Realist, not conformist analysis of the latest financial, business and political news

To Get Ricardo’s Comparative Advantage Entirely Wrong

It is entirely true that David Ricardo illustrated comparative advantage using nations and national economies. England making cloth and Portugal making wine. But to think that the idea really refers to nations or national economies to to misunderstand, to get the idea entirely wrong in fact.

But varied protectionists still manage to do so:

If you want to stump a free trader economist, ask him or her what exactly a big, continental-sized economy like the USA’s ought to specialize in.

There are a number of answers to this, one obvious one being that what to specialise in is emergent from economic activity, not an input into the system.

But the far more important one is that there is no such thing as “a big, continental sized economy like the USA’s”. That is a reificiation and an incorrect one. The correct understanding is that there are a number of economic actors – some 360 million actually – who partake of varied economic activities within the continent sized borders of the United States. Many of them also, obviously enough, partaking in economic activity which crosses said borders.

The question what should the reification specialise in is a nonsense for the reification is not an economic actor. What we want to know is what should the economic actors specialise in?

This being logical for specialisation is an economic action and thus something that must be done by economic actors.

We can even explain this without reference to Ricardo or comparative advantage at all. Pure Adam Smith – increased wealth comes from the division and specialisation of labour and trade in the resultant greater production. OK. Now we’ve agreed that we should specialise and trade. That is, we people, we economic actors. Great – the relevance of the geographic location of those we specialise and trade with is what? Quite so, absent the usual calculations of transport costs their location is an irrelevance.

Or, to put it as simply as is possible, the economic argument in favour of trade is that “we all do the things we’re least bad at and swap the results”. Note that there’s nothing about geography or nations in that at all.

0 0 votes
Article Rating
Total
0
Shares
Subscribe
Notify of
guest

39 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
Spike
Spike
4 years ago

And the boots on the ground of this bad idea (picking a thing for the US economy to specialize in) is the delusion, from Trump’s tariffs to ex-Speaker Paul Ryan’s desire to essentially foist a VAT on us, that in this era of web pages we must revitalize the manufacturing sector. Farming is likewise a tiny fraction of its former size, but likewise produces more goods.

Leo Savantt
Leo Savantt
4 years ago

Surely the USA, or more accurately it’s populous, does specialise. Or don’t PC’s, operating systems, online platforms and microprocessors count as specialisation in IT?

Esteban
Esteban
4 years ago

perhaps the biggest flaw in their thinking(?) is that they assume that someone should or must provide direction to the economy or people. As opposed to allowing free people to make their own choices and living with the results, which it turns out, have been proven far superior to a planned economy

Gavin Longmuir
Gavin Longmuir
4 years ago

“Free Trade” is rather similar to the Anthropogenic Global Warming scam — a smidgen of truth pushed by zealots far beyond its limits. Yes, prosperity depends on specialization, which in turn requires trade. Note the implication — everyone is busy all the time doing what he does best, and production is maximized. Now look at reality — the denizens of Scunthorpe sitting on the dole producing nothing, while the UK imports its steel from China or Germany. Is economic production really being maximized? Hmmm! There are obviously more aspects to this “Free Trade” thing than are captured in the economists’… Read more »

Jim
Jim
4 years ago
Reply to  Tim Worstall

Only because idiot politicians have made it more expensive to produce steel in Scunthorpe than Shenzhen. The lack of competitiveness of Scunthorpe made steel has little to do with comparative advantage and everything to do with political meddling in regulation of businesses.

Pcar
Pcar
4 years ago
Reply to  Tim Worstall

@Tim W

I’d say Jim is at least half correct, especially when your oft promoted “Carbon Tax” and the Green subsidies making energy much more expensive factored in on top of excessive regulation.

Gavin Longmuir
Gavin Longmuir
4 years ago
Reply to  Tim Worstall

However, we do not maximize overall production by having workers sit idle on the dole in Scunthorpe. In the economists’ over-simplified model, those former steel workers in Scunthorpe are now producing other high-value items which are traded for Chinese steel. But in reality, those workers are completely unproductive, a drain on the rest of the community.

This is not an argument in favor of subsidizing inefficient producers — but it demonstrates that the economists’ simple “free trade” model is incomplete and flawed. We have to consider how to optimize the whole system, not just one little part of it.

