23 February: Free trade and protectionism
One of the most widely-accepted truisms of economics is that free trade is a good thing.
derives from David Ricardo’s notion of “comparative advantage,” which Nobel laureate Paul Samuelson
called “the most beautiful idea in economics.”
Elegant it is, but also simplistic and empirically limited.
The underlying idea is that if everyone specializes in what they are most efficient at, they will be able to
exchange with those who have different specializations to the benefit of all.
Notably, gains arise from trade even when one country or individual is more efficient than the other at
In other words, comparative advantage is distinct from absolute advantage.
find comparative advantage, it is necessary to do a cross-comparison of relative prices (which are
inherently comparisons, since they are relative).
Ricardo’s classic example considers a world with only
two products (wine and cloth), two countries (England and Portugal), and input into production (labor),
though the logic extends to more complex settings.
If a bolt of cloth requires seven English worker-days
or five Portuguese worker-days to make, while a cask of wine takes three English worker-days or one
Portuguese worker-day, Portugal can produce either good more efficiently.
In England, if there is no
trade, a cask of wine is worth
bolts of cloth, while in Portugal the cask costs only
cheaper in Portugal.
Meanwhile, a bolt of cloth costs
casks in England and 5 casks in Portugal, so
cloth is relatively cheap in England.
When the world opens up to trade, the Portuguese will produce wine
and the English will produce cloth, leading to aggregate gains.
For example, if the opening up causes 21
English workers to go from winemaking to cloth production and 10 Portuguese workers to move the other
way, total output of wine goes up three casks (Portugal produces ten more casks than before, while
England produces seven fewer, for a net gain of three) and that of cloth increases by a bolt (Portugal’s
production falls by two units while England’s increases by three).
Comparative advantage is silent about
the distribution of these gains: this does not tell us if England is any better off, or whether the winemakers
hoard all the extra production.
Ricardo only gives us a partial equilibrium.