Ricardo and International Trade

Shigeyoshi Senga, Masatomi Fujimoto, Taichi Tabuchi

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351686150
• Edition: 1
• Topic: Economics
• Subtopic: Comparative Economics
• Index: Economics

David Ricardo's theories have been widely studied and discussed, including the prominent theory on comparative advantage. Ricardo and International Trade looks at the ongoing renaissance of the Ricardian international trade theory. The book's interpretation brings fresh insights into and new developments on the Ricardian international trade theory by examining the true meaning of the 'four magic numbers'. By putting together theories of comparative advantage and international money, the book attempts to elucidate Ricardo's international trade theory in the real world.

This book also features contributions from the Japanese perspective and compares Ricardian theories with those of his contemporaries, such as Malthus, Torrens and J. S. Mill. This book will be a valuable reference for researchers and scholars with interests in history of economic thought and international economics.

Part I

Ricardo’s ‘four magic numbers’ and beyond

1 A plain man’s guide to David Ricardo’s principle of comparative advantage

Heinz D. Kurz¹

It is a matter of mortification to me that my execution has been so faulty, – I was too much in a hurry, and have not made my meaning intelligible even to those who are familiar with such subjects, much less to those who skim over these matters.

Ricardo (Works VI: 179)

1. Introduction

According to Paul A. Samuelson, Ricardo’s principle of comparative advantage is amongst the few propositions in economics that are both true and not trivial. That it is not trivial, Samuelson maintained, ‘is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them’ (Samuelson 1969: 683). Many textbook presentations of the principle confirm this: they frequently misapprehend or distort Ricardo’s argument beyond recognition. This is not least due to the fact that James Mill and his son John Stuart put forward flawed interpretations that had a lasting impact on the reception of Ricardo’s doctrine (see Sraffa 1930). However, it has to be admitted that Chapter VII, ‘On Foreign Trade’, of the Principles is not easy to read, because in it all major threads of which the fabric of Ricardo’s analysis is made coalesce and all problems pertinent to the theme under consideration are being touched upon in quick succession on just a few pages. Frequently Ricardo raises a problem and hints at its solution, but does not elaborate on it. He provides the canvas for a monumental painting and in broad brushes indicates the contours of the contents he has in mind, but he leaves it to the reader to accomplish the task. One is reminded of the great Renaissance maestro painters who provided the guiding ideas but left it to their disciples to fill in the details.

A personal experience confirms Samuelson’s observation above. When the German weekly magazine Die Zeit once published a series on major economists, I was invited to contribute an article on Ricardo. Upon delivery of the manuscript the editor in charge, himself an economist, informed me that everything was all right. But when I saw the published version of my piece I was dismayed. Without informing me and asking my permission he had rewritten the passage on foreign trade, purging from it the comparative advantage aspect and attributing to Ricardo a simple absolute cost explanation of trade. I was furious and called him in his office. He justified his reformulation by arguing that none of the readers of the article would have understood what to him was basically a very simple fact because of the excessively complicated way in which I had expressed it, and that he had to intervene on behalf of the magazine’s readers. He added, getting slightly upset, that instead of complaining I should be grateful to him because thanks to his stylistic ‘improvement’ the argument was now clear. I tried to explain to him that his editorial intervention had destroyed Ricardo’s reasoning, but he pretended to be unable to see this and in all probability he was.

We may thus ask: Is it possible to present Ricardo’s principle of comparative advantage in terms that can easily be understood or is it bound to be accessible only to a selected few and remain dark and mysterious to the overwhelming majority of readers? Is there a plain man’s guide to the principle?

With such questions in mind, this is not the opportunity to discuss the bewildering richness of the chapter and to follow all the ramifications of its reasoning. I shall rather focus attention on what in my view is the baseline or gist of Ricardo’s argument. This, I surmise, can easily be discerned in the chapter on foreign trade, and it is a riddle that deserves to be explained, why the chapter has met with so much misapprehension and misunderstanding.

Section 2 recalls the conclusion of Ricardo’s argument with regard to the saving of labour in trade based on the principle of comparative advantage. Section 3 exemplifies the principle in terms of the case of two countries whose currencies are non-convertible. It shows that the principle presupposes arbitrage opportunities that can be exploited by merchants. Section 4 deals with the case with gold as the universal means of exchange. In this case absolute cost advantages of one country over another one trigger a specie-flow mechanism that tends to erode these advantages and brings about a situation in which absolute costs in the two countries reflect comparative advantages. Section 5 contains concluding remarks.

