Ricardo model
The Ricardo model (also Ricardian model or theory of comparative cost advantages ) according to David Ricardo is a simplifying model for explaining foreign trade between two countries. The model is based on the different labor productivity that leads to international trade . So-called comparative cost advantages (from Latin : comparare = to compare) result in comparative price advantages between countries for the considered production factor of human labor . The basic assumption is the existence of different labor productivity and the resulting different opportunity costs . The theory of comparative cost advantages represents a further development of Adam Smith's theory of absolute cost advantages .
History of the development of the theory
David Ricardo (1772–1823), English and one of the main representatives of classical economics, came from a wealthy Portuguese immigrant family. However, from a young age he made a considerable fortune himself.
His main work On the Principles of Political Economy and Taxation (1817), which establishes the theory of comparative cost advantages, was written against the historical background of the Congress of Vienna , which reorganized Europe in 1815 after the end of the Napoleonic Wars and also finally ended the continental blockade against England . With the end of the continental blockade, trade with England flourished again. However, the British government secured the domestic economy with protective tariffs against foreign imports. Especially in the field of agriculture, e.g. B. with the import of wheat, such trade restrictions existed (see Corn Laws ).
David Ricardo then tried to use his theory of comparative advantages to prove that these import tariffs ultimately harm the British economy. He also represented this conviction to the British House of Commons, which, however, did not repeal the Corn Laws until 1846.
In summary, the following quote should stand for Ricardo's conviction:
- It is quite important to the happiness of mankind that our enjoyments should be increased by the better distribution of labor, by each country producing those commodities for which its situation, its climate, and its other natural or artificial advantages is adapted, and by exchanging them for the commodities of other countries ...
Gerhard Bondi translates this in the German edition of the work:
- The increase of our comforts through a better distribution of labor, with each country producing those goods for which it is suitable by its location, climate and other natural or artificial advantages and exchanging them for the goods of other countries, for which Well as important to mankind as its use.
Furthermore, Paul Samuelson , Nobel Prize winner and one of the most important economists of the 20th century, once praised the idea of comparative advantage as the best known example of an economic principle that, despite all its undeniable truth, does not immediately make sense to even intelligent people.
Classification in economics
From an economic point of view, Ricardo's model of comparative advantages forms the theoretical basis for explaining foreign trade between nations. It is a simple and fundamental illustration of the benefits of free trade for all nations involved. In addition, here comparative price advantages are reduced to comparative cost advantages. Fundamental to the emergence of the comparative advantages is the existence of different opportunity costs , which in turn can be traced back to different labor productivity. If states enter into trade with one another, then relative supply and relative demand determine the world market price, which levels off between the respective labor productivity levels.
Basic assumptions
The Ricardo model is based on the following basic assumptions and simplifications:
- International free trade that is not regulated by tariffs or non-tariff trade barriers .
- A world that consists of just two countries (at home and abroad).
- In each of these countries only two goods are produced (good X and good Y).
- One only considers the production factor human labor, assuming homogeneity. This means that all people can do everything equally well. (There is complete intersectoral mobility of the workforce.)
- The production function takes a linear course. (→ a linear transformation curve )
- With constant labor supply (L), full employment prevails . However, the job offer may differ from one country to another.
- Constant labor productivity is still assumed for both goods. This is represented by its reciprocal value, the work coefficient.
- Neither labor nor capital are mobile beyond the national border. (There is complete international immobility of the factors of production.)
- There is complete competition in all markets; H. Price = marginal cost . It is also assumed that the wage rate is identical in both sectors of a country.
Based on these assumptions, it is easy to see that the Ricardo model can only provide a basic clue for explaining foreign trade. Therefore, many critical approaches are unfounded, as they do not or only partially take into account the above assumptions.
description
Core idea: the principle of comparative advantage
- Trade between two countries can be beneficial to both countries if each country exports those goods in which it has a comparative advantage.
