S. Mountifort Longfield and John Stuart Mill
In nineteenth-century Britain, the principle of comparative advantage became an integral part of classical political economy based on Adam Smith’s Wealth of Nations and Ricardo’s Principles of Political Economy.
Ricardo’s principle was extended to more than two countries and more than two commodities. The first professor of political economy in Ireland, S. Mountifort Longfield, took the important step of generalizing the Ricardian model to many commodities by arguing that a commodity is exported by a country if and only if its labour productivity relative to the other country’s exceeds their relative wages. In his words, “That kind of labour will succeed in each country which is more productive in proportion to its price” (Longfield 1835 [1971]: 56). Longfield noted the importance of reciprocal demand in determining the ranges of commodities exported and imported. He remarked (1835 [1971]: 69) that:if a nation enjoyed an immense superiority in the production of two or three articles of very general demand, the wages of her labourers might be, in consequence, so high that she could not compete with the rest of the world in any other manufacture, under a system of free trade.
To interpret the extension to more than two commodities pioneered by Longfield in present-day terms, consider two countries (A and B), and rank the commodities indexed 1, 2,..., j, k,..., n - 1, n in descending order of relative labour productivity pB. When a trading equilibrium between A and B is established, select consecutive commodities j and k in the above range such that the factorial terms of trade (or ratios of income per worker in A and B) yB are smaller than pB but larger than pB. This yields the chain of inequalities:
z y pj IS Pk * -1
which imply that A produces commodities 1, 2, 3,..., j more cheaply than B whereas B produces commodities k, k 1 1,..., n - 1, n more cheaply than A.
This so-called chain of comparative advantage for commodities 1 through n is broken by the factorial terms of trade such that commodities 1 through j are produced and exported by A while k through n are produced and exported by B. Each country exports commodities if its relative productivity in making them exceeds its relative per worker income. The borderline commodities j and k are such that j is the least competitive of A’s commodities and k is the least competitive of B’s given the factorial terms of trade. The location of these borderline commodities along the spectrum of commodities from 1 to n depends on an equilibrium condition similar to that in Mill’s trade model discussed below, that the value of each country’s imports is equal to the value of its exports.The chain of inequalities (8) implies that the higher a country’s wage compared to its trading partner’s, the fewer the commodities it exports and the more it imports. This multi-commodity generalization of the Ricardian model is consistent with empirical cross-country studies of the relationship between relative wages and relative labour productivity across industries. Even if labour productivity in a poor country such as China is much lower than in the United States, its products can nevertheless be competitive on world markets because the wages it pays are proportionally lower compared to American wages. Hence China’s unit labour costs in many manufacturing industries are lower than those in America despite its much lower labour productivity. Cross-country analyses of the relation between labour productivity and labour costs in manufacturing in a large sample of developed and developing countries have likewise found that wages and other labour costs are higher where labour productivity is higher and lower where productivity is lower, so that unit labour costs are roughly similar despite the significant productivity differences among countries (Irwin 2009: chs 2 and 6). The Ricardian model can thus offer empirically valid insights on the relation between productivity, trade competitiveness and real wages in the world economy.
In his Principles of Political Economy of 1848, a friend and admirer of Ricardo, John Stuart Mill, developed the theory of international trade based on comparative advantage in much greater detail and sophistication than Ricardo. He had published an earlier version in his Essays on Some Unsettled Questions of Political Economy (Mill 1844 [1948]) that he had written in 1829-30. Following the lead of his fellow economist Robert Torrens, Mill sought an answer to the question of what determines the equilibrium value of the commodity terms of trade that Ricardo had not specifically addressed. Equating the value of a country’s imports to that of its exports, he found it in the strength of countries’ reciprocal demand for each other’s products, defined as the demand for alternative amounts of a country’s import commodity in terms of the amount of exports it is willing to pay in exchange for them. The stronger a country’s demand for imports, the higher the imports’ price and hence the lower its terms of trade defined as the price of its exports in terms of its imports. Torrens extended his insights to commercial policy by insisting on reciprocity in tariffs rather than unconditional free trade with all countries as recommended by most classical economists. A trading partner’s import tariff should be countered by a similar tariff if a country wishes to forestall a deterioration in its terms of trade. In his Principles of Political Economy John Stuart Mill expressed as follows what he named “the Equation of International Demand” or “law of International Values”:
The produce of a country exchanges for the produce of other countries, at such values as are required in order that the whole of her exports may exactly pay for the whole of her imports... So that supply and demand are but another expression for reciprocal demand: and to say that value will adjust itself so as to equalize demand with supply, is in fact to say that it will adjust itself so as to equalize the demand on one side with the demand on the other.
(Mill 1848 [1920]: 592-3)Mill observed that the two countries’ autarky price ratios set the limits within which the equilibrium terms of trade must lie, and that the stronger a country’s import demand, the closer the terms of trade are to its autarky terms of trade and hence the smaller its gains from trade.
Mill preceded this statement with a discussion of the demonstration effect of trade in stimulating a people in the early stages of economic development to work harder to enable them to import from abroad commodities they are newly aware of:
The opening of a foreign trade, by making them acquainted with new objects, or tempting them by the easier acquisition of things which they had not previously thought attainable, sometimes works a sort of industrial revolution in a country whose resources were previously undeveloped for want of energy and ambition in the people: inducing those who were satisfied with scanty comforts and little work, to work harder for the gratification of their new tastes, and even to save, and accumulate capital, for the still more complete satisfaction of those tastes at a future time. (Mill 1848 [1920]: 581)
Mill made this point with his customary eloquence, and his phrase that trade “sometimes works a sort of industrial revolution” is a memorable one. It contrasts with a trade theory that assumes that tastes are given and unchanged when an isolated society first opens to trade. His insight was not incorporated in the neoclassical trade theory that has dominated the field in the twentieth and twenty-first centuries (more details on the topics discussed in this chapter can be found in my entries on “comparative advantage” and “gains from trade” in Reinert and Rajan 2009).