Monday, April 4, 2011

Comparative advantage once again: Ricardo, List and Krugman

In chapter 7 of his Principles of Political Economy and Taxation (1821), David Ricardo expounds his celebrated theory of comparative advantage in international trade. He creates a two-country model and calls the two countries England and Portugal. Furthermore the wares traded between the two countries are historically accurate: in Ricardo’s time England exported cloth to Portugal and imported wine therefrom, and these are the two wares traded in Ricardo’s model.

Ricardo’s theory of comparative advantage states that even if English cloth is dearer than Portuguese cloth, if Portugal can produce wine cheaply enough, Portugal will import English cloth, since Portugal would find it to its advantage to remove capital from the cloth industry and invest it in the wine industry.

So far so good.

Ricardo does not enquire into the historical operation of the factors that brought about this division of labour. This is not surprising, since Ricardo belonged to the Classical School, which was averse to most historical discussion and preferred to reason using static models in equilibrium.

Friedrich List belonged to the German Historical School. His method differed from Ricardo’s in that List was best described as an economic historian.

List tells the tale of Portugal’s textile industry in his work Das nationale System der Politischen Ökonomie (1841). List produces persuasive evidence that Portugal’s cloth industry flourished until it was undermined by the removal of the tariff that protected it from English cloth. Furthermore he shows that the English ambassador in Lisbon, Methuen, was instrumental in encouraging this reduction in tariffs.

Paul Krugman, in Ricardo’s difficult idea, accuses List of not understanding Ricardo’s comparative advantage theory. Nonetheless even if Krugman is right (and I suppose he is) this in no way detracts from List’s narrative.

List contradicts Ricardo, up to a point.

List’s tale seems to show that England’s trade advantage vis-à-vis Portugal was not comparative, but absolute. If England’s cloth had been dearer than Portugal’s, removal of the Portuguese tariff against English cloth would not have appreciably increased Portuguese cloth imports from England in the short term . Ricardo’s comparative advantage would operate only in the long term, as Portuguese capitalists discovered they could make larger profits by divesting from cloth manufacture and investing in vineyards. Portugal’s cloth production would then decline for lack of investment, and to make up for the missing cloth, Portugal would start importing English cloth.

Another matter altogether is whether the Portuguese economy in the  18th century provided channels for the transfer of productive capital from cloth-making to wine-making.

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