2. The principle

Many interpreters of the principle of comparative advantage appear to have overlooked the fact that in Ricardo’s reasoning merchants and money play important roles. Abstracting from them, Ricardo’s argument is indeed difficult to understand and can easily be misinterpreted. Alas, in much of the secondary literature one is in vain on the lookout for a substantial discussion of the roles of merchants and money. This neglect is probably due to the numerical example by means of which Ricardo illustrates the principle at work, which contains the upshot of his argument (see Works I: 135–136). We may tabulate its assumptions as shown in Table 1.1.

From this Ricardo concludes that it would be advantageous for England to export cloth in exchange for wine imported from Portugal, and for Portugal to export wine in exchange for cloth from England. He adds that under these circumstances ‘England would give the produce of the labour of 100 men, for the produce of the labour of 80’ (Works I: 135).

Table 1.1 Ricardo’s four ‘magic’ numbers

Number of men whose labour is required for one year in order to
produce a given quantity of	Cloth	Wine
In Portugal	90	80
In England	100	120

The following observations are apposite. First, there is, of course, no presumption that cloth and wine are the only commodities produced or consumed in the two countries. All other commodities remain, however, in the background in Ricardo’s analysis. Secondly, Ricardo’s conclusion may easily be misinterpreted as if he was of the opinion that the trading parties are countries rather than merchants, and that their concern is with amounts of labour and employment rather than profits and prices. This is clearly not the case: the example illustrates the macro outcome of the micro actions of self-interested agents, especially merchants.

In the following section we turn to the case of trade between (the agents of) two countries in a regime with non-convertible national currencies. Ricardo clearly cared for what nowadays are called ‘micro-foundations’ (a term that is abused in much of economic theory, viz. models postulating a ‘representative agent’ or an ‘aggregate production function’), which is reflected by the fact that the first type of agent that is mentioned on the very first page of the chapter on foreign trade is the merchant (see Works I: 128). He seeks to exploit profitable opportunities and is the initial beneficiary of foreign trade. Ricardo repeatedly talks about him, discusses his actions and indicates the effects of them for the economy as a whole. In the case under consideration, while there are imports and exports, there are no money flows between countries.

3. Non-convertible currencies

Assume that Portugal has the Portuguese Real (R) and England the Pound (£), which are taken to be non-convertible. With relative domestic prices being proportional to the relative quantities of labour bestowed upon commodities, the money prices of the amounts of cloth and wine in the two countries given in Ricardo’s numerical example are proportional to the quantities of labour spent in producing them. If we assume for simplicity that the numbers are the same, as in his example, we have the situation shown in Table 1.2.

As a (highly successful) stock jobber, Ricardo can be expected to have quickly seen the profitable options waiting for merchants to be exploited in view of the different relative domestic prices of the two commodities in the two economies. An English merchant, for example, may buy for 100 £ a given quantity of cloth at home, ship it to Portugal and sell it there for 90 R. With this sum of money he may then buy 90/80 = ⁹/₈ units of wine from a Portuguese wine grower, a unit costing 80 R. This quantity of wine he may then ship to England, where he sells it for (⁹/₈)120 £ = 135 £. He thus yields a profit of 135 £− 100 £ = 35 £, which amounts to a rate of profit of 35 per cent on an investment of 100 £ over the time it took to carry out his business, that is, export cloth and import wine. (Throughout this note we set aside transportation cost.) Similarly a Portuguese merchant who may buy for 80 R wine, ship it to England, sell it there for 120 £ and buy for this sum 120/100 = ⁶/₅ units of cloth. This quantity of cloth he then ships to Portugal and sells it for (⁶/₅) 90 R = 108 R. He thus yields a profit of 28 R or a rate of profit of 35 per cent on an investment of 80 R.

Table 1.2 The case of non-convertible currencies

Price in Reals (Portugal) and Pounds (England) of
a given quantity of	Cloth	Wine
In Portugal (Real)	90	80
In England (Pound)	100	120

Obviously, the constellation R...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of figures
• List of tables
• List of contributors
• Introduction: Ricardo’s international trade theory 200 years on
• Part I Ricardo’s ‘four magic numbers’ and beyond
• Part II Money and/or international values
• Part III Controversies over Ricardian international trade theory and policy
• Index