Home > Uncategorized > David Ricardo and comparative advantage — a bicentennial assessment

David Ricardo and comparative advantage — a bicentennial assessment

from Lars Syll

Two hundred years ago, on 19 April 1817, David Ricardo’s Principles was published. In it he presented a theory that was meant to explain why countries trade and, based on the concept of opportunity cost, how the pattern of export and import is ruled by countries exporting goods in which they have comparative advantage and importing goods in which they have a comparative disadvantage.

Heckscher-Ohlin-HO-Modern-Theory-of-International-TradeAlthough a great accomplishment per se, Ricardo’s theory of comparative advantage, however, didn’t explain why the comparative advantage was the way it was. In the beginning of the 20th century, two Swedish economists — Eli Heckscher and Bertil Ohlin — presented a theory/model/theorem according to which the comparative advantages arose from differences in factor endowments between countries. Countries have a comparative advantages in producing goods that use up production factors that are most abundant in the different countries. Countries would mostly export goods that used the abundant factors of production and import goods that mostly used factors of productions that were scarce.

The Heckscher-Ohlin theorem — as do the elaborations on in it by e.g. Vanek, Stolper and Samuelson — builds on a series of restrictive and unrealistic assumptions. The most critically important — beside the standard market clearing equilibrium assumptions — are 

(1) Countries use identical production technologies.

(2) Production takes place with a constant returns to scale technology.

(3) Within countries the factor substitutability is more or less infinite.

(4) Factor-prices are equalised (the Stolper-Samuelson extension of the theorem).

These assumptions are, as almost all empirical testing of the theorem has shown, totally unrealistic. That is, they are empirically false. 

That said, one could indeed wonder why on earth anyone should be interested in applying this theorem to real world situations. As so many other mainstream mathematical models taught to economics students today, this theorem has very little to do  with the real world.

Using false assumptions, mainstream modelers can derive whatever conclusions they want. Wanting to show that ‘free trade is great’ just e.g. assume ‘all economists from Chicago are right’ and ‘all economists from Chicago consider free trade to be great’  The conclusions follows by deduction — but is of course factually totally wrong. Models and theories building on that kind of reasoning is nothing but a pointless waste of time.

What mainstream economics took over from Ricardo was not only the theory of comparative advantage. The whole deductive-axiomatic approach to economics that is still at the core of mainstream methodology was taken over from Ricardo. Nothing has been more detrimental to the development of economics than going down that barren path.

Ricardo shunted the car of economic science on to the wrong track. Mainstream economics is still on that track. It’s high time to get on the right track and make economics a realist and relevant science.

  1. April 25, 2017 at 12:42 am

    “(1) Countries use identical production technologies.

    (2) Production takes place with a constant returns to scale technology.

    (3) Within countries the factor substitutability is more or less infinite.

    (4) Factor-prices are equalised (the Stolper-Samuelson extension of the theorem).”

    So basically these can be summarized as saying that capital formation is irrelevant to production. This is a very profitable belief for holders of capital to convince the rest of the world of.

  2. April 25, 2017 at 1:19 am

    Based on ideas derived from my study of the methodology of Polanyi’s Great Transformation, I have come to the conclusion that history and social theories are entangled — they co-evolve in time. We cannot understand social theories (like economics) outside the historical context, just as we cannot understand history without understanding the social theories in use by different groups to try to interpret events in ways that would lead to policy actions in their favor. It is only in context of the struggle of groups with competing interests to impose favorable interpretations upon historical events that we can understand the emergence of theories like comparative advantage. We cannot understand them from the standard “scientific” point-of-view based on the binary of True/False. This dominant mode of understanding will leave us forever confused as to why theories so dramatically at variance with facts can come to dominate, and be widely taught and believed by people who are, by all appearances, perfectly intelligent.

    • April 25, 2017 at 1:59 am

      Well said Asad. Fred Block and Margaret R. Somers give a lot of the context around the early market liberals, especially their fascination with Malthus, his “social naturalism,” haunting us right into the mid and late twentieth century, if not beyond, in their book “The Power of Market Fundamentalism: Karl Polanyi’s Critique.” (2014).

  3. April 25, 2017 at 2:07 am

    Interesting. So where does Vietnamese rubber fit into history of comparative advantages?

    Discuss how a comparative advantage in rubber was affected by invention of the automobile for extra credit.

    What was the socioeconomic impact of automobile invention on Viet Nam? Bonus essay!