This central statement reflects the importance of the comparative advantage on which the Ricardo model is based. The comparative advantage arises from different opportunity costs in the production of the goods in the producing country, i.e. H. the cost of doing without one good in the production of the other is lower than in the second country.
This is in turn due to different labor productivity levels in the participating countries. Different work productivity results, for example, from different climatic or historical conditions.
Absolute cost advantages are therefore insignificant, which also explains why two economically completely differently developed countries will trade with one another. This would be applicable , for example, to trade between an industrialized nation and a so-called “ Third World ” country. The “Third World” country can still participate in world trade despite possibly much higher absolute production costs, namely by using its workers efficiently.
So in the individual countries there is a specialization in the production of goods for which one has a comparative advantage. The other good is therefore no longer produced, but imported.
Ultimately, more can be produced through the efficient use of the production factor labor. In addition, the states involved achieve foreign trade profits by exporting the goods they produce. This in turn means that more of the non-produced good can be consumed (through import). The prosperity of the countries increases accordingly.
The one-factor model of economics
In the first step, it is assumed that there is only domestic. This produces two goods. The labor force is the only factor of production. Due to the different circumstances, different numbers of working hours are required for the production of a unit of quantity of the respective good. This input / output ratio is defined as the work coefficient.
Since the production possibilities of a country are limited by the limited supply of labor, it is therefore only possible to produce a certain amount of goods. These maximum production possibilities are represented on the basis of the transformation curve, with their slope corresponding to the opportunity costs (also called the marginal rate of transformation ). The marginal rate of transformation therefore reflects the amount of renunciation that has to be accepted in the production of an additional good. The negative sign is ignored.
In order to determine the actual volume of production, it is important to take into account that the wage rate is the same in both industries. Otherwise the workers would prefer to work in the branch with the higher wages. The production of the other good would be neglected.
If one continues to assume that the price of the goods is only determined by their costs, then it can be determined that if the price ratio (see relative price ) and the labor ratio are the same, both goods are actually produced. In other words, without foreign trade, the relative price is equal to the relative labor coefficient.
Or expressed mathematically:
If there is initially no foreign trade ( closed economy / self-sufficiency), domestic would produce both goods.
The price of the goods is then referred to as the so-called self-sufficiency price. It is initially calculated as the product of labor input and the wage rate. Since the wage rate is constant, in the two-goods case it can be said that the price ratio of one good corresponds to the opportunity costs of the other, i.e. H.:
The one-factor model of world trade
In the second step, the model is now expanded to include a second country, foreign countries ( marked with a in the formula ). Both countries now produce the same goods (good Y and good X). The following assumption is decisive here:
or in other words:
This means that the ratio of the labor coefficients in the production of one good at home is smaller than abroad, with the foreign country being more productive in the production of the other good. The transformation curve abroad therefore takes a different course. She has z. B. a steeper slope.
If both countries enter into foreign trade relations with one another, then there is the possibility of exporting goods whose relative price is higher abroad than at home.
If a country uses its comparative advantage and exports, it can make a trade profit. But foreign countries would also benefit from trade by using the comparative advantage of the home country in the form of imports and thus restricting themselves to the production of the goods for which they themselves have a comparative advantage. In addition, the countries could increase their consumption options, even beyond the limits set by their respective budget lines .
A world market develops on which relative supply (RS) and relative demand (RD) determine the price (free trade requirement). The intersection of the two curves is called the general world market equilibrium (1).
The course of the RS curve (staircase shape) can be explained as follows:
At the first “level” the world price for good X corresponds to the work coefficient. Below this level there is no supply of good X, since even the domestic market, which can produce more cheaply than the foreign country, would then no longer be able to cover costs. The world price for good Y results from the labor coefficient of foreign countries, which good Y can produce relatively cheaply (second "stage"). The equilibrium on the world market is now leveling between these two prices (1). If the relative demand were lower (RD '), an equilibrium could also result at (2).
