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• Preface
• Studies In the Theory of International Trade
• Chapter I: English Theories of Foreign Trade, Before Adam Smith: I
• I. Introduction
• II. “ Mercantilism” and “bullionism”
• III. the Balance-of-trade Doctrine
• IV. Reasons For Wanting More Bullion
• V. Employment and the Balance of Trade
• Chapter II: English Theories of Foreign Trade, Before Adam Smith: Ii
• I. Legislative Proposals of Mercantilists
• II. the Collapse of Mercantilist Doctrine
• III. Some Modern Interpretations of English Mercantilism
• Chapter III: The Bullionist Controversies: I. The Inflation Phase
• I. the Participants In the Controversy
• II. the Factual Background
• III. Premium On Bullion As Evidence of Excess Issue: the Bullionist Position
• IV. Qualifications Conceded By the Bullionists
• V. Possible Objections to the Bullionist Position
• VI. the Anti-bullionist Position
• VII. the Balance of Payments Argument
• VIII. the Possibility of Excess Issue By Banks
• IX. Responsibility For the Excess Issue: Bank of England Vs. Country Banks
• X. Responsibility For Excess Issue: the Credit Policy of the Bank of England
• Chapter IV: The Bullionist Controversies: II. The Deflation Phase
• I. the Resumption of Cash Payments
• II. Responsibility of Resumption For the Fall In Prices
• III. the Economic Effect of Changing Price Levels
• IV. Ricardo's Position On the Gold Standard
• V. Reform Without Departure From the Metallic Standard
• VI. Paper Standard Currencies
• Chapter V: English Currency Controversies, 1825–1865
• I. Introduction
• II. the “currency School” -“banking School” Controversy
• III. the “palmer Rule ”
• IV. the Bank Act of 1844
• V. the Possibility of Overissue of Convertible Bank Notes
• VI. the Role of Deposits, Bills of Exchange, and “credit” In the Currency System
• VII. the Technique of Credit Control
• VIII. the Relation Between Bank of England Operations and Specie Movements
• IX. Currency Reform Proposals
• Chapter VI: The International Mechanism Under a Simple Specie Currency
• I. Introductory
• II. the Mechanism According to Hume
• III. an Omitted Factor? Relative Changes In Demand As an Equilibrating Force
• IV. Prices In the Mechanism: the Concept of “price Levels ”
• V. the “terms-of-trade” Concept
• VI. the Prices of “domestic” Commodities
• VII. the Mechanism of Transfer of Unilateral Payments In Some Recent Literature
• VIII. a Graphical Examination of Pigou's Analysis 1
• IX. Some Elaborations On the Basis of Pigou's Analysis
• X. an Alternative Solution
• XI. Types of Disturbance In International Equilibrium
• XII. Specie Movements and Velocity of Money
• XIII. Commodity Flows and Relative Price Levels
• XIV. Exchange Rates
• XV. A Criticism of the Purchasing-power Parity Theory 1
• Chapter VII: The International Mechanism In Relation to Modern Banking Processes
• I. Automatic Vs. Managed Currencies
• II. Primary and Secondary Expansion of Means of Payments
• III. Short-term Loans In the International Mechanism
• IV. Primary and Secondary Expansion In Canada , 1900–13
• V. the International Mechanism and Business Cycles
• Chapter VIII: Gains From Trade: the Doctrine of Comparative Costs
• I. the Nature and Origin of the Doctrine
• II. the Division of the Gain From Trade
• III. Trade In More Than Two Commodities
• IV. Trade Between More Than Two Countries
• V. Transportation Costs
• VI. Increasing and Decreasing Costs
• VII. Prices, Money Costs, and Real Costs
• VIII. Dependence of Comparative Cost Doctrine On a Real-cost Theory of Value
• IX. Differences In Wage Rates In Different Occupations
• X. Variable Proportions of the Factors and International Specialization
• XI. Variable Proportions of the Factor and Comparative Real Costs
• XII. “ Opportunity Cost” Analysis As a Substitute For Real Cost Analysis
• Chapter IX: Gains From Trade: the Maximization of Real Income
• I. “ Mass of Commodities” and “sum of Enjoyments”: Ricardo and Malthus
• II. Reciprocal Demand and the Terms of Trade
• III. Terms of Trade and the Amount of Gain From Trade
• IV. “ Net Benefit” In International Trade: Marshall
• V. Total Net Utility Derived From International Trade: Edgeworth
• VI. the Gain From Trade Measured In Money
• Appendix: a Note On the Scope and Method of the Theory of International Trade

