If You Must Quote Ricardo on Free Trade, Try to Get It Right!

People who lead with ‘economics 101’ should take care to get their economics correct when chastising other economists for their failings. A case in point is David Sirota in the Huffington Post (6 May) in his: ‘Econ 101: How Free Traders Distort "Comparative Advantage"’:

"Alan Blinder has a very interesting op-ed in the Sunday Washington Post about "free" trade and job outsourcing. He has been attacked lately for being an economist who is actually pointing out that "free" trade may not be the perfect thing its fundamentalist proponents have been saying it is. Yet, Blinder still falls prey to one of the most insidious distortions that rationalizes "free" trade orthodoxy: the distortion surrounding "comparative advantage." Blinder, invoking "comparative advantage," writes:

"The basic principles of free trade that Adam Smith and David Ricardo taught us two centuries ago remain valid today: Just like people, nations benefit by specializing in the tasks they do best and trading with other nations for the rest."

“But here's the problem - Ricardo's "comparative advantage," which when it works does bring on beneficial specialization, isn't what's going on most of the time with "free" trade today.” U.S. Sen. Byron Dorgan (D-ND) … explains what the theory of "comparative advantage" is:

"Time and time again, companies decide that they can move their jobs to Mexico, China, Indonesia, or other countries to save costs and boost profits...Economist say it is just something called 'comparative advantage' in action [and cite] the theory developed by David Ricardo in 1815 [who] used an example of trade between England and Portugal...The English-Portugese example described a natural comparative advantage each has with respect to the raising of sheep and the growing of grapes. It has to do with the climate and the soil, etc."

Comment
Oh dear. I am not sure that US Senator Dorgan is right in his apparently appealing scientific argument (did his speech writer pay attanetion in his Economics 101 class?).

I have no comment on his political case against free trade – US politics is dominated now by the run up to the Presidential election and we can expect hyperbole and spin by the bucket load. Anyway I do not comment on another country’s politics; I only comment on my own country’s in my own country.

The Senator and David Sirota confuse ‘absolute advantage’ with ‘comparative advantage’, which is not surprising because many Econ 101 students do so as well, and the Senator or Sirota were not paying close attention when they, presumably, attended their 101 classes, however, long ago.

Adam Smith analysed absolute advantage: countries trading goods in which they have an absolute advantage (he quoted wines which do not grow well in Scotland’s climate) will both benefit from the exchange. This was based on specialisation in the sense argued in the article.

David Ricardo, on the other hand – as we economists are fond of saying – extended the absolute advantage case to the comparative advantage case. In this situation, countries gain from trade by trading goods in which they have a comparative advantage.

Suppose two countries both produce aircraft and home entertainment systems. Further Amex is better than Chungwa in producing aircraft and also better that Chugwa in producing home entertainment systems, but not by so much as it is in aircraft. In short, it is better than Chungwa at producing both of these goods.

Should they still trade? Ricardo’s comparative advantage theory says ‘yes’. Amex should produce aircraft and exchange them with Chungwa for its home entertainment systems, because they would both be better off. How so?

Amex should specialise in goods for which it has the highest comparative advantage over Chungwa (aircraft) and not devote resources to producing home entertainment goods, which though it is better at doing so than Chungwa, it is better by a smaller margin. Resources in Amex devoted to home entertainment production, in which it has a small comparative advantage over Chungwa, are better devoted to aircraft production, in which it has a much greater comparative advantage over Chungwa.

The Senator and Sirota appear not to understand Ricardo’s theory, though they both call it into play with the confidence of those who may not know what they are talking about.

If the above economic example is a bit difficult for current Econ 101 students (and for those not paying attention when they were in their classes), try this example of comparative advantage.

David Sirota is a very busy journalist and broadcaster. Let us imagine he is extremely busy, so much so that he is hard at work most of the time. Further, he is busy because he is in great demand as a talented professional journalist and broadcaster, as is obvious from his profile.

However, suppose he is also greatly talented as a PC and Apple user, so good at these tasks in fact that he has never met a secretarial assistant as good as him at preparing his articles and books for press. Now, good as the best of the secretaries he hires are, while some comes close to his own secretarial skills, none have bettered them. And none of them come anywhere near him in his ability to conceive of articles, themes for books, and do the creative part of his journalistic and broadcasting work.

Now, because he is much better than his secretarial staff at both journalism and broadcasting, for which customers are keen to pay him small fortunes a year, should he do his own secretarial work because he is better at this work by a small margin than the very best of the secretaries he can hire?

Surely not! David should concentrate all of his time on journalism and broadcasting for the high incomes it brings him and his family, and he should hire a secretary for his secretarial work. Diverting any of his scarce time to secretarial work, even though he could do it better than his secretary, would reduce his income by the time he spent away from journalism and broadcasting doing secretarial work what somebody else, while not as good as him, nevertheless is good enough for that job.

Why? Because his comparative advantage is highest in the work he does better than his secretary could do in his place, and it is smallest as a comparative advantage he has over his secretary in the work his secretary does in place of him.

That is the real meaning of the gains from trade in comparative advantage according to Ricardo, and it is quite different from the presentation David (and the Senator) put together under the guise of sarcasm about Economics 101 and false claims about ‘insidious distortion’. Read David's column here.

Methinks I hear somebody whispering something about ‘kettles and pots’….