The Fallacy of Comparative Advantage
- by Wayne Bereman
The United States was formed as and prospered, for roughly a century and one half, as a national, protected free market economy.
This historical fact, however, is often unknown to policy makers, elected officials, educators, and to the general public. It’s very
important, therefore, to remind free traders of this fact before proceeding with a discussion on economic policy. After dispelling any
misnomers about what is, and what is not a free market economy (see my short essay on our archives page for an introduction to
that topic), the next step is to remind the free trader that the idea of free trade is an idea that is foreign to the formation and growth of
the United States into an economic powerhouse. A good next point of discussion is the theory upon which unilateral, unquestioned
free trade is built; comparative advantage (or comparative cost).
The supposed superiority of free trade and the unassailable truth of comparative advantage is often so thoroughly indoctrinated into
folks at the university level, that to question it usually is met with a soap box and an arrogant retort to go back to economics 101, or
international economics 201. In fact, it’s so thoroughly reinforced that I believe most economists, policy makers and educators now
accept is as dogma. So, let’s go to the source of the brainwashing and examine it. Let’s go back to an economics text. There is an
entire international economics text book available online. It was written by Steven M Suranovic, and is entitled “International Trade
Theory and Policy”. A simple Google search will reveal it. It’s not unlike most texts, and Suranovic is a very popular author of college
economics text books.
In the first paragraph of the section entitled “The Theory of Comparative Advantage – Overview”, Suranovic tells a story about Paul
Samuelson regarding Samuelson’s belief that comparative advantage is an example of a meaningful and non-trivial result of the
economics discipline. Of course, Samuelson is correct, comparative advantage has been both meaningful and non-trivial. It is also
false and destructive, but certainly not trivial.
Suranovic then begins his discussion of what Comparative Advantage is. Suranovic writes “First, the principle of comparative
advantage is clearly counter-intuitive. Many results from the formal model are contrary to simple logic.” What?! Suranovic believes
in Comparative Advantage (CA), but admits that is false?! If the model is contrary to logic, and logic is the study of propositions, and
truth is propositional, what is contrary to simple logic is contrary to truth. In other words; it’s false. Many of you would probably be
wise to quit reading right there. What else do you really need to know? This speaks directly to the very point of my assertion that CA
is accepted as dogma. It is only by completely turning off one’s cognitive processes that a theory that is “contrary to simple logic”
can be accepted as true.
In reality, comparative advantage was a theory created to answer a simple question: “why should a nation superior in the production
of all things trade with a nation inferior in the production of all things?” In the Suranovic text, and in most any other international
economics text, the idea of trade on the basis of comparative advantage is contrasted with autarky (no trade). The advocates of CA
do not, generally, even address the realities of trade on the basis of absolute advantage (which Suranovic describes as a particular
of the CA universal), or of protected trade. Instead they advocate only free trade, regardless of the degree of superiority one nation
may have in its production possibilities.
What is false in logic is false. Without even moving forward, the reader already knows, from the mouth of a dogmatic supporter of
CA that it is false. Now the question is: Why? Another question is: Is there any evidence of the falsity in the United States now that
free trade, which has been adopted on the basis of CA, has grown more and more widespread?
CA is based on opportunity costs, and what it does is claim that the opportunity cost of producing products that are produced less
efficiently than other products by a nation should be purchased from other nations that have the opposite relationship. For example,
if the United States is better (more efficient) at producing cars than it is paper, it should produce cars and stop producing paper, if
there is a trading partner that can produce paper better than cars. That sounds fine, but it doesn’t completely explain comparative
advantage. The above example could also be trade on the basis of absolute advantage. (if the reader is not familiar with absolute
advantage, they should return to the American Protectionist homepage and click on Adam Smith’s Inquiry into the nature and
causes of the Wealth of Nations). Remember the question that CA is attempting to answer. To trade on the basis of CA, the United
States in the above example should be understood to be superior in the production of BOTH cars and paper, but to have a larger
advantage in cars. For example, the United States might be able to produce 100 units of cars by investing quantity X of scarce
economic resources, and 50 units of paper for the same investment of resources. Its trading partner might be able to only produce
10 units of paper and 5 units of cars when its quantity X of economic resources are employed. In this example, the United States
has a comparative advantage in cars and a comparative disadvantage in paper (even though it can produce 5 times as much paper
as its trading partner). By employing 2 units of economic resources into the production of cars, the United States should produce
200 units cars and 0 paper instead of 100 cars and 50 units of paper. Its trading partner should produce 20 units of paper and 0
units of cars (instead of 10 units of paper and 5 units of cars). On this basis, total world production is said to increase. This is
supposedly the goal of CA; to increase total world production. It’s based on many assumptions which we will examine shortly. If
the nations did not trade, the U.S. would have invested 2X of resources, its trading partner would have invested 2X of resources and
the total world production would have been 105 units of cars and 60 units of paper. By trading, the total world production after 4X
resources are employed will be 200 units of cars and 20 units of paper. This all ignores the demand for cars and paper, the desire
of Americans to be in the business of paper production or of its trading partners to produce cars, and it makes all kinds of
assumptions. I’m sure a critical reader has already begun listing problems with CA that are not answered.
