Comparative Advantage is Not About Trade

by johnswentworth2 min read22nd Sep 202022 comments


EconomicsRationalityWorld Modeling

Braudel is probably the most impressive historian I have read. His quantitative estimates of premodern populations and crop yields are exactly the sort of foundation you’d think any understanding of history would be based upon. Yet reading his magnum opus, it became steadily clearer as the books progressed that Braudel was missing some fairly fundamental economic concepts. I couldn’t quite put my finger on what was missing until a section early in book 3:

... these deliberately simple tautologies make more sense to my mind than the so-called ‘irrefutable’ pseudo-theorem of David Ricardo (1817), whose terms are well known: that the relations between two given countries depend on the “comparative costs” obtaining in them at the point of production

Braudel, apparently, is not convinced by the principle of comparative advantage. What is his objection?

The division of labor on a world scale (or on world-economy-scale) cannot be described as a concerted agreement made between equal parties and always open to review… Unequal exchange, the origin of the inequality in the world, and, by the same token, the inequality of the world, the invariable generator of trade, are longstanding realities. In the economic poker game, some people have always held better cards than others…

It seems Braudel is under the impression that comparative advantage is only relevant in the context of “equal” exchange or “free” trade or something along those lines.

If an otherwise impressive economic historian is that deeply confused about comparative advantage, then I expect other people are similarly confused. This post is intended to clarify.

The principle of comparative advantage does not require that trade be “free” or “equal” or anything of the sort. When the Portugese or the British seized monopolies on trade with India in the early modern era, those trades were certainly not free or equal. Yet the monopolists would not have made any profit whatsoever unless there were some underlying comparative advantage.

For example, consider an oversimplified model of the salt trade. People historically needed lots of salt to preserve food, yet many inland areas lack local sources, so salt imports were necessary for survival. Transport by ship was historically orders of magnitude more efficient than overland, so a government in control of a major river could grab a monopoly on the salt trade. Since the people living inland could not live without it, the salt monopolist could charge quite high prices - a “trade” arguably not so different from threatening inland farmers with death if they did not pay up. (An exaggeration, since there were other ways to store food and overland smuggling became viable at high enough prices, but I did say it’s an oversimplified example.)

Notice that, in this example, there is a clear underlying comparative advantage: the inland farmers have a comparative disadvantage in producing salt, while the ultimate salt supplier (a salt mine or salt pan) has a comparative advantage in salt production. If the farmer could produce salt with the same opportunity cost as the salt mine/pan, then the monopolist would have no buyers. If the salt mine/pan had the same opportunity cost for obtaining salt as the farmers, then the monopolist would have no supplier. Absent some underlying comparative advantage between two places, the trade monopolist cannot make any profit.

Another example: suppose I’m a transatlantic slave trader, kidnapping people in Africa and shipping them to slave markets in the Americas. It’s easy to see how the kidnapping part might be profitable, but why was it profitable to move people across the Atlantic? Why not save the transportation costs, and work the same slaves on plantations in Africa rather than plantations in the Americas? Or why not use native American slaves entirely, rather than importing Africans? Ultimately, the profits were because the Americas had a lot lower population density - there was more land, and fewer people to work it. Thus, labor was worth more in the Americas (and that same comparative advantage drove not just the slave trade, but also immigration and automation). Without a comparative advantage, enslaving people might still have been profitable, but there would be no reason to ship them across the Atlantic.

Let’s take it a step further. This argument need not involve any trade at all.

Suppose I’m the dictator of some small archipelago. I have total ownership and control over the country’s main industries (bananas and construction), and there’s an international embargo against trade with my little country, so there’s no trade to worry about either internally or externally. Let’s say I just want to maximize construction output - although I will still need to order some banana-growing in order to keep my construction workers fed.

The question is: who and where do I order to grow bananas, and who and where do I order to build things? To maximize construction, I will want to order people with the largest comparative advantage in banana-growing to specialize in banana-growing, and I will want to order those bananas to be grown on the islands with the largest comparative advantage in banana-growing. (In fact, this is not just relevant to maximization of construction - it applies to pareto-optimal production in general.) There’s no trade; I’m just using comparative advantage to figure out how best to deploy my own resources.

Takeaway: comparative advantage is not a principle of trade, it’s a principle of optimization. Pareto-optimal production means specialization by comparative advantage.