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Getting Comparative Advantage Right

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In the latest issue of Economic Affairs (gated), I have a new, academic-ish article on comparative advantage. It’s titled “The disadvantage of misunderstanding comparative advantage: a response to Sherman Xie [2].” I wrote it in response to what I believe to be Prof. Xie’s misunderstanding of the principle of comparative advantage and of this principle’s role in the case for a policy of free trade.

Here are two slices:

1 | INTRODUCTION

Somebody or other is always trying to show that the Law of Comparative Cost is valid only under the simple assumptions upon which it was originally formulated. But we shall demonstrate that this is not so and that the simplifications merely help the exposition without affecting the essentials of the matter.

(Gottfried Haberler, 1936)

Haberler’s complaint about attempts to discredit the principle of comparative advantage (what Haberler called the ‘Law of Comparative Cost’) is as valid and relevant today as when he first issued it. Correctly perceived to be a key component of economists’ positive analysis of international trade – and, hence, central to economists’ normative case for free trade – the principle of comparative advantage has been regularly battered by those who wish to promote protectionist policies.

Just the past quarter‐century has witnessed the likes of Sir James Goldsmith (1994), Charles Schumer and Paul Craig Roberts (2004), Ha‐Joon Chang (2009), Ian Fletcher (2011), and Dani Rodrik (Bolotnikova, 2019), among others, assert that comparative advantage applies only under highly unrealistic circumstances and, thus, ought to be jettisoned from its central role in the economic analysis of trade. If so jettisoned, the economic case for free trade would indeed be weakened.

…..

Comparative advantage is not a theory in desperate search for real‐world relevance. Quite the contrary. The real world is, at each moment, filled with comparative advantages. The fact that explanations of the principle of comparative advantage typically use simplifying assumptions in order to make these explanations more tractable and understandable does not mean that this universal principle applies in reality only under these simplifying assumptions. Nor do theoretical demonstrations of the possibility that protectionist policies might yield net social benefits undermine the principle of comparative advantage or the case for free trade that is built upon it.

Dr Xie’s analysis boils down to a seeming attempt to clear the way for industrial policy, including protective tariffs, by discrediting economists’ identification of a central feature of the reality of specialisation and trade. But by failing to properly comprehend the nature of comparative advantage, as well as the role that economists’ understanding of this principle plays in their support for free trade, Xie’s attempted justification of industrial policy, and his case for scepticism of comparative advantage, must be counted as a failure.

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