President Barack Obama, during a May speech in Oregon, insisted that the Trans-Pacific Partnership (TPP) trade deal is good for small-business workers, helps the middle class, and maintains U.S. trade power versus China, which is not a signatory to the 12-nation pact.  “This is not a left issue or right issue, or a business or a labor issue,” Mr. Obama maintained.  “It is about fairness and equity and access.  And like other issues that we’ve waged slow, steady fights on over the last seven years, this is also a question of the past versus the future.”

Indeed, the political left and right united later in the month, with Democrats and Republicans in the U.S. Senate voting to end debate on the international business agreement.  The deal, if approved, would lower tariffs and trade barriers to commerce among Australia, Brunei, Canada, Chile, Japan, Malaysia, New Zealand, Peru, Singapore, Vietnam, and the United States.  Ten other countries, including India, are potential members, though China is not one of them.  The agreement must still pass the House, whose Republican leadership has said Democratic votes will be necessary to approve the measure.

Central to the TPP is comparative advantage, a 19th-century economic concept.  Though Mr. Obama did not mention the idea in his speech, others have cited it to defend the deal.  Syndicated columnist Charles Krauthammer wrote, “That free trade is advantageous to both sides is the rarest of political propositions—provable, indeed mathematically.  David Ricardo did so in 1817.  The Law of Comparative Advantage has held up nicely for 198 years.”  Krauthammer is correct that comparative advantage is the basis for international trade, including agreements, though the idea has more dimensions than his simple explanation.

Ricardo argued that differences in what economists call “factor endowments” (land, labor, and capital) lead to trade gains between two nations.  Chapter 7 of his 1817 book, On the Principles of Political Economy and Taxation, provides an example using Portugal and England.  Ricardo begins by assuming an absence of trade with any other nation (autarchy), asking readers to imagine that Portugal “had no commercial connexion with other countries” and did not already employ her capital to produce wines for trade.  For Portugal, in this example, “The quantity of wine which she shall give in exchange for the cloth of England, is not determined by the respective quantities of labor devoted to the production of each, as it would be, if both commodities were manufactured in England, or both in Portugal.”  England requires “the labour of 100 men for one year” to “produce the cloth,” and “the labour of 120 men for the same time” to make wine.  “England,” Ricardo concluded, “would therefore find it her interest to import wine, and to purchase it by the exportation of cloth.”  Portugal, by contrast, “might require only the labour of 80 men for one year” to produce wine, and “the labour of 90 men for the same time” to produce cloth.  Ricardo concluded that Portugal should “export wine in exchange for cloth . . . notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England.”  England trades the produce of 100 men for the labor of 80.  International trade, in sum, benefits England, Portugal, and their consumers.

Perhaps no writing of Ricardo captures pro-trade sentiment better than the sequence from his book in which he posits an alternative situation that he declares to be “advantageous to the capitalists of England, and to the consumers in both countries . . . ”  In this scenario, “the wine and the cloth should both be made in Portugal, and therefore . . . the capital and labour of England employed in making cloth, should be removed to Portugal for that purpose.”  Ricardo continues,

In that case, the relative value of these commodities would be regulated by the same principle, as if one were the produce of Yorkshire, and the other of London: and in every other case, if capital freely flowed towards those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labour price of commodities, than the additional quantity of labour required to convey them to the various markets where they were to be sold.

In this scenario, the emphasis is on the benefits enjoyed by the consumer, and the fact that labor is displaced—jobs are lost in England—because English capital has been outsourced is ignored.

In developing his theory of comparative advantage, Ricardo built upon Adam Smith’s idea of “absolute advantage.”  Smith used a single factor endowment (labor) to measure a nation’s ability to produce more goods than its rivals.  Labor—specifically the labor theory of value—is central to both Smith’s and Ricardo’s theories, but the labor theory of value was overthrown by economists in the late 19th century, and is irrelevant today outside of Marxian circles.  Thus, when considering the merits of comparative advantage, we must be careful not to view the idea through a lens fashioned in 1817, as some conservatives and libertarians do today.  And some aspects of Ricardo’s argument do not hold true outside of his theory, which assumes that capital and labor are immobile, and all trading is bilateral.  Measuring gains from multilateral trade is more complex.  Trade is dynamic, while Ricardo’s model is static.


Despite these issues, comparative advantage provides a sound basis for international trade; its opposite—autarchy—has proved infeasible except in rare historical episodes.  (Some libertarians overlook the autarchic nature of Robinson Crusoe’s economy, a staple of their textbooks.)  But if we are to restore comparative advantage to U.S. trade policy today, Ricardo’s theory requires an update.

Economists have been working on that update for over half a century, but some politicians and media celebrities have not been paying attention.