Since CA is an illogical proposition and false (according to Suranovic, a well respected expert), it is always advocated in reverse, by
giving numerical examples. The student is trained to reason backward from the particular and accepts the universal. But we know
from the study of logic that a particular can be true while the universal is still false. It’s fallacious to reason from a conclusion.
Truly, numbers can be made to do almost anything a clever writer wants them to do when he sets up the examples himself. And
because when a major premise is false, all the subsequent reasoning can be accurate but a false conclusion still results, it makes
no sense to go very deep into the numerical examples used to attempt to justify CA. If the reader is interested, Suranovic’s text goes
much deeper using both numerical and algebraic reasoning. But remember, a faulty major premise, even with sound minor
premises, results in a false conclusion. CA is “contrary to simple logic”.
Why? Comparative Advantage is reasoned from a conclusion. The conclusion is a worldwide market economy. WITHIN a market,
there should be *exchanges on the basis of comparative advantage. Truly, within a market, comparative advantage boils down to
simple specialization. But the truth of specialization WITHIN a market has nothing to do with trade BETWEEN markets. The United
States was formed as a NATIONAL free market economy. Free trade is the first step toward a GLOBAL free market economy (free
trade creates a global division of labor, 1 of the 4 requirements of a free market economy).
That worldwide market economy, by the way, comes with some very sinister implications; such as open borders. If you desire to
engage in the production of a product that CA says should be produced overseas, you have to move overseas to do it. But since the
free flow of people is a little tougher to achieve than the free flow of capital, in your lifetime you may never have that freedom. Further,
you have to give up your national heritage to do it! This is why open borders immigration policy is a necessary result of free trade on
the basis of CA! (this is an entire other topic that I’ll address in a later article. I just wanted to mention it now as it’s such a ‘hot
button’ topic)
There’s an often told story in economics. Three men are stuck in a 10 foot deep hole in the ground and they cannot escape. The
first man, a mathematician, attempts to calculate how long they will live, and if they can climb out by climbing on top of each other.
He decides it won’t work and is very distraught. The second man, an athlete, attempts to figure out if he can build up his muscles to
jump out, but he realizes he doesn’t have enough time, and it won’t work. He is also very distraught. The third man, the economist
has a solution. His answer begins with the phrase “assume a ladder…”
It’s dangerous when “assume a ladder” becomes “the ladder is a material fact”. THIS is what has happened to too many
economics educators. The existence of a ladder that was really only an assumption has become internalized dogma.
CA ignores many realities. In my view, Ricardo (who is given credit for the theory of comparative advantage) intentionally ignored
them, perhaps for the purpose of being deceptive. Subsequent intellectuals certainly are guilty of this. Any honest reading of Adam
Smith, for example, cannot be completed without a tremendous respect for Smith’s strict belief in the benefits of domestic
production for domestic consumption. Smith was a protectionist, although many dogmatic free traders who have assumed the
ladder of comparative advantage will not accept it, due to their respect and admiration for Smith. This cognitive dissonance is very
common in universities today.
CA ignores the reality of transportation costs. CA ignores the reality of large variations of absolute advantage. CA ignores the reality
of dumping, subsidization of exports, differences in law, and other inequities that exist BETWEEN nations and markets (but not
within a national market system). CA ignores the political impact of free trade on the political economy (so much so that the study of
political economy has now become the studies of politics, and economics, as though they are not related. Truly, many folks now
graduate with economics degrees thinking that economics is a science of ends, not a science of means. If they were to go back to
the foundational works in economics they would see that economics is a science of the means of achieving predetermined ends,
some of which are political). CA assumes uniform technology. CA (and free trade which is the political goal of CA) ignores the
marginal theory of value and drastically overvalues labor (in fact, Ricardo was a labor theory of value theorist, not unlike Marx). CA
ignores the desire of individuals to choose their profession, as it advocates the total destruction of entire industries in a given
nation. CA ignores the 4 requirements of a free market economy, and only deals with creating a shared division of labor. CA
ignores the value of capital accumulation in creating higher wage rates and standards of living. CA ignores the velocity of money
and Smith’s proof that domestic production for domestic consumption employs twice as much domestic labor. In short, CA
assumes an entire hardware store of ladders, but is still accepted as a dogmatic and unassailable foundation for global free trade.
