Wednesday, September 2, 2009

A Quick Take on Ricardo’s Theory of Comparative Advantages.

Adam Smith’s famous analogy of the “invisible hand” was first articulated in regard to the superiority of the market in comparison with import tariffs to protect and augment the national economy. However, Smith’s discussion of the benefits associated with free trade between nations was limited to the theory of absolute advantage. Put simply, if another nation can produce a commodity more efficiently than your own, it is more advantageous to trade then to continue on with inefficient industry. It wasn’t until David Ricardo developed his theory of comparative advantages that free trade between countries came to be considered beneficial in a wider number of contexts. Even if there is no complementary absolute advantage, in terms of inverse production superiorities, Ricardo argued, it can still be more profitable for both parties to trade. The theory of comparative advantages, given its wider applicability, is often taken to be the strongest liberal argument in favour of free trade. Those opposed to the policy of free trade have to contend with Ricardo’s essential argument, updated and reiterated through the neoclassical paradigm.

An originator of the “neoclassical synthesis”, Paul Samuelson, has expressed the view that the theory comparative advantage is one theory which is true, but not immediately agreeable to intelligent observers of economic theory. Smith’s theory of absolute advantage appears manifestly self-evident, while the Ricardian model requires more explanation. Ricardo made the counter-intuitive argument that, even without absolute advantage, there is still an incentive for a nation to specialise its production and engage in international trade. For Smith, the inducement to trade was based on clear cut differences between productive capacities. He likened international trade to the transaction between a tailor and a shoemaker: if the tailor required new shoes, he is better suited to mend cloth and exchange a portion of his income for the shoemaker’s services, rather than attempt to make the shoes himself. For Ricardo, however, the inducement to trade can also be affirmed upon the basis of relative productivity. The classic example Ricardo used, was a two commodity model: trade between England and Portugal in cloth and wine.

In Ricardo’s example, Portugal has an absolute advantage in both the production of cloth and wine. In order to produce a standard quantity of wine, Portugal employ’s the labour of 80 men and for the same output England puts to work 120 men. England fares no better with cloth, to produce the set quantity of cloth she requires the labour of 100 men, compared to Portugal’s 90 men. According to the theory of absolute advantage, there would be no inducement to trade with England given Portugal’s superior productivity in both commodities. From the perspective of comparative advantage though, the motivation lies in relative productivity. If England were to specialize in the production of cloth, and Portugal in wine cultivation, both England and Portugal would make available 20 labours per standard unit of production, than if each had retained both wine and cloth production.

Without a doubt, Ricardo’s theory of comparative advantage is a clear advance upon Smith’s theory of absolute advantage. Nevertheless, doubt can be expressed as to if Ricardo’s theory is a conclusive argument in favour of free trade. The theory is limited in many aspects, two major flaws are that; the benefits of specialization are gained once, and therefore, Ricardo’s model neglects to calculate the long-term outcomes of economic restructuring, moreover, Ricardo assumed that capital was largely anchored to national economies, but in the current age of globalization (or perhaps, more accurately regionalization) capital is no longer fixed within national boundaries. These two concerns are related to the issue of economic power. One consistent criticism of free trade has been that it favours those with a dominant position in the international economy. The German economist Friedrich List went so are as to argue that, if free trade had been introduced in the heyday of the Hanseatic League, Germany and not Briton would have been the dominant economic power in the 19th century.

The history of industrialization and the experience of underdeveloped nation provide the context necessary to evaluate Ricardo’s theory of comparative advantages and the ostensive advantages of free trade. In light of his theory of comparative advantages, Ricardo recommended that countries specialize in the production of commodities that lead to an optimization of their labour productivity. In Ricardo’s example, Portugal had both an absolute advantage in wine and cloth, but given the ratios between Portugal’s and England’s productivity Portugal’s immediate advantage was to specialize in the cultivation of wine . Similarly, many nations endowed with great natural resources and therefore a comparative advantage in the production of agriculture and raw materials would be wise to specialize in such endeavours according to the theory of comparative advantage. However, as noted by H. W. Singer, there has been a tendency for the terms of trade for raw materials and agriculture to decline relative to manufactured goods. Specialization in agricultural production would provide an initial spurt of growth, but in the long run, such specialization would be inimical to the nation’s economic prospects.

Written by Mathew Toll.


Krugman, Paul R. and Obstfeld, Maurice. (2003), International Economics: Theory and Policy, sixth Ed, Boston; Addison Wesley.

List, Friedrich. (1885), The National System of Political Economy, Trans Sampson S. Lloyd, London; Longman, Greens and co.

Ricardo, David. (1933), The Principles of Political Economy and Taxation, London; J.M Dent & Sons LTD

Singer, H. W. (1950). "The Distribution of Gains between Investing and Borrowing Countries." The American Economic Review 4(2): 73-485.

Smith, Adam. (1991), The Wealth of Nations, London; Everyman’s Library.

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