Global economy
David Ricardo (1772–1823)
433 BCE The Athenians impose trade sanctions on the Megarians in one of the first recorded trade wars.
1549 John Hales, an English politician, expresses the widely held view that free trade is bad for the country.
1965 US economist Mancur Olson shows that governments respond more to the appeal of a concentrated group than one that is more dispersed.
1967 Swedish economists Bertil Ohlin and Eli Heckscher develop Ricardo’s trade theory to examine how a comparative advantage might change over time.
The ideas of the renowned 18th-century British economist David Ricardo were clearly shaped by the world he inhabited and by his personal life. He lived in London, England, at a time when mercantilism was the dominant economic view. This held that international trade should be heavily restricted. As a result governments introduced policies that aimed to increase exports and decrease imports in an attempt to enrich the nation through an inflow of gold. In England the policy dated back to Elizabethan times. Ricardo thought that in the long run such protectionist policies were more likely to restrict the ability of the country to increase its wealth.
"The diminution of money in one country, and its increase in another, do not operate on the price of one commodity only, but on the prices of all."
David Ricardo
Ricardo was particularly concerned by the introduction of a British tax known as the Corn Laws. During the Napoleonic Wars (1799–1815) it was not possible to import wheat from Europe so the price of wheat in Britain had risen. As a result of this price increase, many landowners increased the proportion of their lands dedicated to growing crops. However, as the war began to falter in 1812, the price of wheat fell back. As a result, the landowners—who also controlled Parliament—passed the Corn Laws at the end of the war in 1815 to restrict the importation of foreign wheat and place a “floor,” a bottom price, on grain.
The laws protected farmers but also pushed the price of bread beyond what poorer people could pay at a time when newly returned soldiers and sailors were unable to find work.
Ricardo vigorously opposed the Corn Laws, despite being a wealthy landowner himself. He claimed that the laws would make Britain poorer, and developed a theory that has become the mainstay for all those wishing to justify free trade between countries.
In 1819, a crowd of 80,000 gathered in Manchester, England, to protest against the Corn Laws, which kept the price of wheat high by limiting imports. The protest was brutally suppressed.
Adam Smith had pointed out that the climate differences between Portugal and Britain meant they would benefit from trade. A worker in Portugal could produce more wine than a worker in Britain, who in turn could produce more wool than a worker in Portugal. Any person or state able to produce more per unit of resources than a competitor is said to have an “absolute advantage.” Smith said that both Britain and Portugal would profit most by specializing in what they did best and trading the surplus. Ricardo’s contribution was to extend Smith’s argument to examine whether countries would benefit from specializing and trading when one party had an absolute advantage in both goods. Would it be worth trading if one country could produce both more wine and more wool per worker than the other country?
Another way of looking at this is to consider whether a person who is better at making both hats and shoes than someone else should split his time between the two jobs or choose one job and then trade with the less-skilled worker, who makes the other product (see diagram). Suppose that the superior worker is 20 percent better at making hats, but 50 percent better at making shoes—it will be in the interest of both of them if he works exclusively at making shoes (the product he really excels in), and the inferior man works in making hats (the product he is least bad at making).
The logic behind this argument has to do with the relative costs of making a product in terms of the amount of production time taken or lost. Because the superior worker is so good at making shoes, the cost of his making hats is high—he would have to forfeit a lot of valuable shoe production. Although in absolute terms the inferior worker is worse at making shoes and hats than the superior worker, his relative cost when making hats is lower than for the superior worker. This is because he forfeits less shoe production per hat than the superior worker would. The inferior worker is therefore said to have a “comparative advantage” in hats, while the superior worker has a comparative advantage in shoes. When countries specialize in goods for which they have a comparative advantage, more goods are produced in total, and trade delivers more and cheaper goods to both nations.
Comparative advantage resolves a paradox highlighted by Adam Smith—that countries that are inferior at producing goods (they are said to have an “absolute disadvantage” in them) can nonetheless export them profitably.
