Last December, I gave a talk at the Osher Lifelong Learning Institute (OLLI) on Adam Smith’s Wealth of Nations. I blogged about the talk here. And you can see the talk here.
At about the 4:13 point of my talk, I told about being on a taped interview about 20 years ago with someone who I thought was on the same wave length as me. When the host was talking about trade, he stated that Adam Smith had believed in comparative advantage. I corrected him, noting that that idea didn’t come along until James Mill and David Ricardo discussed it in the early 19th century. The host argued back and I stuck to my guns. We had just got started but he got angry, abruptly ended the interview, and hung up on me.
Later in my OLLI talk, at the 23:05 point, I highlighted this quote from The Wealth of Nations:
What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage. (pp. 478-79 of the Edwin Canaan version.)
Then a little voice in my head said, “Wait a minute; that sounds awfully close to comparative advantage. When I used a numerical example to explain comparative advantage to my students over the years, it always came down to cost differences between the two countries. One had an advantage in one; the other had an advantage in the other.” I like learning as I talk. So I confessed to the audience that maybe the guy who hung up on me was making a good point.
I thought of all this when I read an excerpt from Shruti Rajagopalan’s interview of trade economist Doug Irwin (which Tyler Cowen recently quoted).
RAJAGOPALAN: I have a different question on Adam Smith. We’re all taught Adam Smith’s division of labor, specialization, economies of scale, the cliff notes version of that. Then, we learn about absolute advantage in about five minutes. Then, we set it aside and start thinking about comparative advantage.
The first question I have is does Adam Smith’s basic model of division of labor, specialization, and economies of scale anticipate the comparative advantage trade models, or does it actually undermine the comparative advantage trade models in the way that Krugman wrote about or something else?
My answer would have been that Adam Smith did not talk about absolute advantage. Once he uses the word “cheaper,” he’s talking about comparative advantage.
Doug Irwin has a different answer.
IRWIN: I think that Adam Smith has a broader view of trade, a much richer view of trade than what I would think is of the narrower David Ricardo theory of comparative advantage. If you have to read one of the two, read Adam Smith because it’s much more fun to read. Reading David Ricardo is more like reading a textbook in the sense that he doesn’t have this broad historical sense and these new rich ideas and how they’re interacting that leaves a lot to the imagination and leaves a lot to future research to flesh out.
He’s saying, “England can produce wine and cloth. Here are the labor coefficients, and we’re going to do this static comparison between England and Portugal.” That’s a very narrow way of thinking about trade.
It’s true that Smith didn’t have labor coefficients. But he did a lot with words. And with words, I’ve now concluded, Adam Smith was implicitly discussing comparative advantage.
READER COMMENTS
Don Boudreaux
Feb 27 2024 at 11:14am
Comparative advantage is indeed about, and only about, opportunity cost – specifically, one economic entity’s cost of producing different outputs compared to the costs borne by other economic entities of producing those same outputs. So when Adam Smith referred to a lower-cost (“cheaper”) supplier, he necessarily referred to a producer with a comparative advantage at producing the output(s) in question.
The question is: Is such a reference enough to credit the Great Scot with having stumbled upon the principle of comparative advantage? The world has no greater admirer of Adam Smith than me, but I don’t believe that Smith ‘got’ comparative advantage. What Ricardo (or James Mill or Robert Torrens) ‘got’ is the fact that cost is correctly measured in foregone outputs and not in inputs. The absolute amount of labor that X spends to produce a banana compared to the absolute amount of labor that Y spends to produce a banana is economically irrelevant; what matters is how many fish X does not produce when he produces a banana compared to how many fish Y does not produce when she produces a banana.
The difference between reckoning costs in foregone outputs as opposed to the amounts of inputs used is subtle. I concede that, now that we know about comparative advantage, it’s possible to read the above-quoted passage from Smith and conclude that, by gosh!, he did get it. And I don’t rule out this possibility. Because comparative advantage is sheer common sense once it’s grasped, perhaps Smith – brilliant as he was – thought it pointless to elaborate on what he meant by “cheaper.” But it’s nevertheless at least unclear to me that by “cheaper” Smith was thinking of foregone outputs rather than of inputs used.
David Henderson
Feb 27 2024 at 2:22pm
Touche, Don. Well said.
Jorge Morales Meoqui
Feb 28 2024 at 4:22am
Dear Mr. Boudreaux,
If you don’t mind, I will continue our discussion from some days ago.
You are, of course, free to define comparative advantage as you deem fit. What baffles me is that you insist on attributing the definition of comparative advantage in terms of opportunity costs to David Ricardo.
Ricardo did not explain in his Principles the pattern of trade based on the concept of opportunity cost. How could he? Austrian economist Friedrich von Wieser originally developed the opportunity-costs approach 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 what he believed to be Ricardo’s theory of value.
Another Austrian economist, Gottfried von Haberler, reformulated Ricardo’s quantities-of-labour requirements with opportunity costs in 1930 because he erroneously believed that Ricardo’s numerical example was based on the labour theory of value.
I am sure you know about these well-established facts.
Don Boudreaux
Feb 28 2024 at 6:40am
Mr. Meoqui:
Ricardo (whose discussion of comparative advantage is unfortunately opaque) perhaps didn’t – indeed, likely didn’t – realize the full implications of his demonstration, but it is a demonstration of the relevance of opportunity costs in determining the patterns of specialization and trade. The only reason, in Ricardo’s example, England and Portugal gain from trading with each other is that England gives up less wine than does Portugal to produce cloth, and Portugal gives us less cloth than does England to produce wine. It is inherently an opportunity-cost concept regardless of how well or poorly Ricardo consciously understood it to be so.
