Ricardos Contribution to Foreign Trade

Ramberto Jr. Sosa Cueto

Submitted in Partial Fulfilment

Of the Course Requirements
For History of Economic Thought
ECO 505

Master of Arts in Applied Economics

Fall 2016
Table of Contents

Introduction................................................................................. 2
I. Ricardos Comparative advantage............................................3
II. Robert Torrens and James Mill influence.................................8
III. Critiques...............................................................................11
Conclusion.................................................................................. 14
Bibliography............................................................................... 15

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Introduction

This paper discusses David Ricardos main contribution to foreign

exchange. Overall, Ricardo made one important contribution to the case for

freedom of trade and Economic Thought: the comparative advantage. By

convention, is believe that Ricardo first introduces the principle of

comparative advantage in his Principles of Political Economy and Taxation

in 1817 (Rothbard). In particular, a country has a comparative advantage at

producing x good or service if it can produce it at lower opportunity cost

(the value of what is given up) than any other country (Library of Economics

and Liberty). Even more, the theory comparative advantage justifies why

free trade is beneficial for all nations. Specifically, it relies on the idea that

specialization is efficient to place emphatically the broader generalization

that free trade is in the best interest of all trading nations to increase welfare

(Prasch, 83).

Furthermore, the theory implies that poor nations should open their

markets and join the free trade regime to raise their living standards. Overall,

the WTO process of trade liberalization assumes that free trade is the key for

the global economic welfare maximization, based in the theoretical premises

of the comparative advantage. (Prasch, 83)

However, there is much controversy about the theory and the

assumptions behind it. Even more, there are doubts about its originality.

According to Rothbard, not only Ricardo did not originate this theory, indeed

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he had little interest in it. Ricardo devoted only a few paragraphs to the

comparative advantage in his work. Further, he argues that James Mill and

Robert Torrens were the ones really interested in the theory behind the

foreign exchange. (Rothbard)

For the purpose of analyzing Ricardos contribution to foreign trade,

this paper discusses the following: The Comparative advantage

development, the possible influences that contributed to his idea, the

contemporaries thought on the matter and some of the critiques.

I. Ricardos Comparative advantage

Robert Torrens, David Ricardo, James Mill and John Stuart Mill all made

contributions to formulating the comparative advantage. For a start, Ricardo

refined Torrenss idea, that a country may prefer to import a good that is

costlier to produce abroad, to prove that the law of value for domestic

exchange does not apply for international exchange. From the argument,

James Mill obtained the principle of comparative advantage. Indeed, Torrens

did not have any kind of theoretical body, and Ricardo was not aware of a

principle worth developing. Without a doubt, it was from Mills Elements of

Political Economy (1821), and the succeed works, that the theory manages

to get recognition among economist. However, the solid arguments are later

developed by Mills son, John S. Mill, in an essay published only in 1844. And

it was the convincing support for Ricardos original value claim. (Aldrich, 379-

380)

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 To illustrate, the first use of the term comparative advantage is found

in Chapter 19, paragraph 1, of Ricardos Principles of Political Economy and

Taxation (1817), portraying the inefficiency on a countrys foreign trade

caused by a tax on certain goods. While Torrens did not use the phrase until

1827, by the fourth edition of his work, an Essay on the External Corn

Trade (1815). Even more, the phrase had already taken up by James Mill

both in an article for Encyclopedia Britannica (1818) and his book, Elements

of Political Economy (1821). (Rose)

When Ricardo first illuminated on the importance of the principle in the

early 1800s, he deals with an issue left behind by Adam Smith in The

Wealth of Nations. In this work, Smith describes a person who specializes in

making bows and arrows, with more skills than any other, and trades them

for cattle and venison; by doing so he can get more cattle and venison than

if he went to the field to catch them. Later he moved the example from a

single person to a kingdom and finally a country. In his example, if a nation

can acquire a commodity cheaper by means of international trade than by

making it itself, they are better off buying it of a foreign nation with some

part of the produce by their own industry (In which they specialize in). This

type of advantage is known as the absolute advantage. However, In the

Principles, Ricardo rejected this argument. (Aldrich, 381)

