Comparative Advantage

     "What is prudence in the conduct of every private family, can scarce be folly in that
     of a great  kingdom. If a foreign country can supply us with a commodity cheaper than
     we ourselves can make it,  better buy it of them with some part of the produce of our
     own industry, employed in a way in which we have some advantage. The general industry
     of the country, being always in proportion to the capital which employs it,  will not
     therby be diminished... but only left to find out the way in which it can be employed
     with the greatest advantage."
     (Adam Smith, The Wealth of Nations, Book IV:2, Modern Library edition)

Nobel laureate Paul Samuelson (1969) was once challenged by the mathematician Stanislaw Ulam to "name me one proposition in all of the social sciences which is both true and non-trivial." It was several years later than he thought of the correct response: comparative advantage. "That it is logically true need not be argued before a mathematician; that is is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them." 1/

What did David Ricardo mean when he coined the term comparative advantage? According to the principle of comparative advantage, the gains from trade follow from allowing an economy to specialise. If a country is relatively better at making wine than wool, it makes sense to put more resources into wine, and to export some of the wine to pay for imports of wool. This is even true if that country is the world's best wool producer, since the country will have more of both wool and wine than it would have without trade. A country does not have to be best at anything to gain from trade. The gains follow from specializing in those activities which, at world prices, the country is relatively better at, even though it may not have an absolute advantage in them. Because it is relative advantage that matters, it is meaningless to say a country has a comparative advantage in nothing. The term is one of the most misunderdstood ideas in economics, and is often wrongly assumed to mean an absolute advantage compared with other countries.

1/ P.A. Samuelson (1969), "The Way of an Economist," in P.A. Samuelson, ed., International Economic Relations: Proceedings of the Third Congress of the International Economic Association, Macmillan: London, pp. 1-11.