  4. Paul Davidson
    April 25, 2017 at 3:23 am

    The most unrealistic assumption regarding Ohlin and Samuelson’s revision of the law of comparative advsntage relying on different factor endowments of capital and labor in each trading partner IS that there is never a shortage of aggregate demand for any product producible in both nations! In other words, a form of Say’s law!

    Keynes, however, noted that if the same production process for mass production product X and mass production product Z were used in both Nation A and Nation B, then labor efficiency in each industry would be the same in each nation. The nation with the lower wage [ because of a larger supply of labor?} would capture the market for such mass production products, creating unemployment in the higher wage nations –as here woulf not be enough aggregate demand to higher all workers

    Keynes explicitly wrote that free trade benefits [such as Ricardo’s law f comparative advantage] was only applicable to production in Natural Resources and in climate affected industries such as agriculture. Of course in Ricard’s time, resources and agricultural products was most of trade composition!

    • April 25, 2017 at 10:09 am

      Exactly, and scaling assumptions look even more broken in today’s economy. If the goods in your economy are phones and apps, the realistic outcome is one vendor with absolute advantage scales up to produce all the phones. Another vendor gets to produce all the apps, and everyone else is out of work. Ricardo makes assumptions about the limited scalability of potato farms and a universal need for labour, which make his theory look attractive. These assumptions don’t apply in today’s “winner takes all” globally scaling and IP-based economy.

  5. April 25, 2017 at 8:53 am

    I have tried on several occasions to draw Prof. Syll’s attention to some blatant misunderstandings of David Ricardo’s famous numerical example. Unfortunately, to no avail until now.

    In order to keep my comment short, I will concentrate on the biggest blunder. Unlike what is written in mainstream economic textbooks, Ricardo did not base his proof of comparative advantage on opportunity costs. How could he? The opportunity-costs approach was originally developed by Austrian economist Friedrich von Wieser as part of his marginal theory of value almost one hundred years after Ricardo’s death. Moreover, Wieser explicitly conceived his value theory as an opposing view and main alternative to Ricardo’s labour theory of value.

    It was another Austrian economist, Gottfried von Haberler, who reformulated Ricardo’s labour-time requirements with opportunity costs in 1930, because he erroneously believed that Ricardo’s original proof of comparative advantage was based on the labour theory of value.

    It is not surprising to see neoclassical economists commit such kind of blatant historical blunder, since they usually show little interest in the history of economic thought. I guess it would distract them from their petty model-building. But it is a bit surprising to find out that even heterodox economists such as Lars Syll spread this error around without questioning it.

    Mainstream neoclassical economics did not take over Ricardo’s “theory of comparative advantage”. They have rather distorted his original insight to the point of being unrecognisable.

  6. patrick newman
    April 25, 2017 at 11:49 am

    The Chinese clearly dont believe in such nonsense!

  7. patrick newman
    April 25, 2017 at 11:51 am

    The laws of supply and demand are the religion of the Englishman – I have not been able to trace the origin. I dont think it was Marx – neither Karl nor Groucho!

  8. April 25, 2017 at 1:31 pm

    This is nice little article. I forgot Heckshler-Ohlin ( i just saw that in reference in stolper samuelson theorem, which i looked up after reading an article by Krugman which mentioned it. There is an analogous problem in stoichiometry (chemistry–basic mass balance equations).

    Samuelson had a paper in J Economic Perspectives (a sort of generalist review journal, not very technical) in summer 2004 volume 18 on similar issues (mill, ricardo, trade, globalization…) free online.

    i think he basically said his stolper-samuelson theorem was not applicable to the real world. its just a math theorem—don’t take it too seriously. (look a the assumptions (eg ‘full employment’–implict in the,.assumptions, a version of Lucas’ R.E. (rational expections- R.E. is also the name of a famous wash dc band (rare essence). (see ‘overnite scenario’ on youtube or ‘only listen to this at nite’ with doug e fresh—they may be as popular or more-so in japan than in dc.america eats its young. )

    to me the concept ‘opportunity cost’ ism one of the worst around–i wonder who thought that up. probably one of these libertarian or anarcho-capitalists at GMU (mercatus center, Koch money. I actually checked that dept out–they gave me a book to read and said come back.
    i didnt come back or return the book either. they were always leaving me messages–we want our book back and finish your application. . my view was basically i dont go to virginia (i can see it from dc–way too many hostile cops there) and i am not going to work for

    sfullerinstitute.gmu.edu

    or https://sfullerinstitute.gmu.edu/ this is called econiomists for hire or prostitution likelt the way world is going.supply=demand

