David Ricardo, (1772-1823). While Adam Smith was the first great classical economist, David Ricardo was the second. He is known for his development of the concept of comparative advantage.
Career Successor to Adam Smith's pre-eminent position in British economics, his influence continued to dominate the aims and methods of the discipline throughout the nineteenth century. Despite his own considerable practical experience, his writings are severely abstract and frequently difficult. His chief emphasis was on the principles of diminishing returns in connection with the rent of land, which he believed also regulated the profits of capital. He attempted to deduce a theory of value from the application of labour, but found it difficult to separate the effects of changes in distribution from changes in technology. The questions thus raised about the labour theory of value were taken up by Marx and the so-called `Ricardian socialists' as a theoretical basis for criticism of established institutions.
Ricardo's law of rent was probably his most notable and influential discovery. It was based on the observation that the differing fertility of land yielded unequal profits to the capital and labour applied to it. Differential rent is the result of this variation in the fertility of land. This priciple was also noted at much the same time by Malthus, West, Anderson, and others. His other great contribution, the law of comparative cost, or comparative advantage, demonstrated the benefits of international specialisation of the commodity composition of international trade. This was at the root of the free trade argument which set Britain firmly on the course of exporting manufactures and importing foodstuffs. His success in attaching other economists, particularly James Mill and McCulloch, to his views largely accounted for the remarkable dominance of his ideas long after his own lifetime. Though much of this was eventually rejected, his abstract method and much of the theoretical content of his work became the framework for economic science at least until the 1870s.
Writing 40 years before Ricardo, Adam Smith had emphasized gains from trade based on absolute advantage. Smith saw trade as, among other things, a way of promoting efficiency. Smith anticipated modern theories of trade, competition, and growth, arguing that trade both fosters competition and provides opportunities to specialize and gain economies of scale. However, Smith emphasized absolute rather than comparative advantage. This view begs the question: what if a country is bad at making everything? Will trade drive all producers out of business? The answer, according to Ricardo, is no. The reason is the principle of comparative advantage, arguably the single most powerful insight in economics. While Smith understood comparative advantage, it was left to Ricardo to formalize the concept.
Ricardo was born in London on April 19, 1772. Like his father, he made a fortune on the London Stock Exchange. This made it possible for him to pursue a wide range of interests, including science, mathematics, and literature. In 1799 he read Adam Smith's `Wealth of Nations', and for the next ten years he studied economics closely. His first book, `The High Price of Bullion' (1810), argues against the inflationary policies of the Bank of England. His major work is `Principles of Political Economy and Taxation' (1817). Ricardo entered Parliament in 1819 and exerted a strong influence on free-trade policies. Illness forced his retirement in 1823, and he died on September 11 of that year in Gloucestershire.
David's Theory of Comparative Advantage
David Ricardo, working in the early part of the 19th century, realized that absolute advantage was a limited case of a more general theory. It can be seen that Portugal can produce both wheat and wine more cheaply than England (i.e. it has an absolute advantage in both commodities). What David Ricardo saw was that it could still be mutually beneficial for both countries to specialize and trade.
If both countries now specialize, Portugal producing only wine and England producing only wheat, total production is 18 units of wheat and 12 units of wine. Specialization has enabled the world economy to increase production by 1 unit of wheat and 1 unit of wine.
If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not thereby be diminished... but only left to find out the way in which it can be employed with the greatest advantage."
What did David Ricardo mean when he coined the term comparative advantage? According to the principle of comparative advantage, the gains from trade follow from allowing an economy to specialize. If a country is relatively better at making wine than wool, it makes sense to put more resources into wine, and to export some of the wine to pay for imports of wool. This is even true if that country is the world's best wool producer, since the country will have more of both wool and wine than it would have without trade. A country does not have to be best at anything to gain from trade. The gains follow from specializing in those activities which, at world prices, the country is relatively better at, even though it may not have an absolute advantage in them. Because it is relative advantage that matters, it is meaningless to say a country has a comparative advantage in nothing. The term is one of the most misunderstood ideas in economics, and is often wrongly assumed to mean an absolute advantage compared with other countries.
The simple theory of comparative advantage outlined above makes a number of important assumptions:
* There are no transport costs.
* Costs are constant and there are no economies of scale.
* There are only two economies producing two goods.
* The theory assumes that traded goods are homogeneous (ie identical).
* Factors of production are assumed to be perfectly mobile.
* There are no tariffs or other trade barriers.
* There is perfect knowledge, so that all buyers and sellers know
where the cheapest goods can be found internationally.