Free trade economists are very fond of quoting David Ricardo’s (1772-1823) principle of Comparative Advantage, first expounded in his “On the Principles of Political Economy and Taxation” in 1817. Ricardo was one of our greatest economists, but his principle of Comparative Advantage, like much of modern mathematical economics, rested on shaky assumptions and thus had flaws even when it was first propounded (as Ricardo himself admitted). Ricardo’s principle of comparative advantage still gives its proponents status among economists and think tanks, but today, like most luxury beliefs, it immiserates ordinary people.
Ricardo’s principle of Comparative Advantage stated that in a free trade system (which he advocated), production of an item should be concentrated in the place which had the greatest relative cost advantage. Even if Britain was more efficient at producing everything than Portugal, with a 2 to 1 cost advantage over Portugal in producing wine, but a 3 to 1 cost advantage in producing cloth, then wine should be produced in Portugal and cloth in Britain. His example of incipiently industrial England selling cloth to Portugal in return for wine from the rural and impoverished Portugal worked well as far as it went. Cloth was cheaper in England, because it was already efficiently manufactured, whereas wine was cheaper in Portugal than in chilly England (1817 being closer than today to the Maunder Minimum in global temperature).
Even in his example, Ricardo noted that it only worked if capital would not move from England to Portugal, in which case it could set up cotton mills to use cheap Portuguese labor, and thereby undercut British cloth. Actually, Ricardo’s principle contained another fallacy as it stood: it treated labor as fungible. Thus, it did not take account of the specialist skills needed in textile making (or indeed, in wine making). In reality, my great-great-great grandfather “Gorge” Windle was even at the time Ricardo published in 1817 (probably – he was born in 1791) displaying special skills as a spindle forger that would not have been available in Portugal. A Portuguese blacksmith, without Gorge’s training and possibly his mechanized lathe (just coming into use), would not have been able to forge spindles of the necessary precision for textile machines to work properly.
Allow time to pass, and Ricardo’s apparently fixed trading relationships change. In the case of Portuguese wine, British demand was artificially inflated in 1817 because Britain had been at war with France for 22 years and for most of the century before that. Over the next half-century, two developments adversely affected Portuguese wine exports: (i) French exporters returned in numbers to the large and rich British market, naturally reducing Portugal’s market share of British consumption and then (ii) France discovered the virtues of marketing, in 1855 inventing its “appellation contrôlée” system by which the best Premier Cru French wines were deemed to be of a superior quality to all others, hence giving them “snob appeal.” Britain maintained its textile exports to Portugal for longer, but after 1900, with similar machinery in use worldwide, countries with lower labor costs (such as Portugal) were able to undercut the declining British textile industry. Thus, even in the 19th century, Ricardian comparative advantage was less solid and permanent than it appeared in Ricardo’s theory.
Ricardo’s comparative advantage also neglects the influence of geostrategic factors. In 1817, when Ricardo wrote, the world was artificially peaceful, with the Congress of Vienna two years earlier having settled differences between the major powers. Thus, especially for non-strategic goods such as cloth and wine, there was no strategic danger from allowing unlimited imports. Today, for strategically important goods that is no longer the case.
For example, China may be the cheapest source of rare earths, essential for much modern technology, largely because environmentalists have been allowed to run wild in the West, shutting down the inevitably dirty and mildly radioactive production from Western sources. However, everybody today recognizes (and should have recognized in 2010, when the problem was first identified) that the malign China cannot be relied upon to remain the sole significant source of supply for so essential an ingredient to our modern world. Hence other sources of rare earths must be developed, environmentalists must be sat upon firmly, and Ricardian comparative advantage must be ignored in that instance.
There is also a problem in any modern industry that is highly knowledge-based. That was apparent even in my 1817 example above; my ancestor Gorge had special skills that did not exist in Portugal. However, if cloth production were artificially diverted to Portugal with British “technical assistance” then Portuguese workers would have developed Gorge’s special skills, and since Portuguese wages were lower, Britain would eventually have lost its textile industry. Of course, in the 19th century such a loss took decades to occur; in the 21st century it can happen in only a few years.
Two recent examples of this come to mind. In the early oughts we were told that U.S. software companies were being intelligent by outsourcing the simpler portions of their tasks to India, because the more specialist software engineers in the United States had special capabilities (like Gorge) that Indian developers lacked. Of course, the Indian software producers quickly wriggled up the value chain and put the U.S. outsourcers out of business. The process took less than a decade.
In semiconductor hardware also, American companies set up joint ventures with Chinese companies in which they would share their technology (no, I can’t see Gorge showing the Chinese how to forge spindles)! This was profitable in the short-term, but the Chinese companies, no respecters of intellectual property, backward-engineered the U.S. secrets and then proceeded to sell their own hardware with U.S. intellectual property, their own lower labor costs and much higher volumes. Again, Ricardo’s principle of Comparative Advantage proved a hopelessly naïve approach to dealing with a quasi-hostile country with a large potential market, infinite reserves of much cheaper labor and no scruples.
Believing in Ricardo will gain you much respect among economists and think tanks; indeed, the ability to lecture and write convincingly in a way that outlines its beauties may get you a well-paid position with Washington’s Cato Institute. (This was named not after any of the Roman notables of that name, but after “Cato’s Letters” written by a couple of anti-Tory 1720s drunken scribblers, which would become influential among the less well balanced of the Founding Fathers but had no discernible influence in their own country, although one of the scribblers was bought out by Prime Minister Sir Robert Walpole with the appropriate sinecure of First Commissioner of Wine Licenses.)
Like other luxury beliefs – one thinks of climate change and “transgender rights” – Ricardoism is a mechanism for ensuring that the over-educated fashionably left maintain their foot firmly on the neck of the working classes. It mandates infinite profit-seeking outsourcing to the Third World of skilled manufacturing and service work previously undertaken in the United States. This inevitably involves those Third World employees being trained to compete with their previously much better paid American counterparts, who will suffer the fate either of wage immiseration or the unemployment line. The H1B visa scam, of which I wrote last week, then allows unscrupulous employers to import the Third Worlders to the United States at below-market wages, thereby eliminating any advantage the native-born might have had by being close to the world’s largest market.
Meanwhile the United States’ strategic position is undermined by losing its advantage in tech and eventually biotech, which require exceptionally skilled workers, while critical industry after critical industry is dominated by foreign countries who do not necessarily wish us well. The pretty fantasies of the Ricardoists are thus revealed as hollow, resulting over only the medium term in the immiseration of the U.S. workforce and the replacement of the relatively freedom-living global polity dominated by the United States by one dominated by authoritarians, for whom free speech, democracy and free association are laughable remnants of a vanished world.
Once U.S. economic and strategic power has been lost, even the overstuffed elites of the Cato Institute and other Luxury Believers may find themselves out on the street. Ricardo’s principle of Comparative Advantage will no longer be needed; it will have done its malign work.
-0-
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)