Why Ricardo was wrong. Comparative Advantage - the historical fallacy

Why Ricardo was wrong Comparative advantage - the historical fallacy

Here is a quick summary of ‘Comparative Advantage' - the base theory of "Why international trade is a good thing".

Say Country A makes cars at :

1 car every 20 labour hours and 1 Bicycle every 3 labour hours - i.e. it's pretty good at making both.

Say Country B makes cars at

1 car every 200 labour hours and 1 Bicycle every 200 labour hours - i.e. it's pretty bad at making both.

Then, according to Ricardo,  it's actually a good idea for these two countries to trade.

To work out which country will end up making what, you look at the relative ratios of production within each country :

So Country A has a 1/20 car per hour to a 1/3 bike every hour ratio =  (1/20) / (1/3) = 3/20 = 0.15  -  i.e. 0.15 cars per bike

and Country B has a 1/200 car per hour to a 1/200 bike every hour ratio =  (1/200) / (1/200) = 1/1 = 1 - i.e. 1 car per bike. 

So, Country B is, internally, relatively better at making cars compared to how it makes bikes, than Country A.

The theory - neigh ‘Law' - of Comparative Advantage says : Country A should make just bikes and trade it's ‘excess bikes' for Country B's ‘excess cars' - that way everyone will be better off. 

The legal process of removing the trade barriers between these two countries will change this ‘Should' into a 'Will' - a market ‘Force', as the ratios shown above play themselves out into prices, so the car manufacturers in Country A will go out of business due to cheap imports and bike manufactures in Country B will go out of business for the same reason. 

That's essentially it - that's the intellectual driver behind International Trade Theory

Let me show you where the problems with this really are : First of all ‘Comparative Advantage' and the funny maths above is just a pseudo-sophisticated way of saying ‘Let's specialise'. Seen from this angle we can ask the question - 'Is specialisation always such a good idea ?'

- If you go to work in a cartoon style fat cat ‘greed is good' city firm and you see their portfolio and they have two Investments A and B. Say Investment A earns £23.50 per £100 a year and Investment B earns £19.87 per £100 a year. If you go to the boss and say "Hey I've got a great idea - let's sell the Investments we have in B and put the money in A. This way instead of earning £23.50 + £19.87 = £43.37 per £200 per year we could earn £23.50 + £23.50 = £47.00 per £200 per year ! If you say this your Fat Cat greedy ‘All I want is money, money, money" boss, he will sack you. Why ? - Well, all you are doing is a School Boy's 'Maths' question, you're not doing a Grown-up's 'Real-World' question. In reality you don't know that A earns £23.50 - it might have done so last year, it might have done so on average over the past few years - but in terms of the future, of what happens next, of what you get paid for - £23.50 is at best a rough number that might change a little or a lot. The way to look at it, is it's like you are going to the horse races. In the real World, you can't phone up and read yesterday's racing results to the bookies and say I want a back dated bet on yesterdays winning horses - or even just one result - and put all you money on the horse with largest odds after doing your school boy (MBA) maths to get the ‘correct' answer as to what the maximum is that you ‘should' win. If the bookie is quite sharp he'll be more than happy to recommend that you put all your money on the same long shot horse the next time it runs in a couple of days. The whole point is you don't have tomorrow's numbers to bung into your calculator to see what you should bet on... or invest in... or produce. To win in business or the horses you have to use common sense and think ahead using human intelligence and use sound ‘old fashioned', time-honoured principles - one of which is the idea of diversity - which is usually mentioned slightly negatively as "spreading the risk" as though it's only an insurance cost that reduces maximum returns as the price of increased survivability but it could equally be seen as a positive - engineers transferring skills and techniques from one industry to the next. Ok so yesterday's numbers and overgrown school boys with calculators - getting the ‘right answer' - just like yesterday's horse racing results have a use - but if you use yesterday's results ‘automatically' and let calculator boy run the show then you'll be fairly certain to end up in debtor's jail in short time. By lowering trade barriers and tariffs to encourage international trade based on the ‘Law' of comparative advantage (or in other words : I've got a great idea why don't we specialise and de-skill in industries we have quite a high level of expertise in - that we might even be the best in the World in because some foreign country is so bad at doing almost everything it's actually internally relatively better at doing this that we are), what happens is ‘yesterday's numbers' unconsciously and automatically, via the hidden hand of ‘the market', get used to arrange tomorrow's production. Comparative advantage leads to specialisation and, according to academic calculator boy, specialisation leads to higher returns, but according to ‘make real money in the real world and continue to make money in the real world' Big Fat Cat Greedy city traders it means idiotic instability. As said above, not only does specialisation lead to the loss of highly skilled industries as is, but when Mr highly skilled car maker has a fight with his boss and gets a job as a bike maker he can cross-fertilise some of the ideas he learnt in his former industry. Specialisation in one industry leads to increased ossification. Just because the ossification index is too complicated to for calculator boy to work out and so you won't see it the indexes in the national accounts or the WTO's publications does not mean that a) it does not exist and b) is not hugely important. Common sense - human thinking - says it is.

