The comparative advantage argument for free trade and its consequences
David Ricardo (1772–1823) put forward the idea that countries trade in order to gain from their comparative advantages. In his model, countries differed only in the productivity of their labour for producing different goods, and the country that was relatively efficient at producing something should export this good. So, for example, England should export cloth to Portugal and import wine. An important implication of this theory is that countries should trade even if they do not have an absolute advantage in the production of goods: it is not whether a country is better at producing something than another that decides whether or not it should export it, but whether it is relatively better in comparison with other goods. The argument relates to the concept of opportunity costs and is the same idea as that we met in Chapters 2 and 4 as one of the bases of pre-industrial growth. When population or the ‘extent of the market’ expands, specialization is possible. Trade allows the ‘extent of the market’ to cross international borders and for countries to specialize.
The concept of comparative advantage is often considered to be one of the most difficult to grasp in economics, and yet its understanding is crucial. In short, producing a good diverts labour from producing other goods, which are thus lost (the opportunity cost). Of course, in the absence of trade it is necessary to produce all goods, and this is unavoidable. However, with trade it is best for a country to focus on the goods it produces relatively well, because by so doing it can produce most. This extra output can then be traded for the goods it is relatively poor at producing and hence enhance the level of consumer welfare. This is the classic idea of ‘gains from trade’. A numerical example is given in the appendix.