As a matter of fact, Comparative advantage explains why a country

might produce and export something its citizens don't seem very skilled at

producing when compared directly to the citizens of another country. For

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example, in the past few years, India has become a major supplier of phone

answering services for the American market, even though their English

language skills are not uptopar. The apparent paradox is that the citizens of

the importing country must be even better at producing something else,

making it worth it for them to pay to have work done by the exporting

country. Amazingly, the citizens of each country are better off specializing in

producing only the goods at which they have a comparative advantage, even

if one country has an absolute advantage in producing each item. (Library

of Economics and Liberty)

Ricardo is the first economist to differentiate international trade from

a domestic trade. Theoretically, he demonstrates that foreign exchange is

not explained by the law of value as domestic trade. The contrast is based on

the assumption that labor and capital do not have the same mobility

between nations as they do domestically. The reasons for immobility of

capital is resume in fear, when the capital is no within the immediate control

of the entrepreneur, along with the displeasure of leaving one own country of

birth and connections, and entrusts himself with all his habits fixed, to a

strange government and new laws. (Schumacher, 82)

Nonetheless, both theories, absolute and comparative advantage,

converges to one point, the idea that free trade is in the best interest of all

nations. Also, both relies on the underlying principles of specialization, the

division of labor, and exchange. However, the comparative advantage

considers the opportunity cost in place of the cost per se.

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 Ricardo in his Principles explains comparative advantage with the

following paragraph:

Under a system of perfectly free commerce, each

country naturally devotes its capital and labor to such

employments as are most beneficial to each. This pursuit

of individual advantage is admirably connected with the

universal good of the whole. By stimulating industry, by

regarding ingenuity, and by using most efficaciously the

peculiar powers bestowed by nature, it distributes labor

most effectively and most economically: while, by

increasing the general mass of productions, it diffuses

general benefit, and binds together by one common tie of

interest and intercourse, the universal society of nations

throughout the civilized world. It is this principle which

determines that wine shall be made in France and Portugal,

that corn shall be grown in America and Poland, and that

hardware and other goods shall be manufactured in

England. (Ricardo, 7.11)

Thus, it implies that there are different goods that each country may

produce advantageously. In view of, a country by specializing on a specific

good may acquire the rest from the most efficient sources in the world in

exchange for the goods they efficiently produce.

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 Furthermore, Ricardo justifies his point of view with a hypothetical

exchange of cloth and wine, between England and Portugal. In his own

words, it goes at follows:

To produce the wine in Portugal, might require only the labor of 80

men for one year, and to produce the cloth in the same country, might

require the labor of 90 men for the same time. It would therefore be

advantageous for her to export wine in exchange for cloth. This

exchange might even take place, notwithstanding that the commodity

imported by Portugal could be produced there with less labor than in

England. Though she could make the cloth with the labor of 90 men,

she would import it from a country where it required the labor of 100

men to produce it, because it would be advantageous to her rather to

employ her capital in the production of wine, for which she would

obtain more cloth from England, than she could produce by diverting a

portion of her capital from the cultivation of vines to the manufacture

of cloth. (Ricardo, 7.16)

Under those circumstances, it possible that even when a country does

not have the absolute advantage, it can still have a comparative advantage

and thus engage in profitable foreign trade. Consequently, both nation end

up producing more and raising their living standards. Theoretically, Ricardo

demonstrates that free international trade is advantageous for both nations,

even if one nation has a lower productivity in all goods and the other nation

produces both goods more efficiently. This shows that absolute production

7
costs are insignificant internationally, only comparative production costs

matter. If the cost ratios are different in both nations, specialization and

trade will benefit both. (Schumacher, 85)

Additionally, In the example the trade it is inferred that trade does not

take place when the labor between countries are exchange at parity; if

Englands reduce its cloth so that its labor would be equal to that of

Portugals wine assignment, Portugal would pull back from the trade. Though,

Ricardo does not explicitly close this point. (Aldrich, 388)

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 II. Robert Torrens and James Mill influence

James Mill (17731836) and Robert Torrens (17801864) first

advanced conceptions with regard to the advantage of trade when they

wrote against W. Spences Britain Independent of Commerce (1807), a work

caused by the French blockade of Britain. Spence drew on the Physiocrats

(the economists) for his arguments. (Aldrich, 380)

Spence in his work said that blockade should no be a concern for the

Englishmen. Spence understood or thought that only agriculture was

economically important; the effect could be counteracted if English landlords

would spend all their income on consumption. However, Spences

conclusions were controversial. Consequently, inspiring the work of James

Mill, who reviewed critically the Britain Independent of Commerce in the

article Eclectic Review (1807), later transformed into his book, Commerce

Defended (1808). And secondly, exhilarating the first Robert Torrens book,

The Economists Refuted (1808). (Rothbard)