Gavin Longmuir
Gavin Longmuir
4 years ago
Reply to  Tim Worstall

So there are no unproductive unemployed workers in Scunthorpe — or anywhere else in the UK? And the UK’s Balance of Payments is perfectly balanced? Come on, Tim! You are better than this. Don’t avoid the main issue.

Gavin Longmuir
Gavin Longmuir
4 years ago
Reply to  Tim Worstall

A day trader does not need to care about a Balance of Trade deficit, but a citizen of a country should care. Yes, Balance of Payments balances, because either (1) the country sells its crown jewels to the guys with the Balance of Trade surplus until there is nothing left to sell, or (2) the country issues IOUs which will be a burden one way or another in the future, or (3) the value of the country’s currency craters and all those imports which the country no longer makes are now too expensive. A large Balance of Trade deficit is… Read more »

Phoenix44
Phoenix44
4 years ago
Reply to  Gavin Longmuir

Your post is simply wrong. Why would I sell my crown jewels to finance somebody else’s imports? And as Tim has often pointed out, the size of any required crown jewel sales each year is utterly tiny compared to the creation of wealth each year – as it must be in an economy that might face the issues you describe. In a large, rich, developed economy, how could imports ever reach sufficient size to do what you claim? The economy must be crating huge wealth for domestic consumption.

Jim
Jim
4 years ago
Reply to  Tim Worstall

And what if there isn’t anything that adds value? Or at least not enough value to make a decent living? What then? Do we just condemn vast swathes of the West to being economic deserts, because of the god of ‘Free trade’? Personally I don’t want even more cheap tat from China at the expense of making places into economic hellholes in my own country. I’m not that selfish. This is the trouble with you ‘free trade’ zealots, you’re quite happy to condemn huge amounts of the West’s population to live on shitty minimum wage jobs or benefits, just so… Read more »

Jim
Jim
4 years ago
Reply to  Tim Worstall

“The free trade case is that the free trade version leaves us better off in aggregate. And if we think we should make the transfer then both the recipients and the taxed will be better off if we have the trade and then the transfer. Not the other method, stifle the freedom of the trade to gain the transfer indirectly.” Living a life on the dole in a shitty hollowed out former industrial town is not the same as living a life doing a job that pays a decent wage. Thats were you free traders lose it. You’re quite happy… Read more »

Jim
Jim
4 years ago
Reply to  Tim Worstall

“Someone has a lower income so the bloke can keep working in the factory.” And under your solution (tax the people doing well and give those not doing well free money) people lose out as well. They have to pay more taxes to fund the lives of those thrown out of work. So which is better – paying more taxes and having lots of people living sh*tty lives on welfare, or paying more for your goods and people having well paid jobs instead of welfare? And all this free trade is only ever imposed on the poorest (and lets face… Read more »

Jim
Jim
4 years ago
Reply to  Tim Worstall

“The free trade case is that the free trade version leaves us better off in aggregate. ”

But nobody lives in ‘the aggregate’. Thats where it all falls down……..and as the numbers negatively affected grow, the disparity between winners and losers gets ever greater.

Jim
Jim
4 years ago

“Or, to put it as simply as is possible, the economic argument in favour of trade is that “we all do the things we’re least bad at and swap the results”. Note that there’s nothing about geography or nations in that at all.” Apart from the fact that the reason some countries are ‘better’ at doing X or Y is entirely down the the imposition of legislative costs on one side that the other does not have. There is no ‘free trade’ when a factory in the US has to dispose of its waste in complicated and expensive ways, but… Read more »

Gavin Longmuir
Gavin Longmuir
4 years ago
Reply to  Tim Worstall

“always think about consumption” — Very Keynesian! But Keynes main point was production — if the worker did not produce something that hour, then that was lost production which could never be recovered. In the very particular circumstances of the Great Depression, it made sense to stimulate consumption — but implicitly consumption of goods produced within the UK. “Free Traders” miss the implicit assumptions in their simple model.

Jim
Jim
4 years ago
Reply to  Tim Worstall

“The best solution that maximises potential consumption”

Thats where you’re going wrong. The best solution is not one that purely maximises consumption, its one that maximises consumption AND people being able to be involved in the economic life of a nation. Making something a few pence cheaper for tens of millions of people at the expense of making thousands jobless is not my idea of the ‘best solution’.

Jim
Jim
4 years ago
Reply to  Tim Worstall

“The level of employment in a country is not determined by trade.”

