cost disadvantage. With this theory, Ricardo provided the 19th-century free traders with a simple but powerful tool to argue that free trade benefits every country.
Ricardo’s theory is absolutely right — within its narrow confines. His theory correctly says that, accepting their current levels of technology as given, it is better for some countries to specialize in things that they are relatively better at. One cannot argue with that.
His theory fails when a country wants to acquire more advanced technologies so that it can do more difficult things that few others can do — that is, when it wants to develop its economy. It takes time and experience to absorb new technologies, so technologically backward producers need a period of protection from international competition during this period of learning. Such protection is costly, because the country is giving up the chance to import better and cheaper products. However, it is a price that has to be paid if it wants to develop advanced industries. Ricardo’s theory is, thus seen, for those who want to accept the status quo but not for those who want to change it.