Obituary: Ricardian Economics, 1817-2020

Ricardian Trade. The Macro 101 belief made famous by English economist, David Ricardo, that it is better for a country to produce 100% what it has a comparative advantage, rather than anything else, makes the country better off every time due to trade if the trade partner produces the other good, which by definition it will have a comparative advantage, died in 2020.

Comparative Advantage, the main teaching of Ricardian Economics, lived a good life. It was the basis for which the United States became a service producing country and imported most of its hard goods. Life peaked for it when NAFTA was signed, accelerating the balance of good trades out of the United States in 1994. It fell ill with the election of Donald Trump, serious questions started to rise about what America’s purpose was, if just to print money in exchange for goods. The death blow came from the COVID-19 pandemic. The pandemic pointed out serious flaws in relying on foreign goods when a global crisis was causing those goods to be horded abroad. If a country was producing something critical to combating the pandemic, why ship it overseas when it could help at home? The USA found themselves S.O.L. when it came to sourcing PPE, drug ingredients, and things like hand sanitizer.

It’s death comes from the flaw of economics calling itself a science, it is not. Ricaridian Trade only works in theory with strict parameters. Those parameters include a world with only two countries, no costs to import export, only two wigits to be traded, and wigits of identical quality. Throwing out quality, we will not get into the shoddy Made in China problem. For this example let’s call our two wigits goods and services. Let’s say our first example country is the U.S. and in the U.S. it takes 100 hours to produce a unit of service and 120 hours to produce a unit of goods, the U.S. has an advantage in services because it gets 1 unit of service in 100 hours while in the same time the unit of good is only 5/6 the way finished.

The other country, lets call it China, is a little more efficient due to cost of labor we all recognize. It can produce a unit of service in 90 hours and a unit of good in 80 hours. In this country it is better at producing goods in 80 hours than needing 90 to produce a service.

Classically, economists have looked at this chart and said, “US, it takes you 220 hours to produce one good and one service, both of which you want to consume. China, on the other hand, you need 170 hours to get one of each. Why doesn’t the U.S. spend that 220 hours to make 2.2 units of service and China, spend 170 hours to produce 2.175 units of goods. You all can trade and there will be more overall and everyone is happy!”

For awhile this all made sense to me, trade makes everyone better. However, there is not two goods in this world, there are unlimited goods of unlimited quality. The second revelation I had is that we are not at our limit when it comes to hours worked, aka we don’t spend all of our 220 hours from this example. We have more capacity as a country to produce goods, while still specializing in services. The last assumption that doesn’t hold is the concept of free trade, it’s not. There are costs to ship goods and services across the ocean, costs associated with re-allocating resources from a good producer to a service, and costs due to changes in prices when goods become more or less expensive or services on the flip side.

Trade protectionist have been on this for awhile. They have rang the alarms when Ford moves a plant from the U.S. to Mexico or a large corporation off-shores its IT services to India. The backlash is unoriginally the same, these are racist dinosaurs protecting a dying industry. What the COVID pandemic brought forward is that production at home matters. We need physical things produced here when times are tough and the benefit we got from comparative advantage is not worth the risk. America’s #1 export is starting to be printed dollars and one day soon that comparative advantage joke is going to be over and we are going to wish we had industries to satisfy our needs..