Let’s go a little further into the question of what made the United States the economic powerhouse that it was, and why CA (and its
political corollary of free trade) is dismantling it.
The United States was formed as a sovereign nation with the goal of being independent. The economic means employed to
achieve this political goal is now called protectionism. Revenue for government was raised by taxing foreign corporations for
exporting to the United States consumer market. There was no Federal income tax, nor a need for it. Domestic capital was
invested in domestic production facilities. When foreign products were consumed a tariff balanced the trade deficit and there was
no loss of capital investment in production. Debt did not have to be issued to fund the operations of limited government and
consumers did not consume future production (this is the meaning of a trade deficit in consumer goods. Today’s consumption is
paid for by the work of future generations, and interest is paid on it. Sound good to you?).
However, under the Articles of Confederation, there was no social cohesion because there was not a common market. Each state
had its own currency, its own banking and contract laws. There was no uniformity. The system was failing. Truly, to assimilate
these states into a common union could NOT have been achieved without eliminating the trade barriers as a first step toward a
common market. Instead of that incremental approach to a common system (as we see today globally, and which was successful
in destroying the sovereignty of the European nations), a new system was formed. That new system, which was ratified in 1789
formed a common market and bound the United States into an indissoluble union. Truly, it would be impossible to break this union
up, and when the south attempted to do just that (expressly by their refusal to collect the tariff, attempting thereby to form their own
market) they were slapped down. The market is the most powerful force that creates a cohesive social nexus.
The great Austrian economist Ludwig Von Mises knew this. Von Mises identified four requirements of a free market economy: 1)
private property, 2) no institutional interferences, 3) the division of labor and consequent free exchanges within it, and 4) a coercive
government to adjudicate disputes. When a free trader states that we are part of a global market; correct him. We are not part of a
global market until the requirements of a global market are met. However, understand that we are en route to a global market, and
with it comes the global government part. CA assumes a global division of labor. Upon this basis, there should not be tariffs. Just
as it makes no sense for Ohio to put a tariff on goods from Michigan, if Ohio and China are part of a common market, it makes no
sense for there to be a tariff between these exchanges either. But nowhere in the United States Constitution is there the desire to
be part of a global system of interdependence.
Frederic Bastiat, a famous advocate for free trade and highly regarded intellectual said that free trade was not simply an economic
agenda, but instead intended to create an indissoluble, ecumenical union of the peoples of the world. If you can’t take his word for
it, whose word will you accept? By the way, when Ronald Reagan took office the United States was perhaps the world’s largest
creditor nation. By the end of Reagan’s term, it was the world’s largest debtor nation (if not yet, soon thereafter). Reagan’s favorite
philosopher? Bastiat.
Von Mises explained in detail that by far the most important determinant of wage rates and standards of living is the per capita,
capital investment per worker. In other words, if you invest your capital in worker training, new plants, new equipment, and
developing land into production facilities; you will prosper. Under 150 years of protectionism and the Hamiltonian economic system
of the protected free market economy, the United States became the world’s most efficient and productive producer of virtually all
manufactured goods. Under CA and free trade, the United States then stopped investing capital in domestic production centers,
and instead invested it in foreign production centers. It was Japan that got new production facilities. Today it is Mexico and China
who are the beneficiaries of United States investment in workers. In the 1950s and 1960s roughly 33% of Americans worked, and
they were paid as wages about 45% of GDP. Today, over 43% of Americans are working, and they are paid about 33% of GDP in
wages. More people working for less take home. Dogmatic followers of CA and free trade (as a driving force of economic growth)
have to believe that more people working for less of what they produce is better. In my view, that requires thrusting one’s head pretty
deeply in the sand.
