In the early 1800s, David Ricardo developed a theory of comparative advantage as an explanation for the origins of trade. And this explanation has substantial power, particularly in a pre-industrial world. Assume, for example, that England is suited to produce wool, while Portugal is suited to produce wine. If each nation specializes, then total consumption in the world, and in each nation, is expanded. Interestingly, this is still true if one nation is better at producing both commodities: even the less productive nation benefits from specialization and trade.
In a world with industrial production based on division of labor, however, comparative advantage based on weather and soil conditions becomes secondary. Ricardo himself recognized this in his broader discussion of trade, as Meoqui points out. The reason is that division of labor produces a cost advantage where none existed before–an advantage based simply on specialization. Consequently, even in a world without comparative advantage, division of labor would create incentives for specialization and exchange.
This is from Michael Munger, “Division of Labor,” in David R. Henderson, ed., The Concise Encyclopedia of Economics.
Mike persuaded me that the Encyclopedia was missing a lot by focusing on comparative advantage as if it was the main reason for the productivity of division of labor. That’s why I commissioned this entry. Read his whole piece and I expect that many of you will be as persuaded by his argument as I am.
Well done, Michael Munger!
READER COMMENTS
ThaomasH
May 11 2016 at 4:16pm
Although it may be possible under classical comparative advantage, advantage based on specialization + economy of scale opens the possibility of multiple equilibria. Maybe both countries are better off with trade+specialization that with no trade regardless of which country specializes in what, but the distribution of benefits is not the same. This opens an argument for policy to push the equilibrium one way or the other in a way that classical comparative advantage does not.
Richard O. Hammer
May 11 2016 at 4:31pm
I owe a lot to Smith, Ricardo, and subsequent trade-friendly economists. Having learned from y’all, and also from complexity theory, I offer a more clear and compelling explanation for the division of labor. See this paper. Read at least to the end of the section headed “Considerations, 3”.
Also, the “Origins” section (in “Division of Labor“) unfortunately overlooks the development of libertarian political economy since The State: Its History and Development Viewed Sociologically by Franz Oppenheimer (1908). Plato and his translators must be forgiven, of course. But I would plead that we who promote voluntary interaction should be clear about the distinction between “society” and “state”. Plato is describing society, not state. The state is a separate and new organization which grows parasitically, in raiding and plunder, atop an already existing agricultural society (reference Oppenheimer).
Matthew Moore
May 11 2016 at 5:18pm
I have never managed to resolve to my own satisfaction the list of the types of benefits from trade.
Comparative advantage in production is one. Then division of labour has several: economies of scale and learning-buy-doing, etc.
There are also differing utility functions / relative valuations that make trade worthwhile.
I guess also unequal endowments could cause trade even if utility functions were identical
Does anyone know of a semi-definitive list? Seems like most live in an Edgeworth box.
Yaakov
May 11 2016 at 6:51pm
It seems there are extra words in these two quotes:
“compared to the same of number of workers each working alone.”
“Smith gave divides pin-making into 18 operations.”
Peter Gerdes
May 11 2016 at 11:16pm
Interesting remarks but to the extent that you take them to be refuting someone it seems to be a bit of a straw man.
Even if no one initially had a comparative advantage in producing any good once you’ve set up a factory that produces pins you have a comparative advantage in producing more pins relative to the guy who set up a farming business. I think people who emphasize the importance of comparative advantage often have this in mind.
Or to put the point differently people who emphasize comparative advantage can point to comparative advantage as the reason for trade while acknowledging the point Munger makes as a reason that people acquire comparative advantage (learn one trade well rather than many)
Tim Worstall
May 12 2016 at 7:33am
I generally work to the idea that Ricardo is a footnote to Smith (aka, all economics is either a footnote to Smith or wrong).
Comparative advantage is great, yes, but it’s building upon Smith and division and specialisation of labour. Explaining why it works more than you would think purely from Smith’s discussion.
That may not be entirely correct of course but it’s a useful thumbnail to remember.
David R. Henderson
May 12 2016 at 9:18am
@Yaakov,
Thanks.
Cyril Morong
May 12 2016 at 7:36pm
Comparative advantage might have become alot more popular if Ricardo used yards of ale in stead of yards of cloth or wool
Lauren
May 12 2016 at 8:18pm
Hi, Cyril.
Ricardo, with Portuguese roots, in fact did use port wine as his example. See his book, On the Principles of Political Economy and Taxation: http://www.econlib.org/library/Ricardo/ricP2a.html#Ch.7,%20On%20Foreign%20Trade,%20comparative%20advantage. A very appealing choice indeed.
Prakash
May 13 2016 at 3:08am
As specialization deepens, doesn’t uncertainty about the sustainability of that specialization also increase?
1. Uncertainty due to business cycles – The flute player may continue to be paid when his tribe is in a recession, but the string quartet may not be when the town is in one, purely due to Dunbar number reasons.
2. Uncertainty due to technological change? i.e. Are people going to continue to pay for more refined swords or one day will simply manufactured guns going to drive them out altogether. Or in an example closer to my work, will people pay for more specialized development/support on a legacy application or just choose to outsource the whole thing to a saas service?
Is there a point where the uncertainty about the specialization + search costs to find the exact specialization overtake the benefit from specialization?
Should enlightened sovereigns be funding prediction markets in incomes of individual specializations or are overall income markets (NGDP markets) enough?
Cyril Morong
May 13 2016 at 8:46pm
Lauren, thanks!
Comments are closed.