I. The Nature and Origin of the Doctrine

The classical theory of international trade was formulated primarily with a view to its providing guidance on questions of national policy, and although it included considerable descriptive analysis of economic process, the selection of phenomena to be scrutinized and problems to be examined was almost always made with reference to current issues of public interest. This was true even of the classical discussions of the mechanism of international trade, but it was more conspicuously true in the field which is sometimes called “the theory of international value,” where the problems were expressly treated with reference to their bearing on “gain” or “loss” to England, or on the distribution of gain as between England and the rest of the world. Recognition of its “welfare analysis” orientation is essential to the understanding and the appraisal of the classical doctrine. Although the classical economists did not clearly separate them, and shifted freely from one to the other, they followed three different methods of dealing with the question of “gain” from trade: (1) the doctrine of comparative costs, under which economy in cost of obtaining a given income was the criterion of gain; (2) increase in income as a criterion of gain; and (3) terms of trade as an index of the international division and the trend of gain. This chapter will deal with the doctrine of comparative costs.

The doctrine of comparative costs originated as an improvement and development of the eighteenth-century criticism of mercantilist policy, and it has continued to command attention mainly because of its use as the basic “scientific” argument of free-trade economists in their attack on protective tariffs. Protectionists have an obvious motive for attacking the doctrine, but it has also been rejected by economists whose animus seems to arise from the fact that it was one of the outstanding products of the English classical school, by economists who deal with it as an exercise in pure price theory and as such find it unsatisfactory, and by economists who believe that they have at their command a superior technique than it affords for the appraisal of commercial policy. Never widely accepted on the Continent, the doctrine now is clearly on the defensive everywhere.

The doctrine of comparative costs maintains that if trade is left free each country in the long run tends to specialize in the production of and to export those commodities in whose production it enjoys a comparative advantage in terms of real costs, and to obtain by importation those commodities which could be produced at home only at a comparative disadvantage in terms of real costs, and that such specialization is to the mutual advantage of the countries participating in it. In the exposition of the doctrine the “real” costs are expressed as a rule in terms of quantities of labor-time, but with the implication, as throughout the classical theory of value, that these quantities of labor-time correspond in their relative amounts within each country to quantities of subjective cost. The legitimacy of this assumption that labor-time costs are proportional to real costs is examined at length later in this chapter, and for the present will not be questioned.

There has been some measure of confusion as to the nature of the comparisons between costs which the doctrine contemplates. According to Cairnes:

... when it is said that international trade depends on a difference in the comparative, not in the absolute, cost of producing commodities, the costs compared, it must be carefully noted, are the costs in each country of the commodities which are the subjects of exchange, not the different costs of the same commodity in the exchanging countries.1

But it is not costs at all which are directly to be compared, but ratios between costs, and it is unessential whether the cost ratios which are compared are the ratios between the costs of producing different commodities within the same countries or the ratios between the costs of producing the same commodities in different countries.

In the illustration given above, it does not matter whether the ratios compared are , and , on the one hand, or m:r, n:s, and p:t, on the other hand. In the first set of comparisions, country A has its greatest comparative advantage in the production of that commodity whose cost in A appears as the numerator in the first term of the lowest of these ratios, and its greatest comparative disadvantage in the production of that commodity whose cost in A appears as the denominator in the first term of the lowest of these ratios. In the second set, country A has its greatest comparative advantage in the production of that commodity whose cost in A appears as the first term in the smallest of these ratios, and its greatest comparative disadvantage in the production of that commodity whose cost in A appears as the first term in the highest of these ratios. Whatever numerical values are assigned to the unit real costs, both these methods of comparison will necessarily produce identical results, though the first method will ordinarily be found much more convenient to use. If the first method is used, the units used in the measurement of cost need not be identical or even comparable in the two countries. It is then not necessary, for instance, to know whether m is greater or less than r, or whether n is greater or less than s.

In the beginnings of free-trade doctrine in the eighteenth century the usual economic arguments for free trade were based on the advantage to a country of importing, in exchange for native products, those commodities which either could not be produced at home at all or could be produced at home only at costs absolutely greater than those at which they could be produced abroad. Under free trade, it was argued or implied, all products, abstracting from transporation costs, would be produced in those countries where their real costs, were lowest. The case for free trade as presented by Adam Smith did not advance beyond this point.

