David Ricardo: Comparative Advantages and Globalization

In the previous post we boarded a similar line of thought, regarding Adam Smith and The Wealth of Nations. It is only natural, almost a reflex, to do the same thing with another pillar of economics, the  British, David Ricardo (1772-1823).

Among the many anxieties and fears about globalization, there are two very closely related, legitimate questions that stand out:

  1. How do we currently deal with globalization?
  2. What is the best way to deal with globalization?

positive effects of globalization

From my experience, the best way to answer these questions is by using the principle of comparative advantage, brilliantly explained by David Ricardo. Ricardo stated that economic activity and international trade, at all levels, depends on everyone doing what they know how to do best. This principle is universal and applies to all individuals, societies, corporations, regions, and countries at all times.

Originally, Ricardo termed it the principle of comparative costs, and documented it when opposing the protectionist Corn Laws, which restricted imports of wheat. That term was later substituted by comparative advantages – also frequently referred to  as competitive advantages. Personally, I also use the expression making a constructive use of differences, to refer to the same principle.

Human preferences, tastes, abilities, physiques, and metabolisms are different. Therefore, another way of understanding the principle of comparative advantage is by focusing on the constructive use of all differences that exist among individuals.

The principle of comparative advantage can be fully implemented even within a single work group. A football team can be a good example. The position of each player on the field is well defined and different from the others. Yet the individual positions complement one another and are thus mutually reinforcing. Everyone relies on their own team members—just as it happens in everyday life, be it within a profession, family, or any other setting.

The business and professional world is exactly like sports. Using comparative advantages involves specialized labor, for the constructive use of differences and teamwork. The good news is that, as hard as it may be to believe, there are enough jobs for everyone in the world. However, this only holds true if society is appropriately organized. A reasonably well organized society functions under the not-a-zero-sum-game principle, whereby new growth is constantly created, without having to subtract that growth from elsewhere, on the average. In order to properly understand the not-a-zero-sum-game principle, in this context, we must constantly have in mind the creative destruction mechanism. On top of that, given the ever-present protectionist instinct in many nations, it makes us wonder how much humanity has really learned about the multiple, profound and lasting benefits of free trade. The evidence suggests that there is still plenty of learning to do in this regard.

Adam Smith: The Wealth of Nations and Globalization

An Inquiry into the Nature and Causes of the Wealth of Nations (1776) was the original title of the seminal book that lay down the conceptual framework for modern Economics. The book is commonly known as The Wealth of Nations; it was written by the Scottish Adam Smith (1723–1790). The impact of his brilliant work in the following generations has been such that Adam Smith is indisputably considered the father of economics.

I fully agree with many other economics practitioners that the book is the work of a genius. Adam Smith had an extremely perceptive mind –a lawyer by training– that was able to synthesize and explain the major foundations of the nascent discipline.

In addition to emphasizing the free market and the very apt invisible hand metaphor to illustrate it, among many other concepts, the title itself is very profound and relevant. So much so that, very sadly, the title continues to be a valid point nowadays: “… the Nature and Causes of the Wealth of Nations”.

In fact, that very same idea led me to look for a workable solution to the brutal disparity in output and income among nations, as a conclusion to my book Globalization. That brutal disparity in production can be very easily visualized by having in mind that, during 2011, the 22 richest nations on earth, comprising 13% of the world’s population, generated 46% of global output, whereas, at the other extreme of the spectrum, the 45 poorest nations on earth, comprising 19% of the world’s population, generated only 3% of global output! The weighted average of those two extreme groups results in a ratio slightly over 28 to 1 in production capacity per inhabitant. Granted, there is no way on earth to avoid a disparity –even a large one– between those opposite groups. Nonetheless, a 28 to 1 competitiveness ratio is obscene. A clear manifestation that something is profoundly wrong in the world’s current socioeconomic system, that requires to be fixed.

Smith’s effort is second to none given the extreme limitations in the tools and information that were available over two centuries ago. In contrast and very fortunately, 236 years after Smith published his seminal work, the current tools and means available today –particularly including a great deal of practical experiences– make this challenge a very manageable one. Moreover, the conclusion I have reached could not have been possible without the excellent foundations laid down by Smith and many other superb socioeconomic achievements afterwards. Furthermore, in the recent past, there have been numerous profound transformation cases of countries moving from rags to riches in just a few decades. Hence, from my personal perspective, all major elements to solve Smith’s challenging inquiries –over two centuries later– are finally in place and ready to be materialized. It seemed to me that all that it required was an appropriate final process of connecting-the-dots.

In The ABCs to a Global Social Revolution page there is a summarized version of my analysis and initiative regarding how to begin closing the humongous economic gap between failed and developed nations, in a systematic and massive way, which was originally presented in Section 3 of my book Globalization.

The New World Order: G7 and E7 Nations.

There has been a profound change in the world’s progress as we have known it up to recently; capitalism’s geography is changing. In recent years, the average economic growth rates gap between the big emerging countries versus the big developed ones has been both substantial and consistent; that has already been going on for a considerable number of years, overwhelmingly favoring the largest emerging nations. The relative economic and political weight of the E7 economies has been the net result, said weight has been progressively increasing compared to the G7 countries’ weight.

Source: Computations based on GLOBALIZATION, Opportunities and Implications, The ABCs to a Global Social Revolution, Martin Marmolejo, Section 5, page 567-575.

The previous table shows a most interesting comparison between those two groups of nations: the G7 and the E7. The figures shown in the table are 2010 statistics. There are several outstanding points which are very important to bear in mind:

  • The G7 nations’ total output was approximately 33% larger than the E7’s during 2010. That gap was 44% the year before. During 2011, that gap was still reduced further, to less than 30%; we’ll know that for sure later in the year when official 2011 figures are released.

  • During 2011, there also must have occurred a couple of momentous displacements among the top-eight nations of the world in economic output: a) India overtook Japan as the world’s third-largest economy. b) Likewise, Brazil and the UK traded places. Brazil started the year as #8, ending up as #7.

  • During the previous year, 2010, a couple of displacements took place among the top-eight nations: a) Russia displaced the UK from 6th standing. b) Brazil displaced France from the 8th position.

Most of the G7 countries have yet to successfully overcome major long-term structural issues: debt, deficits, deleveraging and the accompanying slow-growth. The E7 nations, in contrast, are  growing at a very healthy and substantially higher rate of growth than the E7’s countries, they currently have very low debt levels, and also low and manageable budget deficits. As a result, to different degrees, the E7 nations are very much on a speedy and consistent catching-up trail with their developed brethren. There still remains a gigantic per capita output gap to be filled, before the E7 countries can be close enough to a developed nation status; it will take a few decades for that gap to be completely filled. On a volume basis, however, that gap is not substantial, and is getting smaller by the day, as we have already seen.

We are living in a very dynamic world. What we have witnessed in the past few years is a harbinger of things to come. It does not have to be a traumatic repositioning of economic and political power. It is of utmost importance, however, to understand what is going on and why in order to be better prepared for new opportunities and risks, as they emerge.

Austria, Netherlands and UK offer the world a great and very constructive testimonial of former world-leading-nations that have transitioned with class and dignity from that status to a new one of highly respected developed nations of a second tier nature. Indeed, they are three role model nations that can teach the world a lot in that particular aspect so critical for the world’s well-being.

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