Mill and Torrens enforced the doctrine of the eighteenth-century rule

found in Considerations on the East-India Trade (1701) to oppose Spence

Argument. The idea shares similarities with Adam Smiths absolute

advantage. For instance, it agrees that import goods from foreign in

exchange for exports when the imported good would cost more to produce

within borders. However, this does not take into account the opportunity cost

and thus neither the comparative cost. (Aldrich, 380)

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 In any case, the arguments of Torrens and Mill differs. On one side, Mill

discusses the gain from opening trade. On the other side, Torrens the loss

from closing trade. Mills explanation for trade had its risk: his proposal of

the gain looks forward to his 1821 demonstration of comparative advantage

with an error. While Torrenss proposal looks forward to that in Ricardos

Principles In other words, Torrens and Mill partially developed Smiths

absolute advantage by evaluating the gain or loss involved in opening or

closing trade. Overall, Torrens did not develop the principle of comparative

advantage and Mills analysis was incomplete and contained errors. (Aldrich,

382)

However, Ricardos On the Principles of Political Economy and

Taxation (1817) was not policy oriented, like The Economist Refuted or

Commerce Defended. Nonetheless, the Principles has enough trade

matters, involving theory and taxation. Trade in the theory part is usually

associated with money as an imported commodity. In the taxation and

polemical parts. The eighteenth-century rule is worked but the Torrens

addition and the comparative advantage material appear in the chapter On

Foreign Trade. (Aldrich, 384)

Of the co-discoverers of comparative advantage, only Torrens argued

that he was involved. In Torrens third edition of the Essay on the Corn

Trade (1826) he describes how in his earlier work he demonstrated, that

goods importation happens, even when costlier in foreign countries than at

national. Under the premise of the comparative disadvantage of the offshore

10
capitalist in producing the imported goods, be less than the comparative

advantage of the inshore capitalist in producing the goods exported in

exchange. Even more, Torrens reprinted The Economists Refuted to

clarified how much it had of the theory. In his favor, In the fifth edition of the

John Stuart Mills Principles of Political Economy (1862) originally published in

1848 It acknowledges that he had a joint claim with Ricardo to the doctrine.

Mills recognition implied that the eighteenth-century rule was crucial in the

discovery. (Aldrich; 393, 395-396)

On the other side, It has been pointed out by Sraffa (1930) that James

Mill did not fully comprehend the gains from international trade because of

an error in his exposition that he attempted to remove in the 1826 edition of

his Elements of Political Economy (Ruffin, 13). Even more, Mills works

through many situations, following Ricardos example, but none of it implied

or refer with exchange equivalency (Aldrich, 390).

Whereas, In the 1826 edition of his Essay Torrenss claim is correct

only because Ricardos theory of comparative advantage proves it. Since

Torrens did not make the accounting of the factors of cost of production in

both countries of all goods involved in trade. In other words, it lacks the

comparison of ratios which is the core of the principle. Additionally, he left

out another key assumption of the theory, that factors of production must be

internationally immobile. Thus, Torrens cannot be given full credit for his lack

of theorems. (Ruffin, 9 & 11)

J. S. Mills Principles of Political Economy is embedded with the major

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breakthroughs of classical international trade theory. And it makes a tribute

to Ricardo as the person who has done most towards the subject. Though

comparative advantage development apparently was not among his goal, his

idea that the law of value for international trade is no the same as for

domestic trade revolutionized the theory. (Aldrich, 395-396)

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III. Critiques

The Neoclassical theory regarded as the orthodox economic theory

adopts the theory of comparative advantages and fitted it in the framework.

Its modern conception dominates the theories of international trade. Further,

the neoclassical economic tools show the premise that free international

trade is beneficial for all parties; utilizing tools such as opportunity cost,

production possibility frontiers, indifference curve and optimized production-

consumption equilibria in autarky. (Schumacher, 86)

At any rate, the assumptions behind the theory of comparative

advantage are questionable. For instance, the theory assumes the following:

1. Capital and labor cant cross borders (immobile internationally), 2. Trade

balance and adjustment mechanism, 3. Full employment, and 4.

