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THE CONCEPT OF comparative advantage has come to be seen as one of the two great conceptual innovations of David Ricardo’s On the Principles of Political Economy when it was published 1817.
The other was his corn model with its enduringly clear explanation of the interrelationship of the marginal productivity of land, the profits of agriculture, and the level of rent (a third concept, usually known as Ricardian equivalence, and meaning the equivalent cost of funding expenditure either from taxation or from debt, is also relevant). Although the two subjects were distinct because the concept of comparative advantage applied in the first instance to international trade, while the corn model applied primarily to the subject of taxation, they were not entirely independent of one another. Both were connected to the subject of the division of labour because both the corn model and the concept of comparative advantage were designed to provide guidance towards the best possible allocation of resources to produce the largest and least costly supply of commodities for as many members of a commercial society as possible. In this respect, the two concepts were variations on the idea of utility, or, as Adam Smith’s followers put it, expediency. The aim of both was, in the first place, to identify a set of arrangements that could be designed to maximise individual and common utility and, in the second place, to identify and establish a corresponding set of fiscal and financial arrangements that could be relied upon to hold the first, utility-oriented, set of arrangements in place.
FIGURE 7. David Ricardo, On the Principles of Political Economy and Taxation (1817)
Ricardo explained the concept of comparative advantage in abidingly simple terms.1 If a country like Britain produced cloth but did not produce wine, it had an obvious incentive to produce a lot more cloth than was needed for domestic consumption because the revenue produced by exporting the surplus could then be used to cover the costs of importing wine. But even if a country like Portugal produced both wine and cloth, it still had an advantage in specialising in wine, not cloth, because wine could be made more cheaply in Portugal while cloth could be produced more cheaply in Britain. If each country favoured its most productive economic sector, each country would have a larger surplus of the commodity that it produced available for export and, consequently, a greater capacity to import larger quantities of the commodity that it did not produce from the country that produced it more efficiently. Comparative advantage meant, in short, that everyone would be a winner.
Over the years, the concept of comparative advantage has come to be seen as a double-edged sword. On Ricardo’s terms, it was designed to favour open markets, free trade, and frictionless transactions so that comparative advantage would work in ways that enabled poor underdeveloped economies to benefit as much as rich developed economies. To its critics, both in Ricardo’s time and now, comparative advantage has usually been said to have had the opposite effect. Instead of reciprocity it has produced dependence; instead of rebalancing the relationship between rich countries and poor countries, it has magnified their inequality; instead of a way out of the world of empire, slavery, and exploitation, it has generated the development of underdevelopment and favoured the formation of a modern world system divided comprehensively between a capitalist West and an exploited rest.2 On this interpretation, the solution to the problems built into the concept of comparative advantage has come to resemble Louis Blanc’s solution to the problems built into what, then, was his novel concept of capitalism. Capitalism, for Blanc, was the product of the private ownership of capital. Its beneficiaries were its owners, while its victims were those without capital. The solution was the nationalisation, or socialisation, of capital and the substitution of endogenous development (or development from within) for the real underdevelopment that had been exogenously imposed (or imposed from without).
Here too, however, the initial problem was not capitalism but the division of labour. Ricardo could see this very clearly both because it was something that Jean-Jacques Rousseau had described two generations earlier and because it had been amplified and discussed by his close friend Thomas Robert Malthus in his famous Essay on the Principle of Population of 1798 and, subsequently, in the long and animated private correspondence that Ricardo conducted not only with Malthus, but also with his other political economist friends, Sismondi, Mackintosh, and Jean-Baptiste Say. As Rousseau had pointed out, the fundamental problem with the division of labour was that it superimposed a spurious uniformity on different types of commodities and the needs that they were supposed to meet. Cloth was certainly exchangeable for wine, but individual consumers are usually more likely to buy a glass of wine a day than a piece of cloth a day. The same absence of comparability was even more strongly pronounced in the difference between subsistence goods like wheat, rye, or bread and items of discretionary consumption like portable phones, television sets, or microwave ovens. People have to eat and drink in order to survive, but they do not need to phone or watch TV to survive.
Rousseau’s initial point, therefore, was that the idea of comparative advantage seemed to reach its limits when it ran into human survival needs. Since everyone has to eat and drink, everyone needs a supply of basic subsistence goods; if this is the case, subsistence goods will frequently be produced under highly suboptimal conditions, and this, in turn, will mean that the costs of producing to meet survival needs will be relatively high, while the returns to the producers will be commensurately low. This, as Rousseau emphasised, meant that the producers of goods that were most fundamental for human survival were very much more likely to be poorly rewarded than those who produced things covered by discretionary expenditure. Agricultural production, he claimed, usually went hand in hand with poverty, but making jewellery did not. In this light, the development of the division of labour coupled with the concept of comparative advantage seemed to lead, at best, to a dead end and, at worst, to a far more literal version of human fatality.
