Home Midterm ECO54 Spring 2008 Research Paper

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Smith believed this would lead to inefficiency.

However, unlike Plato, Smith did not believe that the ideal republic should decide from birth what occupation an individual should follow, rather that the individual must freely choose by his or her own will, how to direct his or her energies and labor in the most efficient and self-interested fashion, which would ultimately result in the advancement of the nation as a whole. Plato's social structure, although not based upon birth, was still based upon a monopoly of philosophers dictating the lives of others according to their state-generated power, unlike Smith's more democratic ideals. Smith's analysis more perfectly echoes that of William Petty, who stressed how breaking down tasks, like Smith's pin-manufacturing plant, could generate higher levels of efficiency in economic production. Petty also placed a strong emphasis, as did Smith, upon the vital need of a nation to practice free trade.

Question

Discuss David Ricardo's 'Theory of Comparative Costs,' its history, and its strengths and weaknesses as a theory of international trade.

David Ricardo argued that a nation should do best, what it can do best, and most cheaply, and because economics is a study in scarcity. For a nation to be entirely self-sufficient, the mercantilists argued, is militarily and economically foolish, leaving it vulnerable to dependency and attack. But Ricardo countered that obtain its goods a nation should trade with other powers that could produce such goods more efficiently relative to the other goods produced within each nation's respective borders. Thus, a nation should specialize in certain types of production. "Using his famous example of two nations (Portugal and England) and two commodities (wine and cloth), Ricardo argued that trade would be beneficial even if Portugal held an absolute cost advantage over England in both commodities. Ricardo's argument was that there are gains from trade if each nation specializes completely in the production of the good in which it has a 'comparative' cost advantage in producing, and then trades with the other nation for the other good" ("David Ricardo," the New School, 2008). In other words, even if a nation can produce everything more efficiently than any other nation, it is still better off specializing in what it can produce at the least expensive cost and engaging in international trade with other nations.

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"Ricardo's simple analysis demonstrated that even when one country is technologically superior in both goods; it could still be advantageous for countries to trade. In this circumstance, a comparative advantage is present for those products that the country can produce most-best in comparison to other countries, even if the most best product is produced less productively than in the other country. For example, suppose the U.S. is 10X more productive in corn and only 2X more productive in watches compared to Switzerland. In this case the U.S. is clearly most-best at producing corn (10x > 2x). At the same time though, Switzerland is 1/2X as productive in watches and (1/10) X as productive in corn. Thus, [watchers are] Switzerland's most-best product and hence its comparative advantage" (Suranovic, 2007).

What did John Stuart Mill later add to Ricardo's trade theory?

In his famous work the Principles of Political Economy, Mill wrote that to prohibit imports or impose heavy duties upon imported goods creates waste both for the labor of the manufacturer and also for the laborers of the home nation, who must make more goods of the same kind, and thus protectionist tariffs conspire to "render the labor and capital of the country less efficient in production than they would otherwise be; and compel a waste of the difference between the labor and capital necessary for the home production of the commodity and that which is required for producing the things with which it can be purchased from abroad" (V.X).

The result is in a national loss "measured by the excess of the price at which the commodity is produced, over that at which it could be imported. In the case of manufactured goods, the whole difference between the two prices is absorbed in indemnifying the producers for waste of labor, or of the capital which supports that labor. Those who are supposed to be benefited, namely, the makers of the protected articles, (unless they form an exclusive company, and have a monopoly against their own countrymen as well as against foreigners,) do not obtain higher profits than other people. All is sheer loss, to the country as well as to the consumer" (V.10.5).

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