International trade is analyzed under Certeris Paribus 5. Next, the

assumption discussion for the points. (Schumacher, 88)

1. International immobility of inputs

Even Ricardo was conscious that the international immobility was a

crucial factor in the comparative advantage framework. However, the claim

that workers and capital do not move across borders is not the case of the

twentieth-first century economy. Even at the end of the 18 th century when

Ricardo developed the principle, labor migration was economically possible.

On the other hand, capital with the decrease of transport and communication

costs have become mobile. In brief, the assumption that labor and capital

can not cross the border it is not a realistic assumption in the modern world.

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(Schumacher, 89)

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 2. Balanced trade and adjustment mechanism

In Ricardos analysis trade takes place as a barter. And the elemental

assumption behind it is the balance trade. Being that balance trade is a

must, every exchange influences international trade. Thus, an adjustment

mechanism requisite a rebalance trade when imbalance. If the value of

exports good is not equal to the value of imports good, there would be no

transformation process which converts comparative production differences

into absolute money prices differences. And since trade imbalances

predominate in the real world, it is impossible for the comparative advantage

to transform to price differences and so, there is no explanation for the

international trade flows. Even Krugman and Obstfeld (defenders of

comparative advantage) concede that a countrys foreign trade is balanced

almost never. Overall, the point of view is questionable. The quantity theory

of money, which Ricardo uses, assumes that money is neutral and oversight

the velocity of money. Indeed, in the real economy velocity is not constant

nor the quantity of money neutral, there is a positive correlation between the

quantity of money and inflation. Further, the adjustment mechanism via fixed

exchange rates or even floating exchange rates has theoretical weaknesses.

(Schumacher, 90-93)

3. Full employment

Another basic assumption is the full employment of labor and capital.

Without it, the theory of comparative advantage does not occur since it is a

necessary condition for the opportunity cost. If there is unemployment of

15
labor or capital, there are no opportunity cost, because it is possible to

increase the production in one good without the production decreasing of

another good. Under those circumstances, there is no measure of relative

costs of a commodity. Furthermore, the capital and labor underemployment

is a common and persisting condition phenomena throughout the economies.

In the same line, since money function as both storage of wealth and means

of exchange, there is no full employment of capital or labor. (Schumacher,

94)

4. International trade under Certeris Paribus

In Ricardos analysis It is assume that specialization and later trade

become advantageous because the innate differences among the trading

countries. These differences between countries are not influenced but remain

constants after trade started. In other words, the theory of comparative

advantage does no include dynamic gains that lead to technological

advances and productivity growth. It is argued that a theory of international

trade should include technical innovation and dynamic gains that

endogenous to trade, because in reality, the advance nations are defined by

characterized technical growth that leads to increase in the standard of living

and wealth, as well as the innate conditions. (Schumacher, 92-93)

Additionally, there are other critics, but does are more controversial. In

either case, the theory of comparative advantage is widely accepted in the

orthodox economics. Further, the government intervention is to blame for

the theory inconsistencies with the data. Such as tariffs and other trade

16
barriers. Thus, the discussion at one point turns out about free market

efficiency and laissez-faire. In the eyes of the neoclassical theory, the

comparative advantage is not uncontroversial. (Schumacher, 99)

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Conclusion

Altogether, the comparative advantage is one of the must noteworthy

narratives in the history of economic thought. The theory is one of the oldest

in the history of economic doctrines. In particular, it constructs over the idea

of specialization in order to prove that free trade is in the best interest of all

parties. In other words, international trade increases the economic welfare of

the country involves.

Furthermore, in the intellectual origin of the principle. Torrens did not

make the necessary theoretical contribution for the development the

comparative advantage. The theoretical framework that proves that the law

of value for international exchange is not the same as for domestic

transaction. However, many historians of economic thought consider that

Ricardo should share credits with two of his compatriot: James Mill and

Robert Torrens. Under the argument that the principle of comparative

advantage was not Ricardos main goal in his discussions within The

Principles of Political Economy and Taxation. On the other hand, Mill and

Torrens, were discussing the advantage of trade a decade earlier than

Ricardos Principle. However, the word comparative advantage, the

theoretical assumptions and demonstration belongs to Ricardo. Whereas, he

started the discussion or not.

Nonetheless, there is much controversy about the theory and the

assumptions today. Particularly, the theory assumes the following: 1. Capital

18
and labor cant cross borders (immobile internationally), 2. Trade balance

and adjustment mechanism, and 3. Full employment. All the earlier ones,

without a defense strong enough to promote agreement between the

different lines of thought.

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