David Ricardo: The Principles of Political Economy

Like many of the great thinkers of his time, David Ricardo had little by way of formal economics education. Indeed, he had little by way of education. He left school at the age of 13 and learned practical skills, in the sense that he was working on the stock market with his father from the age of 14. That meant, he was a pretty wealthy man by his 20s, and that gave him the opportunity to essentially become a thinker. And he wrote a very famous book called, The Principles of Political Economy. Enormous impact, this book has had, yet it’s a very short book, very short, indeed. And when it comes to international trade, it’s essentially on one chapter.

And it’s called, “On Foreign Trade,” which has had an extraordinary impact, a truly extraordinary impact, in the way that we think about international trade, in the sense that the principles that David Ricardo set out in his chapter on foreign trade still provide the bedrock to the undergraduate teaching of economics and international trade and, indeed, to the way in which many practical policy makers and politicians think about international trade. So what was that great insight? Well, before Ricardo came along, the prevailing wisdom on international trade was something called, absolute advantage. Absolute advantage comes essentially with size.

So you’d think if you’ve got two countries, one big country– let’s call it United States– and one tiny country– and let’s call it Mauritius– you’d think they wouldn’t trade, because you can’t think of anything, really, that the United States couldn’t produce more efficiently than Mauritius could produce. Yet, in fact, these two countries did trade, still do trade. And the insight that underpins that, that was attributable to Ricardo, is that it’s not absolute advantage that’s important when it comes to driving the international exchange of goods and, indeed, services. It’s comparative advantage. It’s what you’re relatively good at, compared to the countries you might trade with.

And the idea is that you put more of your limited resources into what you’re best at doing and take them away from things that you’re relatively inefficient at producing. And Ricardo explained this beautifully with a very nice example that had two countries, Portugal and England– Portugal producing wine and England producing cloth. And he worked systematically through the principle of specialisation and exchange in this chapter on foreign trade. He was actually taking an insight of Adam Smith’s that specialisation is important, but embedding that in, if you like, an open economy context.

And it’s from that fundamentally important chapter that our insights into the gains from exchange and specialisation, which amplifies those gains from exchange, actually putting resources into the things that we do best, are the bedrock of modern international trade analysis. It doesn’t mean to say, by the way, that we haven’t moved on from there. So when thinkers these days talk about gains from trade, they also talk about gains from dynamic economies of scale, gains from pro-competition effects from international trade, or gains from spillovers that come from investment in research and development. But those fundamentals, the gains from exchange and the gains from specialisation, we still owe to David Ricardo.