As a result, the countries specialize in the production of good X or good Y and achieve foreign trade profits for the respective good, which enable them to import the other good at the world market price (which is lower than the price for their own production). This leads to increased consumption opportunities. The prosperity of the countries consequently grows with it.
Extension of the model: the comparative advantage with several goods
The Ricardo model can also be expanded to include several goods. Of course, nothing changes in principle. Every country produces the goods for which it has a comparative cost advantage .
The world market equilibrium can again be represented with the help of the RS and RD functions.
Inclusion of transport costs and non-tradable goods
The complete specialization of a country in the real world economy is hardly feasible for the following three reasons and is therefore severely restricted.
1. In reality there are several factors of production which influence one another and counteract complete specialization.
2. States often want to protect certain industries against foreign competition and take measures to shield the domestic market from the outside world ( protectionism ).
3. In his model, David Ricardo does not take into account any transport costs for the goods being traded. These transport costs make up a certain percentage of the production costs, which must be included in the calculation. The inclusion of transport costs leads to the development of non-tradable goods. Due to a lack of significant (national) cost advantages or excessive transport costs, these goods are not traded.
A trade in which the weighting of goods in relation to their value is very high is not worthwhile. For this reason, importing cement, for example, is not recommended in most cases, even if it is significantly cheaper to produce abroad. In some cases it is even impossible to conduct foreign trade, as many services, for example, cannot be transported and can therefore only be used regionally.
Multilateral trade
In reality there are far more than 2 countries and two goods. There are 150 countries trading in millions of different goods and services. The trading opportunities are enormous today, one country can import something from another without having to export anything. A cycle is created, see figure on the right “Multilateral Trade”. Many different trading participants are required to achieve better results. Multilateral trade agreements are indispensable nowadays in order to have an efficient use of the respective resources.
example
David Ricardo's foreign trade theory is based on the principle of comparative advantage he developed. At its core, the theory says that the exchange of goods between two countries is worthwhile for both, even if one country can produce all goods with less effort than the other.
Ricardo illustrates his considerations using the example of the trade in cloth and wine between England and Portugal. If there is no trade between the two countries, each country produces both products - cloth and wine - itself. England needs 100 workers to produce 1,000 rolls of cloth and 120 workers to produce 1,000 barrels of wine. Portugal, on the other hand, only needs 90 workers to produce the same amount of cloth and 80 workers to produce the same amount of wine. Both countries together produce 2000 rolls of cloth and 2000 barrels of wine.
If both countries now specialize in the good that they can produce more productively relative to the other good in their own country, this leads to an overall larger output volume with constant labor productivity:
| State without trade | |||||
|---|---|---|---|---|---|
| England | Portugal | ||||
| Number of workers | Application rate | Labor productivity | Number of workers | Application rate | Labor productivity |
| 100 | 1000 rolls of cloth | 10 cloth / worker | 90 | 1000 rolls of cloth | 11.11 cloth / worker |
| 120 | 1000 barrels of wine | 8.33 barrels / worker | 80 | 1000 barrels of wine | 12.5 barrels / worker |
| 220 | 2000 units | ⌀ 9.09 units / worker | 170 | 2000 units | ⌀ 11.76 units / worker |
| State with trade | |||||
| England | Portugal | ||||
| Number of workers | Application rate | Labor productivity | Number of workers | Application rate | Labor productivity |
| 100 | 1000 rolls of cloth | 10 cloth / worker | 90 | 1125 barrels of wine | 12.5 barrels / worker |
| 120 | 1200 rolls of cloth | 10 cloth / worker | 80 | 1000 barrels of wine | 12.5 barrels / worker |
| 220 | 2200 rolls of cloth | ⌀ 10 cloth / worker | 170 | 2125 barrels of wine | ⌀ 12.5 barrels / worker |
In Ricardo's example, Portugal specializes in the production of wine, as the country requires less labor to make wine than it does to make cloth. Assuming that 1000 rolls of cloth are equivalent to 1000 barrels of wine and that the 90 workers from the cloth production have the same productivity as the already employed wine workers, Portugal can produce an additional 1125 barrels of wine. Portugal no longer produces 1,000 rolls of cloth and 1,000 barrels of wine, but produces 2,125 barrels of wine. England, in turn, stops its wine production and only produces cloth. The former 120 wine workers can produce an additional 1200 rolls of cloth with the same productivity as the workers already employed. Similar to Portugal, England no longer produces 1,000 rolls of cloth and 1,000 barrels of wine, but produces 2,200 rolls of cloth.
