Do you know the law of comparative advantage?

A half century ago my father told me that a man “votes his pocketbook” when he enters the voting booth. I think the phrase is applicable to many of our beliefs about life and politics. The trouble is, we often don’t know much about economics and come to the wrong conclusions about what is going on.

Murray N. Rothbard once wrote:

“It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science.’ But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.”

Vociferous is defined as, “making, given to, or marked by noisy and vehement outcry”. It is obvious that many people do give loud and vociferous opinions on economics even though they are completely ignorant of the subject.

One of the least understood laws of economics is probably that of comparative advantage and yet it is one of the easiest to understand. I suppose propaganda and demagoguery surrounding the issue might explain that oddity. A short description of comparative advantage can be seen at the Wiki.

Comparative advantage works when talking about different countries, or regions, or even individuals. It is easier to explain using countries though, and that is the way you normally see the topic introduced. I’ll stick with that this morning.

Why would anyone trade in the first place? Austrian economic theory tells us that we trade to become better off. I trade an apple to another man for a tomato and we both think we have come out ahead in the bargain. We are both more wealthy, since value is a subjective thing. If there was no subjective difference in our evaluations of the fruit then we would have not made the trade at all. Trade between nations happens for the same reason.

A classic example is that the nation of Greece has many advantages over the US on the production of olive oil. Greece excels in terms of quality, since approximately 75 percent of the Greek olive oil is extra virgin, in contrast with 45 percent in Italy and 30 percent in Spain (mainly due to the special morphology of the country). On the other hand, the US has many advantages over Greece in the production of corn. It should be obvious that the two countries would both be wealthier if they engaged in international trade in these food items.

But what about the case when we have two countries and one of them is better at producing both products? Rothbard pointed out:

The law of comparative advantage tackles such hard cases, and is therefore indispensable to the case for free trade. It shows that even if, for example, Country A is more efficient than Country B at producing both commodities X and Y, it will pay the citizens of Country A to specialize in producing X, which it is most best at producing, and buy all of commodity Y from Country B, which it is better at producing but does not have as great a comparative advantage as in making commodity X. In other words, each country should produce not just what it has an absolute advantage in making, but what it is most best at, or even least worst at, i.e. what it has a comparative advantage in producing.

If, then, the government of Country A imposes a protective tariff on imports of commodity Y, and it forcibly maintains an industry producing that commodity, this special privilege will injure the consumers in Country A as well as obviously injuring the people in Country B. For Country A, as well as the rest of the world, loses the advantage of specializing in the production of what it is most best at, since many of its scarce resources are compulsorily and inefficiently tied up in the production of commodity Y. The law of comparative advantage highlights the important fact that a protective tariff in Country A wreaks injury on the efficient industries in that country, and the consumers in that country, as well as on Country B and the rest of the world.

Another implication of the law of comparative advantage is that no country or region of the earth is going to be left out of the international division of labor under free trade. For the law means that even if a country is in such poor shape that it has no absolute advantage in producing anything, it still pays for its trading partners, the people of other countries, to allow it to produce what it is least worst at.

Exactly how does anyone know who has the comparative advantage (or even the absolute advantage) in the matrix of millions of products between the hundreds of countries? Is there a ‘trade board’ someplace that knows all this? No. Only the free market can best regulate the production of items free from interference from those who would try to impose their own nationalistic concerns on the free flow of trade. The regulatory mechanism is “price”. It should be easy to see that any governmental intervention into trade makes the human population less wealthy by reducing the efficiency of the system of trade that would take place absent the interference.

One of the great difficulties in the Empire is that it is easy for demagogues to convince people that the countries of the middle east would not trade us oil for other products if we did not have a military presence there to force them to sell their oil. What baloney. More to the point, there has been a lot of talk lately about China securing trade agreements with many countries to obtain natural resources. China uses trade agreements and grows wealthy while the US Empire uses force, coercion, and fraud while it goes bankrupt. It is time to dismantle the interfering bureaucracies of the national governemnt and to bring the troops home from overseas. In this way the US can again become a wealthy nation rather than the world’s largest dead-beat debtor.

In peaceful free trade we all are better off. The only “fair trade” is laissez-faire free trade.


One thought on “Do you know the law of comparative advantage?

  1. Pingback: Comparative advantage and the unemployed | On the Mark

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