Here’s a letter to a long-time “proud Trump man” correspondent.
Mr. McKinney:
You ask my “opinion of Spencer Morrison’s critique of comparative advantage” (“Debunking Comparative Advantage,” April 21). Here’s my opinion: His critique is tired and tendentious.
Protectionists have for years seized upon David Ricardo’s assumption that capital is internationally immobile as reason to assert that, because in today’s real world capital is very mobile, comparative advantage no longer applies. Journal articles written decades ago exposed the fallacies that infect this alleged ‘proof’ that comparative advantage doesn’t apply in today’s world.
Were Ricardo alive today, he would recognize – in his example of England and Portugal trading cloth and wine – that if Portugal’s legal and economic institutions treated owners of capital with respect, enough English (or global) capital might flow into Portugal to give that country a comparative advantage at producing both wine and cloth, thus eliminating England’s comparative advantage as a cloth producer. But the great economist would also recognize that, because the amount of capital in the world isn’t fixed, as long as England remained hospitable toward investors, new capital would be created and invested in England to launch other industries at which she would have not only a comparative advantage, but a comparative advantage better for her than the one she lost in cloth-making. Ricardo’s (and Adam Smith’s, and Frédéric Bastiat’s, and Alfred Marshall’s, and Leland Yeager’s, and Vernon Smith’s, and Jagdish Bhagwati’s, and Arvind Panagariya’s, and Douglas Irwin’s, and every other competent economist’s) case for free trade based upon comparative advantage would continue to hold without qualification.
But just to show how utterly confused Morrison is, consider this passage:
Remember, in Ricardo’s example, Portugal had an absolute advantage in making cloth and wine. Therefore, the most efficient allocation of capital would be to make everything in Portugal and nothing in England—assuming that England could pay. If so, English industry should be offshored to Portugal, and England should run a trade deficit.
The unintentional hilarity of this passage goes beyond Morrison’s non sequitur of supposing that if Portugal gains a comparative advantage also in making cloth then England will make “nothing.” The real howler is Morrison’s supposition that the movement he describes of capital being shifted from England to Portugal would result in a trade deficit for England. Morrison apparently doesn’t grasp the elementary point that if a country experiences a net loss of capital it runs a capital-account deficit – and such a deficit is necessarily matched in that country by a current-account – or “trade” – surplus. It’s difficult to discern what goes on in a mind as confused as his, but Morrison seems to think that the English ship their factories physically to Portugal and that such a transaction would be recorded in the accounts as a sale by the English of assets to the Portuguese – and thus create an English trade deficit.
But if such sales and physical shipments were to occur, they would be recorded as English exports, thus causing England to run, not a trade deficit, but a trade surplus. (And, by the way, Morrison also fails to ask what the English might do with the funds they earn from these sales. He presumes, wrongly, that the English necessarily use these funds exclusively to pay for current consumption.)
One way textile-factory investments in Portugal would happen in reality is that the English would use some of the reals they earned by exporting to build textile factories in Portugal. This activity would be accounted as a net inflow of capital to Portugal and would give that country a capital-account surplus and a trade deficit, while the net outflow of capital from England would give that country a capital-account deficit and a trade surplus rather than, as Morrison asserts, a trade deficit.
There are several other possible ways that a Portuguese textile industry might arise alongside the Portuguese wine industry, including the Portuguese themselves increasing their domestic savings to get the funds to build the textile factories, but without having any impact on the either Portugal’s or England’s balance of trade.
Whatever the particular case, as long as individuals have different talents and tastes, mutually advantageous trade will be possible, both domestically and internationally. And this trade, if it is free, will be according to comparative advantage. As Gottfried Haberler observed in 1936, “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.”
Contrary to Morrison’s claim, the principle of comparative advantage, although discovered long ago by David Ricardo, is no less operative in today’s world than is the law of gravity, although discovered long ago by Isaac Newton.
Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030