In an earlier chapter, however, it has been shown that several writers prior to Adam Smith, and especially the author of Considerations on the East-India Trade, 1701, stated the case for free trade in terms of a rule which would provide the same limits for profitable trade as does the doctrine of comparative costs, the rule, namely, that it pays to import commodities from abroad whenever they can be obtained in exchange for exports at a smaller real cost than their production at home would entail. Such gain from trade is always possible when, and is only possible if, there are comparative differences in costs between the countries concerned. The doctrine of comparative costs is, indeed, but a statement of some of the implications of this rule, and adds nothing to it as a guide for policy.2

Many of the classical economists, both before and after the formulation of the doctrine of comparative costs, resorted to this eighteenth-century rule as a test of the existence of gain from trade. Ricardo incorporated it in his formulation of the doctrine of comparative costs:

Though she [i.e., Portugal] could make the cloth with the labor of 90 men, she would import it from a country where it required the labor of 100 men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth.3

Malthus had credited as a factor contributing to the prosperity of the United States her ability to sell “raw produce, obtained with little labor, for European commodities which have cost much labor.” 4 To this, Ricardo replied:

It can be of no consequence to America, whether the commodities she obtains in return for her own, cost Europeans much, or little labor; all she is interested in, is that they shall cost her less labor by purchasing them than by manufacturing them herself.5

This explicit statement that imports could be profitable even though the commodity imported could be produced at less cost at home than abroad was, it seems to me, the sole addition of consequence which the doctrine of comparative costs made to the eighteenth-century rule. Its chief service was to correct the previously prevalent error that under free trade all commodities would necessarily tend to be produced in the locations where their real costs of production were lowest.

In his Principles, first published in 1817, Ricardo presented the doctrine of comparative costs by means of what was to become a famous illustration, in which the quantity of wine which required for its production in England the labor of 120 men could be produced in Portugal by 80 men, while the cloth which in England required the labor of 100 men could be produced in Portugal by 90 men. Portugal would then import cloth from England in exchange for wine, even though the imported cloth could be produced in Portugal with less labor than in England.6

Credit for the first publication of the principle of comparative costs is generally given to Ricardo. Leser,7 however, in 1881, assigned to Torrens the credit of discovery of the doctrine on the strength of the following passage in Torrens's Essay on the External Corn Trade, 1815:

If England should have acquired such a degree of skill in manufactures, that, with any given portion of her capital, she could prepare a quantity of cloth, for which the Polish cultivator would give a greater quantity of corn than she could, with the same portion of capital, raise from her own soil, then tracts of her territory, though they should be equal, nay, even though they should be superior, to the lands in Poland, will be neglected; and a part of her supply of corn will be imported from that country. For, though the capital employed in cultivating at home might bring an excess of profit over the capital employed in cultivating abroad, yet, under the supposition, the capital which should be employed in manufacturing would obtain a still greater excess of profit; and this greater excess of profit would determine the direction of our industry.8

Leser's comment attracted no notice, but some years later credit for priority in formulating the doctrine of comparative cost was again claimed for Torrens, this time by Professor Seligman.9 Professor Hollander has replied, in defense of Ricardo's claims, that much of the evidence in support of Torrens presented by Seligman was not relevant or was of questionable weight; that even after the appearance of Ricardo's Principles Torrens never realized the full significance of the comparative cost doctrine and never made explicit use of it; and that Ricardo's claims to priority could not be overcome merely by the fact that Torrens, in a single paragraph, had correctely stated the doctrine “in outline” before Ricardo had published his Principles.10

Torrens clearly preceded Ricardo in publishing a fairly satisfactory formulation of the doctrine. It is unquestionable, however, that Ricardo is entitled to the credit for first giving due emphasis to the doctrine, for first placing it in an appropriate setting, and for obtaining general acceptance of it by economists. Hollander, moreover, appears to be justified in his contention that the doctrine was never an integral part of Torrens's thinking. While Torrens again stated the doctrine, and stated it very well, in at least two of his publications,11 and incidentally first used the term “comparative cost” in connection with the doctrine,12 these later statements are frankly presented as improvements on Torrens's earlier views resulting from the discussion of the problem by other economists. Torrens's grasp of the doctrine, moreover, was not so firm that he could not occasionally display confusion about its meaning and implications.13

Much of the evidence from Torrens's writings which Seligman cites to demonstrate that he was an exponent of the doctrine of comparative costs shows only, as Hollander says, that Torrens accepted the argument that international division of labor was beneficial, or that he accepted the principle that it paid to import commodities if they could thus be obtained at lower cost than the cost of producing them at home, a principle which I have shown above to have had its origin early in the eighteenth century.

