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Ricardo and comparative advantage at 200

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Summary:
The idea of comparative advantage is an essential part of every economists’ intellectual toolkit. On the 200th anniversary of the publication of “On the Principles of Political Economy and Taxation”, this column salutes David Ricardo’s achievement of setting out the theory for comparative advantage for the first time. “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.

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The idea of comparative advantage is an essential part of every economists’ intellectual toolkit. On the 200th anniversary of the publication of “On the Principles of Political Economy and Taxation”, this column salutes David Ricardo’s achievement of setting out the theory for comparative advantage for the first time.

“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.”

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.

In the 200 years since Ricardo set out the theory of comparative advantage, economists have built much more sophisticated models of international trade that draw on his basic framework. The Ricardian model has been extended from two goods to a continuum of goods (Dornbusch et al. 1977) and to a full general equilibrium setting with firm-level productivity (Eaton and Kortum 2002). Ricardo’s framework has endured as a workhorse model of international trade because of the malleability of its underlying structure and the timeless insights that it yields.2

Thus, on 19 April, the 200th anniversary of the publication of The Principles of Political Economy, let us all raise a glass of Portuguese wine to salute Ricardo for his magnificent achievement!

References

Chipman, J (1965), “A Survey of the Theory of International Trade: Part 1, The Classical Theory.” Econometrica 33: 477-519.

Dornbusch, R, S Fisher, and P Samuelson (1977), “Comparative Advantage, Trade and Payments in a Ricardian Model with a Continuum of Goods.” American Economic Review 67: 823-839.

Eaton, J, and S Kortum (2002), “Technology, Geography, and Trade.” Econometrica 70: 1741-1779.

Gehrke, C (2015), “Ricardo’s Discovery of Comparative Advantage Revisited: A Critique of Ruffin’s Account.” European Journal of the History of Economic Thought 22: 791-817.

Krugman, P (no date), “Ricardo’s Difficult Idea”.

Ruffin, R (2002), “David Ricardo’s Discovery of Comparative Advantage.” History of Political Economy 34: 727-48.

Samuelson, P (1972), The Collected Scientific Papers of Paul A. Samuelson. Volume 3. Cambridge: MIT Press.

Stigler, G J (1982), The Economist as Preacher and other Essays. Chicago: University of Chicago Press.

Endnotes

[1] John Chipman (1965: 480) remarked: “It does not seem to have been recognized that Ricardo’s own statement of the law is quite wanting, so much so as to cast some doubt as to whether he truly understood it; at best, his version is carelessly worded.” For further background on Ricardo’s discovery, see Ruffin (2002) and the critique by Gerhrke (2015).

[2] However, there have always been critics. Peter Navarro, the director of President Trump’s National Trade Council, recently told the National Association for Business Economics that “most of our profession, as well as much of the mainstream media, continues to embrace and espouse an antiquated Ricardian view of the world that has little to do with the events or risks of our time.” https://www.c-span.org/video/?424924-3/peter-navarro-outlines-trump-administrations-trade-policy-economic-policy-conference

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