Ricardo's Theory of Comparative Advantage: The Least Understood Idea of Our Time

As long as people are free to pursue their own interests, and market prices are not artificially prevented from adjusting, they will tend to choose to specialize in what they have a comparative advantage in.

Opponents of those who advocate for private property rights and free markets often call them social Darwinists who wish to exterminate the weak for the benefit of the strong. However, under capitalism, both groups gain and virtually all survive better, including the weakest, without violating individual liberty, making it dramatically anti-Darwinian.

But opponents fail to see that the voluntary arrangements of the marketplace replace the jungle. Competition to create added wealth produces no real long-run casualties. There are only beneficiaries. But dog-eat-dog, “survival of the fittest,” social Darwinism rhetoric overlooks why that is true. And a substantial part of it is its misunderstanding of both absolute advantage and comparative advantage.

Absolute and Comparative Advantage

What would happen if workers from group B were exactly half as good at producing both good X and good Y as workers from group A. In that case, group B workers would presumably not be among “the fittest.” But would group A workers’ absolute advantage mean that group B’s workers starve? No. When wages are not prevented from adjusting, they will allow both groups to be productively employed.

If I am half as productive as you at everything, I still can still survive in the marketplace because at half of your wage, the cost of producing using me would be the same as producing using you. Where wages are prevented from responding to such different abilities, some adverse results can arise (as with $15 an hour minimum wage laws, that can overprice low-skilled labor and reduce their employment), but that is the result of overriding markets, not of allowing them to work.

When prices are allowed to adjust and trade is not artificially restricted, no workers are rendered unemployable.

If we change the example so that B’s workers were half as productive as A’s workers in producing good X, but only one third as productive in producing good Y, B’s workers still aren’t among the apparently fittest, as A’s workers still have an absolute advantage in producing both goods. But now B’s workers have a comparative (or relative) advantage in producing good X relative to A’s workers because they only give up two-thirds as much Y per unit of X they produce compared to A’s workers.

When prices are allowed to adjust and trade is not artificially restricted, no workers are rendered unemployable. Rather, both groups of workers can gain by having B’s workers specialize in the production of X (which they are relatively better at), some of which they trade to A in exchange for A’s production of Y (which they are relatively better at). In fact, in this case, B’s workers are the relatively fittest for X production in the marketplace even though they are absolutely less fit than A’s workers.

That is, in essence, what David Ricardo demonstrated with his theory of comparative advantage in 1817. Even if one country’s workers are less productive in making every good than another country’s workers, specialization according to comparative advantage combined with international trade can benefit both countries’ workers.

Both True and Non-Obvious

And it is an important idea to grasp. According to Deirdre McCloskey, when mathematician Stanislav Ulam challenged Nobel Prize winner Paul Samuelson to name a principle in the social sciences that was both true and non-obvious, his answer was, “Ricardo’s theory of comparative advantage.” And he continued,

[T]hat it is not trivial is attested by the thousands of important and intelligent men [and even women, dear] who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.

The social Darwinist criticism arises from the idea that only those who are absolutely the best at things survive, and others fall by the wayside. But that is not the reality of market competition. As long as people are free to pursue their own interests, and market prices are not artificially prevented from adjusting, they will tend to choose to specialize in what they have a comparative advantage in, even if they are absolutely worse at producing everything and cannot claim absolute advantage in anything.

Price adjustments in markets allow even those who are less capable in an absolute sense to survive rather than being weeded out. And as Sheldon Richman put it, “in the market, the less ‘fit’ don’t perish. They just make less money. That is no small consideration when comparing capitalism with other social arrangements.”

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