Home > RWER > RWER issue 55: Ian Fletcher

RWER issue 55: Ian Fletcher

Dubious assumptions of the theory of comparative advantage
Ian Fletcher   [U.S Business and Industry Council, USA]

The theory of comparative advantage is the core of the case for free trade. However, contrary to orthodox myth, this theory is crippled by the dubious assumptions upon which it depends.

Review of the theory

To understand comparative advantage, it is best to start with its simpler cousin absolute advantage. The concept of absolute advantage simply says that if some foreign nation is a more efficient producer of some product than we are, then free trade will cause us to import that product from them, and that this is good for both nations. It is good for us because we get the product for less money than it would have cost us to make it ourselves. It is good for the foreign nation because it gets a market for its goods. And it is good for the world economy as a whole because it causes production to come from the most efficient producer, maximizing world output.

Absolute advantage is thus a set of fairly obvious ideas. It is, unfortunately, also false. Under free trade, nations observably imports products of which they are the most efficient producer—which makes absolutely no sense by the standard of absolute advantage. This is why one must analyze trade in terms of not absolute but comparative advantage. Boiled down to its essence, the often-misunderstood theory simply says this:

Nations trade for the same reasons people do.

And the whole theory can be cracked open with one simple question:

Why don’t pro football players mow their own lawns?

Why should this even be a question? Because the average footballer can al-most certainly mow his lawn more efficiently than the average professional lawn mower. The average footballer is, after all, presumably stronger and more agile than the mediocre workforce attracted to a badly paid job like mowing lawns. Yet nobody finds it strange that he would “import” lawn-mowing services from a less efficient “producer.” Why? Obviously, because he has better things to do with his time.

The theory says that it is advantageous for America, for example, to import some goods simply in order to free up its workforce to produce more-valuable goods instead. We, as a nation, have better things to do with our time than produce these less valuable goods. And, just as with the football player and the lawn mower, it doesn’t matter whether we are more efficient at producing them, or the country we import them from is. As a result, it is sometimes advantageous for us to import goods from less efficient nations.

This logic doesn’t only apply to our time, that is our man-hours of labor, either. It also applies to land, capital, technology, and every other finite resource used to produce goods. So the theory of comparative advantage says that if we could produce something more valuable with the resources we currently use to produce some product, then we should import that product, free up those resources, and produce that more valuable thing instead.

The whole of this paper may be downloaded at: http://www.paecon.net/PAEReview/issue55/Fletcher55.pdf

  1. December 18, 2010 at 9:47 am

    While Mr Felecher concentrated on the USA, the theory of comparative advantage is even more problematic and irrelevant when applied to the case of developing countries. There are a couple of other assumptions which drastically wrong in the case of developing countries. One is the assumption of full employment of resources, including labour. In practice developing countries have an army of surplus labour which can not be absorbed in primary commodities. Another assumption is the lack of influence of experience on cost, i.e.present cost has no influence on future costs-learning-by-doing does not influence costs of production. Yet more perfect competition prevails not only in the exporting country, but also elsewhere in the world. Thus there is no monopoly and oligopoly power of large TNCs which enjoy increasing return to scale and monoply poer in technology. Further, there is no uncertainty and risk involved in production and exportation and the necessary technology is freely available; countries are similar in all respects expect in factor endowments.

    Therefore, all in all this theory is a science fiction rather than a guide to development. Yet for the Neo-classical econonomists it is a”religion”!!

  2. Keith Wilde
    December 24, 2010 at 2:06 pm

    I have been reading a pre-publication version of Mr. Fletcher’s book and found it to be exhaustively researched and thoroughly persuasive. (Not accessible to me at the moment as I am in travel status.) A curiosity, however, is that there is no indication that expositions of this theme by Michael Hudson from as long as 20 years ago were influential or useful to the current author. Doubly curious given their simultaneous appearance in this issue of RWER.

  3. Tim
    May 8, 2011 at 4:37 am

    That’s quite a thought-provoking paper.

    I have some quibbles with some of the author’s arguments, but most of his points seem to be pretty valid.

    I do, however still believe that there are certain parts of the economy where we would benefit from more free trade rather than less. Protection of the sugar industry is one such example. Our climate is not suited for it, and the industry has destroyed large portions of the Florida Everglades. Importing it would be cheaper for consumers and better for the environment.

    Another quibble is this: The article says that “When America, for example, does not cover the value of its imports with the value of its exports, it must make up the difference by either selling assets or assuming debt. If either is happening, America is either gradually being sold off to foreigners or gradually sinking into debt to them. We are poorer simply because we own less and owe more.3”

    This conflates the trade deficit with the government’s budget deficit. The trade deficit by itself is not a “debt.” Although America happens to have both a trade deficit and a budget deficit, it is theoretically possible for the country to balance its budget and even pay down the debt without ending the trade deficit. Nor do we have to sell our assets to foreigners (we may if the price is right, but are never obliged to). This is because cash money is not a debt, and neither is it a limited resource as long as our printing presses are working. A bond is a debt, and a loan is a debt, but when you pay cash, that is not a debt because you incur no obligation. I anticipate the objection that “we can’t just print unlimited amounts of money because foreigners will stop accepting it.” While this is true in extreme circumstances, we can increase the money supply at a steady rate without risking this. As this happens, the dollar will gradually weaken and the trade deficit will come into balance.

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