Comparative advantage

In a very few words, the theory of comparative advantage states that the economically rational course is not necessarily to do what one does best, but what gives the greatest profit in the given market.

Economists in the 18th and 19th centuries discussed at great length the conditions under which international trade was beneficial to the state and to society generally. Adam Smith (1723–90) emphasized absolute advantage: if one country is best at producing one product, and another is best at some other product, then it is economically rational for each to specialize in one product and obtain the other by exchange.

David Ricardo (1772–1823) refined Smith’s theory by introducing comparative advantage. If one country has an absolute advantage in both products, it can still be advantageous for it to specialize in one, export it, and import the other. His example concerned wine and cloth in Portugal and England: the Portuguese were best at producing both, but their advantage was greatest in wine production; it was therefore rational for Portugal to specialize in wine, export it, and import cloth from England.

In our example from 18th-century Norway peasant production of iron had an absolute advantage over industrial production, because peasant labour in the agricultural slack seasons was cheap. In 1782, according to Ole Evenstad’s calculations, the peasants still had this absolute advantage in iron production, but in the course of the 18th century something had happened – perhaps increased demand for timber, perhaps improved transportation to markets – which shifted the comparative advantage over to timber production. It became economically rational for peasants to produce and sell timber and buy industrially produced iron.

There is a useful short discussion of comparative advantage on Brad DeLong’s home page.