Some honest economists will state that the infant industries argument is a valid defense of protectionism. The infant industries
argument states that protection of domestic industries has merit if those industries are newly forming. But free trade doctrine must
believe that “good can be bad”, because CA and free trade advocate abandoning those protections later, regardless of any absolute
advantage acquired, and ignoring the cause of economic growth and increased wage rates and standards of living. In other words,
protect your industries while they are infants, but let them be torn down later by consuming foreign products instead, so long as the
labor employed in those foreign products is cheaper. You build an industry, and then abandon it on the basis of CA, ignoring
absolute advantage (among all the other things CA ignores). After all, if a Chinese worker can live on $10 a day, it simply must be
advantageous to invest capital there (well, it may be advantageous for a multi-national corporation, but not for American workers or
consumers!). After all, the protection of the domestic industries will cause the domestic wage rates and standards of living to grow
until they tower over the rest of the world (the United States is the case in point). Opening up the market to the free importation of
products from command economies with standards of living that are only a fraction of the domestic standards will create exactly
what you see happening; workers in the United States working more jobs, longer hours, and for less pay. Entire industries are
outsourced and destroyed, and the political goals of moving toward inter-dependence (instead of in-dependence) win the day. The
answer to this argument always deflects, and the free trader says “but look at all the cheaper goods that you are able to consume”.
This ignores the profit motive of those foreign producers and the marginal theory of value. Over time (often very quickly) the price of
those “cheaper” foreign goods equals or exceeds what it would have been from domestic production. A simple reality of economics
is that consumers demand a certain quantity at a certain price. The foreign producer is not going to sell products for a small
marginal profit when he’s able to sell them for a larger marginal profit. Once the domestic competition is destroyed, only the foreign
producers are left. Prices will keep going up, up, up.
In fact, a nation that offered unlimited opportunity no longer does. Entire industries are being eliminated. There was a time, under
the protected national economy, that the American dream of choosing your profession and earning enough money to care for your
family was a reality. Now, if you want to work in textiles, for example, you need to move to China to do so. Your choice of
professions is rapidly disappearing. Even the free traders admit: there is a shift to a “service economy” underway. Worse still, now
most folks cannot support a family with only 1 income; now it requires two. When the wage rates continue to drop under CA, you’ll
observe more and more families moving into one house with their parents and grandparents. It will take multiple wage earners to
support their taxes, debt service, and to buy the necessaries of life. You’ll also continue to see deterioration in the standard of
living. There will be more poverty, more crime, more fraud, and eventually immigration won’t be a problem, everyone will be leaving
to find jobs elsewhere. TAxes will never stop increasing as the need for safety nets will never cease. Social Security is a system in
crisis; does anyone believe the Social Security taxes will not need to be increased?
Some conservatives will advocate free trade, but still lament the social effects of massive importation of foreign workers (more and
more often, illegally). I agree, there are serious adverse consequences to creating an illegal underclass of undocumented workers
that do not even speak English. But these folks do not recognize the massive social cost of consuming foreign production without a
tariff to balance the trade. We have a Social Security crisis in this country that will result soon in the increasing of Social Security
taxes or a decrease in benefits (or both). How much of the price of a product produced in China is paid to Social Security? (none)
How much of the price of a product produced domestically goes to this purpose? (some). What about the property tax paid by the
manufacturer? How much of it is invested in the domestic education system from a foreign producer? How much do foreign
producers pay to the domestic health care system? How much domestic infrastructure is created by foreign production? CA
ignores all of this as well. It “ignores the 10 foot hole, and assumes a ladder to get out anyway”.
Finally, free traders always say that because foreign holders of U.S. Dollars have to “reinvest them” here, there is no disadvantage
to a massive trade deficit. (never mind of course that the enormous Federal Debt that results requires drastic inflation of the
currency, which destroys the standard of living) But this reality of debit/credit accounting has no deeper meaning in economics than
just that. When those dollars are “repatriated”, it is in the form of the purchase of bonds (used to pay for consumption due to the
deficit), in the form of land, or in stock/equities. They either buy our companies, buy our real estate, or finance our over-
consumption, (or they can hold the dollars at a loss of course).
I look forward to receiving your feedback on this topic and I’m willing to address any questions you may have. This is a very complex
topic and it’s impossible to discuss all of the various arguments and ideas surrounding trade policy in a single essay. But I hope
this essay reinforces in the reader’s mind the legitimacy of the traditional American economic system of a protected free market
economy; a nationalist state independent from the rest of the world. Remember, protectionism is not isolationism. In fact, with
protected trade, there is no down side to consuming some foreign products; the taxes paid on those products will reduce or
eliminate the burden on consumers to pay sales tax, income tax, and will fund the federal operations of government and improve
the domestic infrastructure. It’s only by giving away for free the valuable right of access to the large United States consumer market
that starts the nation down the slippery slope to global interdependence and the eventual complete loss of nationalistic sovereignty.
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