The Ricardo Theory of Comparative advantage and its grand failure

Criss-crossing through the complex jargons of Social Studies, we often come across a disposition which appeals to us as inherently logical and perfect. While trying to understand them, we are inclined to believe that finally, Social Studies are inching closer to scientific precision. But, almost always, a deeper analysis tells us that it was an absolute fluke. Ricardo Theory of Comparative advantage is also one of them. The theory has almost always fallen flat on its face whenever it was tested in the real world.

Adam Smith and absolute advantage

David Ricardo was one of the few names dominating the top echelons of classical economics. Classical economists believe that a market economy (demand and supply-driven economy) should be self-regulated. According to them, the production units will be driven by demand and in turn demand will be driven by supply. This will keep the circle going.

Adam Smith known as the Father of economics was the biggest exponent of this school of economics. In his book, The Wealth of Nations, Adam Smith argued that countries should develop symbiotic economic relationships. A country which produces a particular product with less cost should export it to that country where the cost of producing the same product is higher. The other country will return the favour with other products in which it has the advantage of producing at low cost. This is termed as the theory of absolute advantage.

But there is an inherent flaw in the Ricardo theory. If we want to follow it, then two countries having similar productivity strengths in both objects will be needed. But Earth is an unequal place. Most of the time, there is a huge gap in the industriousness of the two countries. It gets more complicated when more than one commodity is involved. In those cases, one of the two countries devising its bilateral or even multilateral trade policy on the lines of absolute advantage theory will be in for a huge loss.

Ricardo’s theory of Comparative advantage

Then came David Ricardo. Ricardo provided a solution (at least what it seemed to be at that time) to the problem. Suppose, there are two countries namely Country A and Country B. Country A produces wine and cloth efficiently and at a cheaper price than country B. Then according to Smith’s absolute advantage theory, countries A and B should not engage in trade with one another.

But Ricardo said, No! Both countries can gain from trading. During Ricardo’s time, Portugal was the country producing both products at a cheaper rate. According to Ricardo’s thesis jotted down in the book called ‘The Principles of Political Economy and Taxation,’ both England and Portugal needed to find out which product they had a comparative advantage in.

Basically, Ricardo said that Portugal needs to find that, out of cloth and wine, which commodity it can produce with less cost and focus on producing only that. Ricardo suggested that Portugal needs to export wine to England and import cloth from England (even though it is producing cheaper cloth itself). Ricardo reasoned that by producing more wine, Portugal could gain more than focusing on producing both clothes and wine. Going by Ricardo Theory, Portugal should have jettisoned its infrastructures which produced clothes and replaced them with winemaking ventures.

For England, producing more clothes was more viable. They would have a prepared market (Portugal) to export. So, at the end of the day, England would export Cloth to Portugal and in return they would be getting Wine, making it profitable for both the geographical entities.

At the time of its publishing, Ricardo’s theory was believed to be more in line with reality. Since there were extreme inequalities among countries all around the world, Ricardo’s comparative advantage theory was believed to be more relevant. But, over a period of time, the cracks started to appear.

Only supply and demand do not drive the production

The first problem with the theory was that it operates in the state of equilibrium. That is to say that all other operators of the economy which include Government, and state machinery among others would not pose any restriction on the transaction of two commodities. To put it simply, Ricardo eliminated any prospect of sovereign boundaries affecting cross-border trade. Additionally, supply chain bottlenecks were also out of the equation in Ricardo’s theory. Moreover, the theory assumes that production is a continuous process and is not subject to change, which is not an observable reality.

Comparative advantage turns into Comparative disadvantage

The second problem with it was the inherent destructive mechanism of the Ricardo theory. As countries started to devise their policy on this model, they started to realise that they are getting trapped in a comparative advantage trap. The Ricardo Theory was most disadvantageous for developing and underdeveloped nations. China and its trading partners are the latest victims of it.

Due to having cheap labour, China has had a comparative advantage for decades. Over a period of time, technological development took place and a large section of the labour force got occupied in tech-intensive industries. People employed in the tech-intensive sector started to get better salaries. Meanwhile, labour-intensive sectors always rely on cheap labour. The simultaneous existence of labour-intensive and tech-intensive sectors ended up increasing inequality in China, the after-effects of which are being felt in the form of civil unrest.

On the other hand, various companies shifted their production units to China. The single most reason for it was cheap labour, which accounted for a huge comparative advantage. Things were good for a few years as the countries where these companies were originally based, kept getting cheap produce while China kept getting technologically upgraded. China was in for huge economic growth, which was reflected in its increased might.

But other countries started to witness a decline in their employment numbers. Companies were concentrated on China and hence young population of their homeland started to lag behind. Finally, then US President Donald Trump came and set the stage for tightening foreign trade policies. Most of his policies were intended to minimise China’s negative influence on the US. After Covid, it spread like a wildfire and now almost every other country on the planet has its bilateral trade policy to the disadvantage of China.

Covid-19 exposed Ricardianism

The third and possibly the biggest flaw in the Ricardian analysis is that it is impractical. The final extrapolation of Comparative advantage theory mandates that every country should stick to its strength, and for its other needs, it should rely on the expertise of other countries. Ricardo seems to have been too much of an optimist about human nature, as his theory assumes that humans and by extension, nations are rational entities. Only on the basis of the assumption that countries are always in a cooperative state with each other, Ricardo asked them to be fully dependent on their counterparts.

This is where the Ricardo theory fell flat on its face. Human life is full of chaos. Rarely will you notice that the fight is about bread and butter. It is mainly about reversing the relative inequality between two groups. Because of the inherent race to get as many resources as we can, for us as well as our future generations, people are forced to fight each other. Our governments are not much different from us. Throughout the world, conflicts for resources still continue.

At the time when Ricardo was shaping his theory, European states were always in brawls with each other. There was no chance that if given an opportunity, one would not pounce on it to choke the other. This is exactly what the Comparative advantage provided. It conveyed to the nations that you can strangle your enemy by first making them dependent on you for a product, and then stop its supply when it desperately needs it.

Covid-19 has proved to be a horrifying illustration of the failure of the Ricardian ‘Comparative Advantage’ theory. Virtually, every other country made bilateral as well as multilateral trade their last priority. For a brief period, the chances of people dying from hunger were more imminent than people dying from Covid complications. Western liberal democracies turned out to be the most illiberal regimes. When finally, the vaccines for Covid-19 arrived, they simply refused to pass on the benefits of their dominance in the manufacturing and supply chain structure of vaccines to the rest of the world.

Various countries which ignored Ricardo and followed protectionism witnessed booming and sustained rates of growth. These include modern-day Japan, South Korea, and 20th century Germany among others, who supported relevant and important industries to make them self-sufficient.

Renowned Economist Paul Samuelson had once opined, “If theories, like girls, could win beauty contests, the comparative advantage would certainly rate high in that it is an elegantly logical structure.” No one could summarise it better than Paul. The Ricardo Theory is extremely logical. Unfortunately, this is the problem with it.