Its weird then that life in places like Stoke which have lost employment to foreign made goods is so awful then. The raw unemployment stats also don’t take into account that a job in a factory that pays a decent wage a man can live on is not the same as a minimum wage zero hours contract job. All you ever look at is numbers, not people.

Snarkus
Snarkus
4 years ago
Reply to  Tim Worstall

Tim, really ? Here in Oz about 80% of the shutdown car industry workers have not worked again. In earlier decades the same figures appeared for clothing and textile workers. The others now have casual jobs or gave up and retired early. Not to mention the quality of imported clothing and footwear was and is dismal. That significant engineering skills have been lost also concerns some Australians. For much of Oz, imported cars mean either light trucks or very expensive conventional cars which don’t have the towing ability or range Oz made vehicles had. A few businesses have adapted, but… Read more »

jgh
jgh
4 years ago
Reply to  Snarkus

If the imported goods are crap, surely that’s a gap in the market for a domestic producer? Or any other producer.

Snarkus
Snarkus
4 years ago
Reply to  jgh

jgh. er, no. eg Try to buy a mobile phone that can be read in the sun. Original Bell Streak is the only affordable one found and it is old, old. The only phone I can find is the Cat ones which are expensive. Who needs infrared imaging capabilities when one just needs to be able to see a screen without finding a convenient cave, concrete or otherwise ? Likewise one can still buy Oz footware, but Oz $950 for a pair of boots is a bit much for farm use. As for cars, I just don’t have $150k in… Read more »

Snarkus
Snarkus
4 years ago
Reply to  Tim Worstall

problem there Tim, is that costs of production in say, China, do not have the pollution control costs somewhere in West must have. The locals producing cheap steel may not like the fouled air and water but have no choice. The comparative advantage assumed by free trade enthusiasts seems to ignore quality of life costs in cheaper producers. I do agree I cant see a way of sanely balancing setting quality of life tariffs to even out cost of production advantages where competing suppliers have different cost disadvantages due to humane concerns.

jgh
jgh
4 years ago
Reply to  Jim

No, the conclusions still apply. The costly regulations are just another input costs that is summed as a negative into the “what I’m good at” part of the equation, just as positives are summed into that “what I’m good at”, such as education, literacy, a common language.

Gavin Longmuir
Gavin Longmuir
4 years ago

Let’s stipulate that true (almost never seen) “Free Trade” would maximize total global economic production — which would be good. We still have to recognize that in the real world the distribution of the benefits of “Free Trade” within a country matter. When the bond trader in the City of London lives high on the hog with cheap imported goods while the resident of Scunthorpe sits unhappily on the dole, it is no surprise that many people come to see the supposed benefits of “Free Trade” as a lie.

Chester Draws
Chester Draws
4 years ago
Reply to  Gavin Longmuir

Yet the Scunthorpe resident on the dole still has a better lifestyle than the person producing the steel in China! (Don’t think just about wages, they also have better health care, roads, internet access etc.) That is because if we allow free trade we become much richer, in aggregate. We can then choose to redistribute the money so that the bond trader has to give some to those less fortunate. But in the end even the person on the dole does better. Social Democracy is the privilege of the wealthy countries, not the poor. The worst solution is to “fix”… Read more »

Gavin Longmuir
Gavin Longmuir
4 years ago
Reply to  Chester Draws

Chester — talking about everyone earning a similar amount is a straw man. The real issue is that the world is a much more complicated place than economists’ over-simplified little equations would suggest. We have to consider the human aspects as well as the theoretical aspects. A society can be richer “in aggregate” and be a much worse, much less stable place. To some extent, unbalanced “Free Trade” is analogous to the Tragedy of the Commons. For each individual business, it makes sense to offshore the manufacturing to China and the coding to India; but the overall effect when many… Read more »

JdL
JdL
4 years ago

Well stated.

jgh
jgh
4 years ago

Something that has to go hand in hand with trading that which you have best advantage at is that somebody must be willing to pay you for it.

I’d love to be paid for what I’m good at and enjoy doing, unfortunately, nobody is prepared to pay me to do it. So I cascade down through moderately good, average, passable, until I get to people prepared to pay me to do what I’m barely competent at and I continuously worry that somebody will find me out.

39
0
Would love your thoughts, please comment.x
()
x