  9. April 25, 2017 at 9:34 pm

    https://johncarlosbaez.wordpress.com has related ideas on recent blog post. (to me this is old news–i been reading kirman and epstein a long time–over 10 years and they go back much longer. i viewed that as ‘mainstream economics’. i think epstein was for awhile at Brookings Institution in DC for awhile–a very mainstream econ think tank. I talked over phone to his co-worker H Peyton Young around 2010. They didnt really have any ideas about study or jobs.
    Baez is mostly a mathematician. Now he has switched a bit in to theoretical biology and also climate science. Also cousin of joan baez (famous folk singer, tho i’m not much into folk music unless its really old and original ).

    • Paul Davidson
      April 25, 2017 at 9:58 pm

      Brookings may be mainly mainstream but back four decades or more ago, I was a member of the Brookings Economics Panel and Brookings actually published a paper I wrote with two coauthors– one a junior assistant professor and one a graduate student of mine The Paper on the crude oil problems of supply actually used Keynes’s concept of user costs to explain the oil price spike in the crude oil problems of the 1980s when Nixon was present.

      And user cost was not a concept even known to mainstream writers.

      • April 25, 2017 at 11:48 pm

        hey paul davidson—only way i know your name is rwer and old papers in AJES on tobin tax–you were against it i disagreed.

        my mom used to work at LWV and FOE friends of earth–across from brookings–cato and heritage are furhter away. i even had a short job writing articles on nonionizing radiation and cancer (eg cell phone, power lines) since i knew a bit about quantum biology.
        i would like to go through that ‘bayes theorem’ example –somewhere on rwer.

  10. April 26, 2017 at 6:54 am

    Block and Somers are just wrong in the “Power of Market Fundamentalism.” This discussion focuses on what economists believe about markets and how they define markets. I don’t care about that. I care about how non-economists define and use markets. In all the work I’ve done I find almost every client believes in markets. Just not the markets that economists talk about. The non-economist considers markets a means to an end, not an end in itself. If designed and regulated appropriately markets provide services. They allow humans to have access to the resources they need and require. But they’re not magic. To operate openly, transparently, and effectively markets require a great deal of work in construction, oversight, and repair through their entire lives. They are not self regulating. They are not free. And they most certainly do not create any sort of equilibrium between buyers, sellers, financers, and regulators. In fact, markets often lead to the exact opposite result. Which is why those involved in them monitor and review them constantly. Fixing problems as they occur, if possible. Economists provide no help in any of this. Their designs for markets are often poor, their regulation protocols ineffective, and their concerns that markets actually function fairly for all involved nonexistent. This is the root of the confusion, and frankly stupidity of economists discussing and designing markets. Their markets don’t do the things that most people who use markets want them to do in the ways they want them to do these things. So while they both use the same term, markets, the actual expectations, forms, and operations are about as different as it’s possible to be.

    • robert locke
      April 26, 2017 at 7:45 am

      Eugen Schmalenbach believed in a market economy but he also believed in the skill of a well trained accountancy to police them properly. Schmalenbach and his students at Cologne by 1932, worked out charts of accounts (Kontenrahmen) that were used in firms to calculate transfer prices and in studies of comparative firm efficiencies (Betriebsvergleich) in German industry that allowed Hitler’s command economy to function.. Germany had the best cost accounting in the world at the time. Hitler squandered their talents, but postwar West Germany benefitted a great deal from the presence of their talents. Business economists were, however, not economists.

      • April 26, 2017 at 8:46 am

        Germany still has the best cost accounting in the world. We work with clients who use analytic accounting models based on German accounting standards. Mapping these to GAAP is difficult since the German-based models are so much more detailed. We joke sometimes that with these models companies can track what happens to individual nails in individual panels in buildings. Obviously, this is sometimes a good thing and sometimes not. I can certainly see how companies operated with these standard would be more efficient than anything in the US-UK world.