Secondly there is an assumption that ‘labour' is actually important in modern Industry so that if it takes 1 person to make 10 things then it takes 2 people to make 20 things. The comparative advantage bods have the Car workers in country A moving to the Bike industry and producing bikes at the previous rate of knots, so that with double the workforce now the output would be doubled. The reality is that if you have a secretary and asked her to sent out emails to 10 people and then later she needed to send out an email to 20 people - you don't (unless you work for local government) need 2 secretaries to produce twice the output - one click - from one labourer - will send a million emails with the same labour as to 1 person. What works for emails works for adding accounts numbers up on a spreadsheet - thousands of numbers can be added up in a second - the same second it'll take to add up only 2 numbers. Computerised production lines share quite a large element of this huge scalability factor and if the factories hadn't closed down in the West because of the ‘Law' of comparative advantage, then they might be an awful lot higher again. An accountant might say : "Why didn't I add up a 1000 numbers ? Because you didn't ask me to - not because of lack of ‘labour'. As I said it's not quite the same as with say making cars : "Why didn't I build 1000 cars today ? Because you didn't ask me to" but it's not far off - there are millions upon millions more cars the Japanese factories could have produced with minimal increase in labour force but they were limited from producing them because they were limited from selling them by the American and European import controls. For many things less complex than cars the scale is easily this high - I could type '1000' then 'Return' into my computer and a 1000 books, or a 1000 leaflets could be printed for virtually the same labour as one book or leaflet. As a ‘factor of production' labour could almost be defined now-a-days as a type of machine with the following properties: "Expensive, troublesome, highly inefficient at repetitive tasks but useful for tasks for which the repetitive output is so small that it's cheaper to use than the cost of setting up an automated process". That's why American shoe makers, made unemployed by Chinese imports, were never going to go to the Ford Factory to help "Double the production of cars" - Ford could double its car production if customers doubled their orders with little or no increase in ‘Labour' - indeed if the orders doubled and stayed doubled - it might be worth Ford's while to increase the automation of some of the tasks they used ‘human machines' to do and it's not inconceivable that a doubling of the car orders would - say after 5 years or so would actually result in a lower work force - Ford doesn't double its car production not because of labour limitations but because the Sales order aren't there. All "Labour productivity" is the ratio of Output/Labour. You could do a ratio of Output to CCTV cameras in the car park but it wouldn't prove that if I doubled the amount of cameras it would double the output.

With tariffs you have ‘average American Joe' paying say 20 % more for an American made car than he could have paid for a foreign car. But he gets to live in a country with a thriving advanced manufacturing base with all the social and industrial positive spin offs from that. Without tariffs ‘average American Joe' gets a slightly cheaper car at first but then lives in a country full of unemployed and unemployable drug addicts and former specialised tool makers and fathers who are now divorced and flip burgers for their rent money - while their fatherless feral kids now roam the streets with murderous rap lyrics in their head and weapons in their pocket - which means half the country is not safe to drive his 20% cheaper foreign car in as he'll get attacked at the traffic lights. And oh look the government now has to increase the sales tax and his income tax to pay for all the unemployed people and the war on Drugs... and Crime fighting... and... So after 30 years of the ‘Law' of Comparative Advantage,  he's driving a smaller foreign made car than his Dad's American made car from 30 years ago and wondering if there really very much practical Advantage to be had after all from the theory of Comparative Advantage... all for 20 % off - the ultimate quick buck. Mailto: Socrates2005@Live.co.uk  Discussion Forum : http://www.websitetoolbox.com/mb/glenis_devereux