Interestingly, and particularly in the light of his bleak diagnosis, Rousseau did not give up on the division of labour. Nor, though perhaps less surprisingly, did Ricardo. This is because the related concepts of comparative advantage and the division of labour can be described in two different ways. One way is to focus on commodities and the needs that they could meet. Another way, however, is to focus on the same set of commodities but this time to highlight the value that they could have. Since, as Rousseau had emphasised, these needs and values have very little relationship to each other, the differences between needs and values displayed by almost every type of commodity could be used to make the idea of comparative advantage work under conditions of real human diversity rather than under the conditions of the spurious uniformity imposed by markets and prices. This was Ricardo’s real insight and, contrary to the later caricatures produced by his Marxist critics, the key to his version of the concept of comparative advantage.
The full title of Ricardo’s most famous book was The Principles of Political Economy and Taxation. This, at least in part, was because the concept of comparative advantage had as much to do with taxation as it had to do with trade. The subject that encompassed both trade and taxation was, however, the subject of money and its relationship to both a national bank and a national debt. Ricardo spent some time thinking and writing about all three of these subjects. He incorporated part of a pamphlet entitled Proposals for an Economical and Secure Currency that he published in 1816 into chapter 27, dealing with currency and banks, of his Principles of Political Economy and, at the time of his death, was still at work on a second pamphlet entitled Plan for the Establishment of a National Bank that was published posthumously in 1824. A strong case could be made to argue that the subjects of money, banking, and debt were the keys to Ricardo’s treatment of trade and comparative advantage because, as he set out to show, they provided much of the leverage that was to be used to turn the differences between needs and values into the foundation of a system of trade based on comparative advantage. Ricardo’s interest in money and debt was long-standing, partly because he was a banker and partly because of the public prominence acquired by the two subjects during the period of the French revolutionary and Napoleonic wars. The starting point was the decision taken in 1797 by William Pitt’s government to fund the costs of war by issuing a paper currency that, among other things, could be used by the Bank of England, without gold or silver security, to purchase government debt. The decision, taken more or less concurrently with the almost total collapse of the French paper currency, the assignat, between 1793 and 1799, gave rise to a protracted public debate during the following dozen years over what came to be called “the currency principle” and “the bullion principle.” At issue was the extent to which the levels of prices, production, and prosperity were determined either by the quantity of money in circulation or by a specified ratio between the currency and gold or silver bullion and its putatively positive effects on price stability, production, and productivity.
Ricardo’s position was that a well-designed financial and fiscal system would make it possible to have the benefits of both the currency principle and the bullion principle. This in turn would make it possible to reconcile the real benefits of comparative advantage with the real differences in human needs and circumstances. In this respect, his argument for a fiscally and financially based currency was rather like Hegel’s argument in favour of a state-funded system of administration. The fundamental attribute of the two systems was credit. For Hegel, credit was built into the hierarchy of administrative institutions that straddled civil society and the state. The absence of any independent source of income in the administration meant that it would have to rely as much on borrowing and lending as on taxing and spending. The same applied to Ricardo’s idea of a paper currency. It too would be credit based, and, because it was, its value and stability would have to be tied to a fiscal and financial reserve. “A currency,” he wrote, “is in its most perfect state when it consists wholly of paper money, but of paper money of an equal value with the gold which it professes to represent. The use of paper instead of gold, substitutes the cheapest in place of the most expensive medium, and enables the country, without loss to any individual, to exchange all the gold which it before used for this purpose, for raw materials, utensils and food; by the use of which, both its wealth and its enjoyments are increased.”3
Ricardo made it clear that the quantity of a paper currency that could be issued would have to be limited by subjecting the institution responsible for its creation, whether it was the state or an institution like the Bank of England, to the obligation to pay its notes either in gold coin or in bullion. In addition, there could be a set of commissioners, or something like a National Bank or a Federal Reserve, with the power to issue the paper currency “totally independent of the control of ministers,” as Ricardo put it.4 This fiat currency would be something like the long-established national debt, but it would not bear interest. The commissioners could, therefore, use it to manage the rate of interest on the real national debt by purchasing quantities of debt and issuing equivalent quantities of the currency to do so. This, in conjunction with the reserve requirements that would set a ceiling on the quantity of paper currency to be issued, would enable the commissioners to manage interest rates in ways that could be combined with the more directly political and accountable process of managing taxation to bring the relationship between needs and values into what, in the final analysis, was a more moral alignment. Taxes on goods with a high value but a low utility could be used to offset tax exemptions on goods with a low value and a high utility. Tax revenue could also be used to maintain gold reserves and, consequently, loosen the constraints on the money supply, while, in other circumstances, the opposite types of procedure could apply. Comparative advantage, in this setting, was a product of fiscal and financial incentives or disincentives as much as it was an effect of costs and productivity. It could accommodate changes of policy as well as changes in the underlying economies of both rich states and poor states because its real foundations were not to be found in the relative costs of imported or exported commodities but in the financial and fiscal systems on which both importers and exporters were obliged to rely. With Ricardo, monetary policy and fiscal policy could be used to manage markets, and, as a result, capital could be used to neutralise, offset, or circumvent the otherwise relentless logic of the division of labour and the proliferating imperatives of the various types of commercial society that it brought in its wake. Empires existed long before—and long after—the idea of comparative advantage. There is no reason to conflate Ricardo’s distinctive concept with the more generic concept of empire.