  11. May 5, 2017 at 2:18 pm

    This post (at least the major part of this post) seems to be a reproduction of Lars Syll’s
    The end of Ricardo-Heckscher-Ohlin-Samuelson trade theory
    posted December 19, last year.
    A commnet on an article of Real World Economic Review
    https://rwer.wordpress.com/2016/12/19/the-end-of-ricardo-heckscher-ohlin-samuelson-trade-theory/

    I have posted a comment below to the post recently. Now Syll does not use the old title, but what he proposes is the same as the post of December 19, 2016. I think my comment there is still valid and I reproduces it here. In fact, we can in this way celebrate the bicentennial of the first edition publication of Ricardo’s Principle, because the arrival of the new theory of international values is a good news for all Ricardians and those who believe the great potential pf classical economics paradigm.

    There are several dimensions that we have to argue on Lars Syll’s short article. I can count three major topics:
    (1) Is it plausible to use the name Ricardo-Heckscher-Ohlin-Samuelson trade theory?
    (2) Admitting that HOS model (or HOV model) is completely false, what is the alternative to HOS model or more widely neoclassical trade theories?
    (3) How should we assess the free trade policy? Are there any alternatives on policies to be adopted in relation to international trade?

    Let me briefly argue each of them.

    (1) HOS theory is not an authentic descendant of Ricardo.
    It is necessary to know that there lies a deep valley between classical and neoclassical economics. If I cite the term that J. R. Hicks used, classical economics is an economics of production (Plutology) and neoclassical economics is an economics of exchange (Catallactics). Now Ricardo with his cost of production theory of value, Ricardo is the main person who clarified (even though of course insufficiently) the logical structure of the classical economics. He did not argue in terms of input substitutions. He clearly admitted that different country may have different production technologies. A conspicuous example is his four magic numbers.

    HOS models are conceived totally in the framework of neoclassical economics. Factor proportions (resource scarcity) and input substitution (infinite factor substitutability) are two of conspicuous characteristics of neoclassical economics.

    Many authors who think they are not in the neoclassical tradition confuse the great difference between Ricardo and HOS theory. We should not use the term “Ricardo-Heckscher-Ohlin-Samuelson trade theory.”

    (2) Alternatives to HOS model
    After HOS model, there are many “new” theories of international trade: HOV models (V indicates Vanek who thought that trade is only an exchange of factors), Krugman’s new trade theory (which explain the possibility of intra-industry trade), Melitz’ new new trade theory (which was born in the 21 century and explains why large number of firms do not engage in international trade while some of the same industry actively trade across national borders.) and Eaton and Kortum’s “Ricardian” model (which is thought to have explained gravity equations).

    I do not argue the reality of those theories. Let me only point that first three theories (HOV, the New, and the New New) deal only with trade of finished goods. They exclude input trade. Eaton and Kortum’s “Ricardian” model admits intermediate goods (input goods) but assumes that labor share in the total cost is the same for all industries. We cannot say that it is a theory which really admits input trade.

    As everyone knows we are in the age of global economy where global value chains are changing the picture of the world production. The mainstream economics has no general theory by which to analyze the global values chains and globalization. They are far back from the actual economy.

    However, to criticize the mainstream alone is not productive. The most important point is what we have. Fortunately, we have now a new theory of international trade. For the details, please see my paper:
    The New Theory of International Values: An Overview
    https://www.researchgate.net/publication/304717720_New_Theory_of_International_Values_A_General_Introduction
    (This is already published as chapter 1 of a book of Springer-Science, but you can get a rough image by the draft paper.)

    The new theory of international trade is an extension of the Ricardo’s domestic value theory to international trade situation. It is based on a Ricardo-Sraffa trade economy composed of many countries and many commodities. Each nation has its own set of production techniques and choice of production techniques is explicitly analyzed. The international value (comprising wage rates of all nations and prices of commodities) is stable when all firms are producing with global optimal procurement policy. There is no need to assume any special patterns of specializations as they are assumed in the most of mainstream analysis of input trade, fragmentation or outsourcing, and others.

    Another merit of the new theory is that it has an explicit theory on how the wage disparity between nations necessarily appears. It is totally different from HOS theory which admits Factor Price Equalization Theorem as a standard situation. It is useless to say that we can know what to do if we know the real mechanism of the origin of wage disparity.

    Thus the theory of international trade is one of rare fields of economics where an heterogeneous theory supersedes the mainstream theories.

    (3) Trade policy
    The new theory of international trade has no uniquely determined policy implications. It can be used to know the origin of gains from trade (e.g. Sraffa bonus that Samuelson named). As it admits involuntary unemployment, it can be used to know what kind of protection strategy and transitive measures.

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