What determines comparative advantage? Swedish economists Eli Heckscher and Bertil Ohlin argued that it comes from countries’ relative abundance of capital and labor. Capital-rich countries will have a comparative advantage in capital-intensive products such as machines. Labor-rich countries will have a comparative advantage in labor-intensive products such as farming goods. The result is that countries tend to export goods that use their abundant factor of production; capital-abundant nations such as the US are most likely, therefore, to export manufactured goods. Heckscher and Ohlin’s analysis led to another prediction. Not only would trade tend to reduce the differences in prices of goods in different countries, it would also reduce wage differences: the specialization in labor-intensive sectors by labor-abundant economies would tend to push up wage rates, while an effect in the other direction would be seen in the capital-abundant country. So despite the overall increase in the short run, ultimately there may be losers as well as winners, and consequently opposition to the opening up of trade.
The cries for protectionism are as loud today as they were in Ricardo’s time. In 2009, China accused the US of “rampant protectionism” for imposing heavy taxes on imported Chinese car tires. The decision to increase tariffs came after pressure from US workers, who had seen tire imports grow from 14 to 46 million from 2004–08, reducing US tire output, causing factory closures, and creating unemployment. However, the US had previously accused China of unfairly subsidizing its own tire industry, so tensions mounted. China’s response was to threaten retaliatory increases in import taxes on US cars and poultry.
Tariffs produce effects that ripple through economies. Any protection gained for US tire producers from the tariffs on tires, for example, was counteracted by other negative impacts. Higher tire prices increased the costs of US cars, making them less competitive and reducing the numbers bought by US consumers. The retaliation by China also damaged US export industries. The jobs of some US tire workers may have been saved, but in the wider economy many more jobs were lost.
The increased importation of tires from China led the US to impose trade restrictions in 2009. This, in turn, led to a full-blown trade battle and a deterioration in diplomatic relations.
The US economist Mancur Olson has helped to explain why politicians continue to impose policies that are likely to damage the overall economy, even though the costs are widely known. He points out that those against the tariffs—a small number of large domestic producers and their workers—suffer a visible impact from cheap imports. However, the potentially larger number of consumers who have to pay higher prices because of tariffs and those workers in affiliated industries who might lose their jobs through connected impacts are dispersed around the economy.
Today, most economists support the basic Ricardian position on trade and, in particular, believe that it helped today’s industrialized countries. US economists David Dollar and Aart Kraay have argued that over the last few decades trade has helped developing countries to grow and reduce poverty. They claim that the countries that cut their tariffs have grown faster and have seen less poverty.
Other economists have questioned whether trade always helps developing countries. The US economist Joseph Stiglitz argues that developing countries often suffer from market failures and institutional weaknesses that might make a too rapid liberalization of trade costly for them.
There are also contradictions between theory and practice. When the government of India removed tariffs on imports of cheap palm oil from Indonesia, for instance, it had the positive effect of raising the living standards of hundreds of millions of Indians, in line with Ricardo’s theory, but it destroyed the livelihoods of 1,000,000 farmers who grew peanuts for oil, which was now passed over for palm oil. In a perfect Ricardian world the peanut farmers would simply transfer into the production of other goods, but in practice they can’t because their investment in capital is immobile—a machine that processes peanuts has no other use.
Ricardo’s critics argue that in the long run these kinds of impacts might hamper the industrialization and diversification of poorer countries. Moreover, although rich industrialized countries became successful traders, they did not practice free trade when they were first developing. How countries build up comparative advantage over the long run may be more complex than Ricardo’s model suggests. Some argue that Europe and then later the Asian Tigers built it up through trade protection in which skills were developed before trade opened up.
Goods made in Asia are transported to Western countries in vast container ships. It is estimated that 75 percent of goods in a typical US shopping cart are exported to the US from Asia.
Considered one of the world’s greatest economic theorists, David Ricardo was born in 1772. His parents moved to England from Holland, and at the age of 14 Ricardo began working for his father, a stockbroker. Aged 21, Ricardo eloped with a Quaker, Priscilla Wilkinson. Religious differences between the families resulted in both sides abandoning the couple, so Ricardo started his own stockbroking firm. He made a fortune betting on a French defeat at Waterloo (1815) by buying English government bonds. Ricardo mixed with notable economists of his day, including Thomas Malthus and John Stuart Mill. He retired from the stock exchange in 1819, and became a member of Parliament. He died suddenly of an ear infection in 1823, leaving an estate worth more than $120 million in real terms today.
1810 The High Price of Bullion
1814 Essay on the Influence of a Low Price of Corn
1817 On the Principles of Political Economy and Taxation