Hungarian economist Bela Balassa developed “revealed comparative advantage” in the mid-20th century as an index to measure advantages discerned from trade flows.  Indexes show which nations benefit from trade within economic sectors.  Review of Social Economy, published by the Association for Social Economics, examines comparative advantage’s modern dimensions.  In a 1999 article in that publication, John Davis notes that “The majority of mainstream economists believe that globalization and trade liberalization have had a minor role in increasing U.S. wage inequality.”  Davis argues for “a shift in policy perspective, to consider the ‘equity costs’ of trade liberalization in terms of eroded U.S. labor market institutions.”  Such a shift in perspective would produce “a larger framework for analyzing the consequences of globalization and trade liberalization than is available in traditional comparative advantage efficiency reasoning.”  In 2008, Geoffrey Schneider and Paul Susman advanced a theory of “comparative institutional advantage” that analyzes systemic differences among countries.  These differences lead some businesses to arbitrage production.  Capital can be exported to benefit from lower labor costs, or repatriated to obtain access to more efficient higher-order production processes.

Ricardo’s idea should also be reapplied to durable and nondurable goods production—a 21st-century theory of comparative manufacturing advantage.

Liberal Paul Krugman won the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2008 for his contributions to trade theory.  In the New York Times (December 12, 2013), Krugman writes that

one little-known aspect of the literature on trade liberalization is that to get any kind of large effect it’s necessary to drop the assumption that markets are highly competitive and efficient, and assume instead that there are large inefficiencies that will be reduced as a result of international competition.

But what if some inefficiencies cannot be so easily reduced?  What about preexisting differences in factor endowments?  Labor may be cheaper, but capital may not exist in a Third World country.  Even if capital is invested, it may not be enough to overcome systemic deficiencies.  These might include a labor force that cannot compete thanks, in part, to the inadequacies of its education system; or a corrupt political regime—one that is not bound by a tradition that includes the rule of law, freedom of contract, or property rights—that persistently threatens to expropriate capital.  By contrast, a country with a skilled labor force, advanced production processes, and a legal system that protects capital investment enjoys a significant advantage over countries who lack some or all of those things.

If large inefficiencies are reduced as a result of international competition, as Krugman suggests, efficient manufacturers in certain sectors might still attract capital investment and jobs in the short run.  The inefficiencies that Krugman describes take a long time to disappear; they are rarely fixed in a year or less.  Regardless of the time frame, a more efficient production process will attract capital, provided that the international competition also does not become more efficient.

The bottom line is that U.S. manufacturers can achieve a comparative manufacturing advantage by increasing their efficiency.

Some U.S. manufacturers have repatriated a portion of their production.  In 2012, Apple began building the most expensive model of its Macintosh computer back in the United States, a reversal of its decision in the late 1990’s to produce those machines in the People’s Republic of China.  The Macintosh is the smallest Apple core product, a point noted by critics who characterized the move as a public-relations ploy.  Most Apple core production occurs in China through Taiwan-based Foxconn.  But others have noted efficiency’s role in the repatriation of high-order manufacturing.  In congressional testimony in 2012, Alliance for American Manufacturing Executive Director Scott Paul said that rising costs in China “are beginning to drive production to lower cost locations like Vietnam and Cambodia” and to “more automated systems in the United States.”  This “new manufacturing economy won’t look like our old one,” Paul warned.  “Apart from what we already have in the automotive, commodity-based production, shipbuilding, and aerospace sectors, we’re unlikely to see anything like the old Fordist system, with massive factories each employing thousands of workers.”  (“Fordist system” is a reference to the assembly-line process of mass production developed by automotive manufacturer Henry Ford a century ago.)  “If Apple does produce iPads in America,” Paul continued, “the factory will be highly automated, though staffed by well-paid engineers and technical professionals.  Hundreds of thousands of Foxconn workers would be replaced by perhaps only hundreds of engineers.”

Advanced, high-order production is central to the achievement of a comparative manufacturing advantage in the United States.  These durable-goods sectors include chemicals; petroleum and coal; plastics and rubber; primary and fabricated metals; machinery; computers and electronics; electrical appliances and components; and transportation equipment such as motor vehicles.  Automotive engines have been built at a factory in my hometown, an industrial suburb of Detroit, since the early 1950’s.  “The Plant,” as we call it, employs about half the labor it once did.  But the capital is so far advanced that some of it is unrecognizable from the machinery in use just a quarter-century ago.  It is beyond the imagination of our youth, and, for that matter, of David Ricardo and the commercial world he inhabited, a world that relied on whale oil and buggy whips.  The apt image isn’t New York Times columnist Thomas Friedman’s flat world, in which the United States no longer enjoys any comparative advantages in trade.  It’s the kaleidoscope comparative advantage described by Jagdish Bhagwati and Vivek Dehejia two decades ago: Countries specialize in different stages of the production process (or value chain) according to the relative sophistication of their production processes.  In this scenario, products aren’t built using labor and capital based in one country.  Some are manufactured with advanced processes that transcend multiple national borders.

This is the American advantage: skilled labor, advanced production processes, a (relatively) uncorrupted legal and political system.  Use it or lose it.

The commerce of the future will be led by problem-solvers creating yet unforeseen production processes.  The United States will dominate the higher-order sectors if our manufacturing remains more advanced and efficient.  Domestic manufacturers will have to take into account foreign production processes.  Domestic news media must comprehend that trade policy cannot be reduced to a sound bite.  The comparative advantage described by Charles Krauthammer is simplistic and two-dimensional: two nations, two factor endowments.  The reality in today’s commercial world is complex and multidimensional: multiple nations, multiple factor endowments, multiple advancements.  The process will accelerate.  The future described by Mr. Obama is already prologue.