Through division of labor and trade, England and Portugal can increase their combined output by 200 rolls of cloth and 125 barrels of wine. Trade with the other country ensures the supply of goods that are no longer produced and is the basis for increasing prosperity.
Empirical confirmation
The core idea of the Ricardo model - that countries primarily export those goods for which their productivity is relatively high - can be confirmed empirically.
For example, using data from the period after World War II, the productivity and trade of Great Britain and the USA were compared. It found that the US was more productive than the UK in all 26 industries surveyed. So the Americans had an absolute advantage everywhere. Yet the total volume of British exports was only slightly smaller than that of the Americans. UK exports were greater than US exports in twelve sectors. Confirming Ricardo's theory, these were the sectors where Britain's productivity disadvantage was relatively small. Consequently, American exports only noticeably exceeded British exports in those sectors in which the USA had a high relative productivity advantage.
The figure opposite illustrates Ricardo's theory that trade depends not on absolute, but on relative advantages. The figure shows that American companies export more in an industry, the higher their relative productivity advantage there.
Empirical evidence that foreign trade benefits the participating actors is provided by the enormous increase in world trade relationships with the associated increases in welfare in a large number of economies after the Second World War. This development is undoubtedly largely due to increasing global trade.
In addition, the model of comparative advantages is still an important argument for the liberalization of the world trade system by the World Trade Organization .
criticism
On closer inspection, the Ricardo model can only withstand comparison with reality to a limited extent.
The model assumes human work as the only production factor. Ricardo disregards capital as a production factor in his theory. Thus Ricardo does not include the different resource endowments of the countries, which in practice also leads to trade between the nations, in his model.
Another point of criticism concerns Ricardo's assumption that the factors of production are freely movable between the sectors and that all goods can therefore be produced by all workers. This also applies to Ricardo's assumption that the goods produced by different producers are homogeneous goods . We do not encounter either of these assumptions to this extent in reality.
In addition, Ricardo's assumption of full employment must be viewed critically. In real economies there is always a certain group of people who cannot or do not want to pursue gainful employment. Contrary to Ricardo's assumption, in reality the existing workforce is not fully utilized.
In addition, Ricardo neglects transaction costs in his model of comparative advantages . In particular, the lack of transport costs is often criticized in the specialist literature.
Ricardo assumes constant economies of scale in his model , ie he assumes that productivity does not depend on the quantity produced. In practice, especially in industrial companies with an increasing output volume, mass production advantages become noticeable, which lead to increasing economies of scale. In agriculture, on the other hand, declining economies of scale can usually be assumed due to the limited usable soil. Consequently, Ricardo's assumption of constant returns to scale has to be assessed as unrealistic.
Foreign trade has been shown to have a strong influence on the distribution of income within the participating countries. Ricardo does not go into the resulting distributional effects, but merely states that foreign trade has a positive effect on the prosperity of the countries as a whole.
One should also not forget that Ricardo restricts himself to explaining inter-industrial trade and that the model therefore does not cover all conceivable areas of world trade.
Despite the obvious weaknesses of the model, Ricardo's core statement - that productivity differences play an important role in international trade and that the comparative rather than the absolute advantage is more important - is undisputed.
Common mistakes of various arguments
There are three common misconceptions in economics and politics that are often mentioned in connection with foreign trade.