The only claim to priority over Ricardo with reference to the doctrine of comparative costs which Torrens made14 was based on the passage in the 1815 edition of the Essay already cited above. Hollander surmises that even this earlier passage itself may owe something to discussion of the question with Ricardo, but until it is at least made clear that Torrens and Ricardo were already acquainted in 1815, not much weight is to be attached to this possibility. On the other hand, Torrens's own claim to priority should not be given too great emphasis, since Torrens was erratic both in his claims and in his acknowledgments, and could be abundantly quoted against himself.15

Ricardo's illustration implies a number of important assumptions which, in conformity with his usual practice, he never expressly states. His conclusions have been criticized both on the ground that they do not follow from his assumptions, and on the ground that the assumptions necessary for the validity of his conclusions are unrealistic and that with their abandonment or correction the conclusions would cease to hold. It is more or less obvious that Ricardo based his analysis on the following assumptions: ample time for long-run adjustments; free competition; only two countries and only two commodities; constant labor costs as output is varied; and proportionality of both aggregate real costs and supply prices within each country to labor-time costs within that country. Those criticisms or corrections of Ricardo's analysis which do not involve a rejection of his assumptions will be examined first, and the more fundamental criticisms which question the validity of his assumptions will be dealt with later.

[1]J. E. Cairnes, Some leading principles of political economy, 1874, p. 312.

[2]Cf. F. Y. Edgeworth, Papers relating to political economy, 1925, II, 6: “Foreign trade would not go on unless it seemed less costly to each of the parties to it to obtain imports in exchange for exports than to produce them at home. This is the generalized statement of the principle of comparative cost, with respect to its positive part at least.”

[3]Principles of political economy, in Works, pp. 76–77. For other instances of resort to this rule by classical economists for the purpose of establishing the existence of gain from trade, or, in some cases, measuring its extent, see R. Torrens, The economists refuted [1808], reprinted in his The principles and practical operation of Sir Robert Peel's Act of 1844, 3d ed., 1858, pp. 53–54; James Mill, Commerce defended, 1808, pp. 36–38; N. W. Senior, Political economy [1st ed., 1836], 4th ed., 1858, p. 76; J. R. McCulloch, Principles of political economy, 4th ed., 1849, p. 147; J. S. Mill, Principles of political economy [1848], Ashley ed., p. 585.

[4]Malthus, Principles of political economy, 1st ed., 1820, p. 428.

[5]Ricardo, Notes on Malthus' “Principles of political economy” [1820], Hollander and Gregory editors, 1928, p. 209.

[6]Principles, Works, pp. 76–77.

[7]“Torrens hat ... eine andere grossartige Entdeckung gemacht, die aber auch nicht an seinen Namen, sondern an den des Ricardo geknüpft zu werden pflegt ... Wir haben hier genau die vielbewunderte Auseinandersetzung voruns, die Ricardo ... gegeben hat. ...” (E. Leser, Untersuchungen sur Geschichte der Nationalökonomie, I, 1881, pp. 82–83, note.)

[8]Torrens, An essay on the external corn trade, 1815, pp. 264–65; cf. also p. 266.

[9]E. R. A. Seligman, “On some neglected British economists,” Economic journal, XIII (1903), 341–47; reprinted in Seligman, Essays in economics, 1925, pp. 70–77.

[10]J. H. Hollander, David Ricardo: a centenary estimate, 1910, pp. 92–96. Cf. also the further discussion by Seligman and Hollander, “Ricardo and Torrens,” Economic journal, XXI (1911), 448 ff.

[11]Essay on the external corn trade, 4th ed., 1827, in a section, “Effects of free trade on the value of money,” pp. 394–428, first added in this edition; Colonization of South Australia, 1835, pp. 148 ff.

[12]Seligman stated that: “Neither Torrens nor Ricardo uses the term ‘comparative cost.’ This term was introduced by Mill in his Unsettled Questions in 1844.” (Economic journal, XXI (1911), 448.) Hollander points out that Torrens did use the term “comparative cost,” but in a different connection, in his Essay on the external corn trade, 3d ed., 1826, p. 41, and claims that James Mill first used the word “comparative” in connection with the theory of international trade. (Economic journal, XXI (1911), 461.) But Torrens did use the term “comparative cost” correctly in the 4th edition of his Essay on the external corn trade, 1827 (p. 401), and Ricardo, in all the editions of his Principles, had used the phrases “comparative disadvantage as far as regarded competition in foreign markets” (Works, p. 101) and “comparative facility of ... production” (ibid., p. 226). Terminological usage by the classical economists must have been so influenced by their oral discussions as to make the record of priority in print have little bearing on the question of priority in use.

[13]Cf. infra, pp. 487–88.

[14]Essay on the external corn trade, 4th ed., 1827, p. vii.

[15]Cf., e.g., Torrens, Tracts on finance and trade, no. 2 (1852), 17: “In his chapter upon foreign trade, that profound and original writer [i.e., Ricardo] propounded for the first time, the true theory of international exchange.” Torrens, it is true, apparently has reference here rather to the terms of trade question than to comparative costs, but he had also claimed priority with respect to terms of trade doctrine.