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Today is an important anniversary. It is part of the explanation of why we design chips in silicon valley but manufacture them in Taiwan. Or why, on the back of every iPhone, it says "Designed by Apple in California, manufactured in China."
On this date exactly 200 years ago, April 19, 1817, David Ricardo published The Principles of Political Economy and Taxation. This contained a description of "comparative advantage" which is widely regarded as both one of the most powerful but also counterintuitive ideas in economics. Paul Krugman calls it "Ricardo's difficult idea".
A good start to understanding the theory of comparative advantage is simply to look at transactions. If I buy a chair off you for $100, the key thing to note is that the transaction makes us both better off. I wanted the chair more than $100 (otherwise I wouldn't have bought it) and you wanted $100 more than the chair (otherwise you wouldn't have sold it). Although it is less obvious, this remains true when scaled up. I buy a gallon of milk for $3 and I'm better off since I wanted milk more than $3, and Safeway wanted $3 more than milk. Nothing is changed by the fact that Safeway is only stocking milk in the first place in the expectation that people like me will come by and purchase it.
Absolute advantage comes about when one entity (which can be an individual, a company, or a country) is absolutely better at making some product than somewhere else. Things get more complex when more than one product is involved.
The theory of comparative advantage comes then, especially when one entity is better at making both products than another. Surely, the worse entity can never benefit from any transactions and will be in trouble? Ricardo's insight was that this is not true.
In Ricardo's era, he used the example of cloth and wine, and England and Portugal, with the number of hours of labor required to produce a unit shown in the table below:
The first thing to note is that Portugal has an absolute advantage in producing both cloth and wine, requiring fewer hours of labor than England in both cases. But England has a comparative advantage in producing cloth. It is much worse at producing wine than Portugal, but only a bit worse at producing cloth, and thus comparatively better at producing cloth. If the default position is that both countries produce their own cloth and wine, they will not have as much as if Portugal specializes in wine, and England in cloth, and they trade. Both England and Portugal can consume more wine and more cloth than under the self-sufficient scenario. I'll leave it as an exercise to work through the math, but basically it is a waste for Portugal to spend time producing cloth, when instead it could produce more wine and trade it for more cloth than it could have got from the same labor.
Now you know why heart surgeons don't mow their own lawns. At the margin it makes more sense to do one more heart operation, and use the money to cover a whole year of lawn mowing.
As a result of this, economists are unanimous in agreeing that free trade is a benefit to both countries. But you can see from this example, that it can be true in the aggregate but still produce winners and losers. In the artificial wine and cloth world, the wine producers in England will lose their jobs, which might not matter as long as they can sell their labor into the booming cloth industry, but skills are not always fungible like that. Laid off factory workers cannot easily become neural network experts. We use "Luddite" as a somewhat derogatory term as if the Luddites were misguided. They were on the wrong side of history, to be sure. But they were absolutely correct that their livelihood as manual weavers would be destroyed by automatic looms.
Of course, laws can be used to ban technology, too. A famous, probably apocryphal, story is about Milton Friedman, the Nobel-prize-winning economist visiting India (yes, I know, technically it's not a Nobel prize). A large hole is being dug by hundreds of laborers with shovels. He asks why they don't use bulldozers. He is told that this way creates more jobs. After thinking for a moment, he replies, "Why don't they make them use spoons?"
Talking of trade and Milton Friedman, here is a wonderful analogy that is hard to forget once you have heard it. It comes from David Friedman, son of Milton. I first came across this analogy in Steven Landsburg's wonderful The Armchair Economist. Also, in a weird coincidence, I was at his house about 10 days ago. I say weird coincidence since the date of this post was preordained 200 years ago.
Here's his analogy:
There are two ways to make cars in the US. One is to make them in Michigan (or, increasingly these days, the US south). The other is to grow them in Iowa. You already know about the Michigan way. The other way is to grow corn. The corn is then put onto trains and taken west to where they have a magnificent factory of some sort. But anyway, a few months later, the same trains return laden with cars. Somewhere out there, they have some amazing technology that can turn corn into cars.
Of course, you and I know that there is no such amazing factory. The corn is shipped off to Korea and Japan. It is trade that is the amazing factory. Trade is just a form of technology.
Talking of Steven Landsburg, I can't resist finishing this post with one of his anecdotes. When his daughter was small, she came home from Jewish primary school and said her homework was to complete the sentence "To be more like God, I will..." Presumably her teacher was looking for something like "keep my room clean" or "be kind to animals." Her father suggested "kill the first-born sons of my enemy." Don't miss The Armchair Economist or his other books, if you like that sort of counterintuitive statement that makes you think.