The competitive argument
It is assumed that free trade is only beneficial if one's own country can withstand foreign competition. Foreign trade profits, however, do not result from absolute, but rather from comparative advantages. Even if the home country is more inefficient than the foreign country in any of its productions, it can successfully participate in foreign trade, since an absolute advantage is not a sufficient condition for a comparative cost advantage.
The wage dumping argument
This line of argument argues that international competition harms other countries if a competitive advantage is based on low wages. One should not measure oneself against other countries that are less productive but pay lower wages. These "low-wage countries" would gain a competitive advantage from paying their workers less money. This argument is regularly used by trade unions to call for industry protection. It does not matter in which area the foreign country has a competitive advantage, because trade profits arise from the fact that one's own country has a comparative advantage in a good and then exchanges it for a good from abroad. The point is that those countries that manufacture the product more cheaply through specialization and trade, have an advantage over the self-sufficient countries.
The exploitation argument
Through foreign trade, a low-wage country is exploited by countries with higher wages. This argument is usually put forward on the emotional level and is intended to bring the moral question to the fore, whether it is okay to pay people in other countries significantly lower wages than in one's own country. However, from a purely economic point of view, a country with lower wages is not exploited by a country with higher wages. However, one has to consider the alternative without foreign trade. So the question is whether or not it is worth trading. In self-sufficiency, only absolute advantages are used, the relative ones are ignored. So trading profits resulting from relative advantages would disappear. Accordingly, the country would be even worse off without trade than with.
literature
- Paul Krugman , Maurice Obstfeld : International Economy. Theory and Politics of Foreign Trade. ("International economics"). 7th edition Pearson Studium, Munich 2006, ISBN 3-8273-7199-6 .
- Paul Krugman , Maurice Obstfeld : International Economy. Theory and Politics of Foreign Trade. ("International economics"). 8th edition, Pearson Studium, May 1, 2009, ISBN 978-3827373618 .
- David Ricardo: On the principles of political economy and taxation. (" On the Principles of Political Economy and Taxation "). FinanzBook-Verlag, Munich 2006, ISBN 978-3-89879-141-0 (The library of economic classics; 3).
- Horst Siebert : Foreign trade. 6th edition G. Fischer Verlag, Stuttgart 1994, ISBN 3-8252-8081-0 ( UTB for science ; vol. 8081)
- Malte Fischer: David Ricardo: The free trader . WirtschaftsWoche Online, December 4, 2011.
Individual evidence
- ↑ Horst Siebert: Außenwirtschaft , p. 28.
- ^ David Ricardo: On the Principles of Political Economy and Taxation (Everyman's Library; 1590). Dent, London 1987, ISBN 0-460-11590-1 , p. 84 (reprint of the London 1817 edition).
- ↑ David Ricardo: On the principles of political economy and their taxation , p. 121.
- ^ Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , p. 54.
- ^ Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , p. 56.
- ^ Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , p. 59.
- ↑ cf. Klaus Rose, Karlhans Sauernheimer: Theory of Foreign Trade , Edition 14, p. 450 ff.
- ^ Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft, 8 ed. Pp. 80, 81
- ↑ Bernhard Beck: Understanding Economics . 4th edition vdf-Verlag, Zurich 2005, ISBN 3-7281-3000-1 .
- ↑ Malte Fischer: David Ricardo: The Free Trader , p. 4.
- ↑ See Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , 8th edition, pp. 82–84.
- ↑ See Sebastian Hammer: The theory of comparative cost advantages according to David Ricardo, pp. 18-19.
- ↑ See Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , 8th edition, p. 82.
- ↑ See Sebastian Hammer: "The theory of comparative cost advantages according to David Ricardo", pp. 16-17.
- ↑ See Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , 8th edition, p. 71.
- ↑ See Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , 8th edition, p. 72.
- ↑ See Paul Krugman, Maurice Obstfeld: Internationale Wirtschaft , 8th edition, p. 74.