On the Theory of Comparative Advantage

(10 am – promoted by ek hornbeck)

One thing I find is a constant experience in my life, as well as a major thread in human history, is that nearly everything I and we believe is untrue.

For example, I believe that I am sitting on a chair as I write this, a chair I have sat in many times before.  But the truth is that I am not sitting on the chair, but levitating just ever so slightly above the chair, and I have never in my life made actual contact with the chair, or with any chair for that matter.  The atoms making up my body and the atoms making up the chair wisely refuse to touch (as touching would make those atoms explode) and instead repel one another, holding me and the chair apart with an electromagnetic field of sub-microscopic proportions.

That much of what we think we know is incorrect is true no matter how intelligent or insightful we are into certain matters.  Isaac Newton was as devoted to attempting to expand the knowledge of alchemy as he was in physics.  But as laughable as his belief that there was a secret formula which would turn lead into gold was, his belief in Descartes’ concept of the Luminiferous ether was even more false, and far more influential.  The belief that the universe was permeated by an invisible and weightless medium which permitted the movement of light waves through space lasted until Albert Michelson, the first American to win the Nobel Prize in Physics, disproved it by accident in 1887, exactly two hundred years after the publication of Newton’s Principia.

Depending on your perspective, one of the most interesting or depressing things to happen in modern political thought is taking center stage right now.  One of the foundational rules of economics, the theory of comparative advantage, is being questioned at the highest levels of political thought.  Indeed, a statement which questioned the theory by Sen. Hillary Clinton nearly drove economist Clive Crook into apoplexy.  

The doctrine in question, devised by David Ricardo in 1817, makes a strong claim about the gains that accrue from trade. It would be difficult to exaggerate the centrality of the idea in modern economics. For nearly 200 years, the principle of comparative advantage, and the ideas about economic policy that flowed from it, divided the world into two camps: those with basic economic literacy, and the rest. Understanding this idea, and advocating it to the world, was part of what it meant to be an economist-especially an American economist.

At heart, the theory is easy to understand.  The idea is that trading goods creates added value beyond the inherent value of the goods.  If I have corn, and you have beef, and we exchange, then both of us are better off.  Further, it is in my interest to specialize in corn production, since by doing so I create enough excess corn to trade for more goods than I could create myself if I tried to produce corn, and beef, and widgets, and sport-utility vehicles, and so on all at once.  In an economy composed of various specialists engaging in trade between them, the theory indicates that more is produced and everyone ends up with more goods than if we all tried to be self-sufficient.

The problem, as Crook astutely points out, is that the new movement questioning Ricardo’s theory lacks any new theoretical insight.  Of course, this does not mean that people questioning Ricardo’s theory are wrong.  Michelson disproved Newton’s theories about the lumineferous ether by accident, as I mentioned, and without a theory which explained why his data clearly showed Newton to be wrong.  It took another twenty years for Albert Einstein to conceive the specialized theory of relativity, and another decade before the general theory emerged and was widely accepted to supersede Newton.

But this example also demonstrates how faulty any possible remedy to our current policies regarding trade will be without new theories to counter Ricardo.  What Michelson proved was that light does not move at a different rate based on distance from its source, but instead travels at a constant rate.  But Michelson’s data did not give us the means to use that knowledge; it took the famous explanation that energy is the equivalent of mass multiplied by the speed of light squared for humans to use that knowledge.

For those who believe data exists which disproves Ricardo, the words of Crook quoted above may remind them of the words of famed British physicist J.J. Thompson in 1909, over two decades after Michelson’s discovery: “The ether is not a fantastic creation of the speculative philosopher; it is as essential to us as the air we breathe.”  They may as well be as wrong as Marx and others who have challenged Ricardo in the last two centuries.  Or the answer may lie between the two; it may be that the economic policies of China, which has used its trade surplus not to benefit itself but to allow the government to build up massive hard currency reserves is akin not to capitalism but to mercantilism, the shaping of the economy to create gold reserves for the government which was the opponent of Adam Smith’s seminal An Inquiry into the Nature and Causes of the Wealth of Nations.  Indeed, questions of the boundary between capitalism and mercantilism or corporatism seem central to the questions of economic policy in the new millennium.

Luckily, our ability to conceive of new ideas and to utilize them is great.  But we must eschew the desire for quick political reforms we hope might work, and ponder what the data tells us about how our world works.  Policy must be dictated by sound theory, rather than on faith as the Republican party has insisted.  One of the things that Einstein’s theory of relativity means is that the amount of potential energy within each human being is greater than that of thousands of hydrogen bombs.  That potential energy was always there; Einstein merely made us aware of it.  What new theories might we find, if we are willing to work and seek them, that will allow us to harness greater amounts of that potential?