Jorge Morales Meoqui
Feb 28 2024 at 8:11am
Mr. Boudreaux,
Perhaps Ricardo’s numerical example appears opaque to you because you insist on interpreting his four numbers in a way entirely alien to their original intention.
Ricardo knew too well that the only thing a Portuguese trader cared about was that the English cloth had a lower price than the Portuguese cloth. According to Smith and Ricardo’s value theory, English cloth can only be offered at a lower price for a sustained period if its natural price is lower than that of Portuguese cloth. For Ricardo, natural price is just another name for the cost of production.
In addition to contradicting Ricardo’s theory of value, there are also logical reasons for rejecting the reformulation of his four numbers in terms of opportunity costs. The concept of opportunity costs requires the assumption that the factors of production are fully employed. Otherwise, the opportunity costs are zero, according to their mathematical definition.
If one assumes that the factors of production are fully employed in both countries, then England could not have produced the amount of wine imported nor Portugal the cloth because neither of them had the necessary free internal production capacity to make them. In that case, England and Portugal would trade cloth and wine not because this exchange was mutually beneficial (Ricardo’s line of argument) but because of a lack of internal production capacity.
Don Boudreaux
Feb 28 2024 at 11:17am
Mr. Meoqui:
This comment is the last that I will make on this matter in this thread.
Ultimately, what Ricardo the man understood about his example or didn’t understand about it doesn’t much matter. It is an example that shows that the Portuguese had a lower opportunity cost of producing wine than did the English, and the English had a lower opportunity cost of producing cloth than did the Portuguese. And comparative opportunity costs such as these are all that comparative advantage refers to.
As for your claim that comparative advantage works only if factors of production are fully employed, I cannot agree with it. Moving factors of production from a state of unemployment to one of employment means moving them into some particular employment. The forgone outputs of the employments to which these factors of production could have been, but weren’t, used to produce are the cost of the outputs that the factors of production are in reality used to produce.
Jorge Morales Meoqui
Feb 28 2024 at 1:16pm
Mr. Boudreaux:
I fully understand and respect your decision not to continue our discussion in this venue. You can contact me by email if you please so. I am always open to debating my ideas and interpretations with others, both in public or privately, preferably with those with different opinions or interpretations.
That said, I would like to comment briefly on your last answer.
If what Ricardo wrote and meant to prove with the four numbers does not matter much to you, what was the purpose of our discussion?
Mr. Henderson’s post was about whether Smith anticipated the idea of comparative advantage. My answer is no, and neither did Ricardo. Both used a different and superior rule for specialization. In this context, what Smith and Ricardo wrote and meant is of the utmost importance.
Lastly, my claim was that if one defines the cost of a product not as the sum of the expenses necessary for making the product and bringing it to market, including the ordinary profit rate (= natural price or cost of production used by Smith, Ricardo and the classical school) but in terms of forgone production (=opportunity cost), one has to assume that the factors of production are fully employed. Otherwise, one would not have to sacrifice a certain amount of, for example, banana production to catch an additional fish. This is why the assumption is an integral part of the concept of opportunity costs, as recognized by Haberler.
Thank you for your time.
Joy Schwabach
Feb 27 2024 at 6:28pm
I defer to Milton Friedman on this one. On page 44 of “Free to Choose,” (the paperback published in 1979 and reissued in 1990) and here https://www.k-state.edu/landon/speakers/milton-friedman/transcript.html he refers to “what was dubbed 150 years ago, in the jargon of economics as the principle of comparative advantage.” Going 150 years back puts you roughly in Ricardo territory. So he gives Ricardo credit for developing the jargon, but Adam Smith credit for developing the concept.
It seems surreal to think Adam Smith explained something so well without grasping the full concept of comparative advantage.
The idea is the important thing, not the jargon.
Jorge Morales Meoqui
Feb 28 2024 at 4:25am
Dear Mr. Henderson,
I want to draw your attention to my article titled “OVERCOMING ABSOLUTE AND COMPARATIVE ADVANTAGE: A REAPPRAISAL OF THE RELATIVE CHEAPNESS OF FOREIGN COMMODITIES AS THE BASIS OF INTERNATIONAL TRADE, which was published in 2021 in the Journal of the History of Economic Thought. It can be accessed through this link: https://bit.ly/30GuzUl
The paper proves that David Ricardo consistently used the same rule for specialization as Adam Smith. This rule stipulates that one should not attempt to make a commodity that costs less to buy, and that it is generally beneficial to import commodities whenever they are bought more cheaply than what their internal production would cost. I coined it the classical rule for specialization.
Furthermore, the paper shows that the popular contraposition of Smith’s absolute and Ricardo’s comparative advantage arose from John Stuart Mill’s misinterpretation of Ricardo’s famous numerical example in chapter 7 of the Principles (1817). Mill was the first to claim that Ricardo had allegedly proven that international exchanges were based on a comparative rather than an absolute advantage in the cost of production.
The paper refutes this interpretation by proving that the English cloth had to have a lower cost of production than the cloth made in Portugal.
The mathematical proof is trivial and can be expressed in a single line. The variables CWPOR, CCENG, and CCPOR represent the costs of production of Portuguese wine, English cloth, and Portuguese cloth, respectively.
Since CWPOR = CCENG and CCPOR > CWPOR, it follows that CCPOR > CCENG
Finally, the paper also explains why neither absolute nor comparative advantage in the cost of production are proper notions to explain the basis of international trade and the proper rule for specialization. Given the problematic origin of these terms and the ongoing confusion generated by their contraposition, I would not recommend using them to popularize the genuine and still valid insights of Smith and Ricardo on international trade.
Best regards,
Jorge
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