by Spencer P. Morrison
Comparative advantage may work in theory, but in a world of mobile capital and asset trade, it's a recipe for national decline.
In our recent debate, Peter Schiff argued that comparative advantage was a fact—an economic law akin to gravity or the conservation of energy. As such, global free trade is not only justified, it is desirable and perhaps inevitable. Any impediments to free trade—especially tariffs—are not just foolish; they are economically illiterate.
Schiff is wrong.
Why? The theory of comparative advantage is predicated on an exchange of goods for goods and does not apply if it is possible to sell assets and debts. Obviously, this is possible. Further, the theory is predicated on capital immobility. Again, capital is mobile in today’s economy, so the theory breaks down.
Theory is not reality. Peter Schiff should touch grass.
Comparative Advantage for Dummies
David Ricardo devised the theory of comparative advantage in his treatise On the Principles of Political Economy and Taxation, which Peter Schiff has clearly never read. For Schiff’s edification, let’s begin by explaining how comparative advantage works.
The theory is straightforward: countries should trade stuff they are relatively good at making for stuff they are relatively bad at making. This makes the economy more efficient by ensuring countries produce what they are best at—the world makes more stuff with less work.
To illustrate this point, Ricardo provided the following example: England and Portugal both make cloth and wine. It takes the English 100 man-hours to make a bolt of cloth and 120 to make a barrel of wine. In total, it takes 220 hours to make one unit of each. Notice that England is relatively better at making cloth.
Meanwhile, it takes the Portuguese just 90 hours to make a bolt of cloth and 80 hours to make the wine. Overall, it takes 170 hours to make one unit of each. In this case, although Portugal is absolutely better than England at making both cloth and wine, it takes the Portuguese less time to make either commodity, Portugal is relatively better at making wine.
According to Ricardo, because England is relatively better at making cloth and Portugal is relatively better at making wine, even though Portugal is better at both, we can say that each has a comparative advantage in their most efficient product. Basically, England should make cloth and Portugal should make wine, and they ought to trade for the other item. Doing so results in the most efficient division of labor.
This makes mathematical sense. If neither country specialized, it would take 220 hours for England to make one unit of each, while Portugal would take 170 hours. However, if they both specialized and traded, then the same labor could make 2.2 units of cloth and 2.125 units of wine—like magic, specialization and trade make everyone richer.
Schiff—and the rest of the free trade brigade—argues that this logic applies globally. If only countries maximized their comparative advantage—if they specialized in what they were relatively best at and traded for the rest—then we could increase economic efficiency and make everyone richer.
Comparative advantage is an elegant theory. But it has its limitations.
Comparative advantage’s first limitation: offshoring
Although Peter Schiff believes comparative advantage always applies, David Ricardo was not nearly so foolish. Ricardo recognized that the theory only works when countries trade production for production—goods for goods.
If countries were able to trade something else, like past or future production, assets, or debts, then comparative advantage no longer applies. Why? Offshoring. Ricardo writes:
…it would undoubtedly be advantageous to the capitalists [and consumers] of England… [that] the wine and cloth should both be made in Portugal [and that] the capital and labour of England employed in making cloth should be removed to Portugal for that purpose.
Remember, in Ricardo’s example, Portugal had an absolute advantage in making cloth and wine. Therefore, the most efficient allocation of capital would be to make everything in Portugal and nothing in England—assuming that England could pay. If so, English industry should be offshored to Portugal, and England should run a trade deficit. According to Peter Schiff, this is the economically optimal.
Of course, Ricardo was not nearly so stupid. He knew that if England imported everything and made nothing, England would have no economy. Further, he recognized that England would be vulnerable to foreign suppliers.
Accordingly, Ricardo added an intellectual buttress to ensure his theory would not collapse. Ricardo writes, “Most men of property [will be] satisfied with a low rate of profits in their own country, rather than seek[ing] a more advantageous employment for their wealth in foreign nations.”
And there you have it. Ricardo’s argument—the entire theory of comparative advantage, global free trade itself—depends on the assumption that people love their country more than money and will invest domestically out of patriotism.
Someone please tell Peter Schiff that he needs to start buying American! I am sure he will oblige, given his dedication to defending comparative advantage.
Of course, recent history has shown us that Wall Street is willing to sell America to China for thirty pieces of silver. So much for free trade.
The False Assumption of Capital Immobility
Ricardo also used a more technical defense of comparative advantage against this obvious flaw. He argued that offshoring is practically impossible because capital is immobile—that is, England’s textile mills could not be moved to Portugal.
To be fair, when Ricardo wrote his Principles, capital was indeed largely immobile. His theory of comparative advantage worked because, in the early 19th century, transportation was an order of magnitude more expensive, machinery could not legally be exported from Britain, tariffs on manufactured goods exceeded 50%, capital markets were undeveloped in most countries, and endemic warfare prevented a large-scale commodity trade.
This hypothetical problem remained purely hypothetical for Ricardo. This is no longer true.
Today, capital is highly mobile in today’s economy. A factory can be relocated from the United States to China in short order, and transportation for bulk goods is incredibly (almost unbelievably) cheap. In fact, in the decades after Ricardo’s death in 1823, capital grew ever more mobile, and his hypothetical dilemma soon became real.
Throughout the 1800s there was a steady increase of capital outflows from Great Britain, as British investors built projects abroad seeking higher returns. In 1815, £10 million was invested abroad. In 1825, this climbed to £100 million, and by 1870 it was £700 million. By 1914 (the peak), over 35 percent of Britain’s national wealth was held abroad—Britain suffered a severe, decades-long shortfall in domestic investment.
This is essentially what is happening to America today. America has run trade deficits every year since 1974. The cumulative value of these deficits is $25 trillion. How was this paid for? By selling assets and debts. The result? Over 60,000 factories moved abroad and 7 million people lost good-paying manufacturing jobs.
Who could have guessed? David Ricard! Peter Schiff would have known this if he bothered to read the source material.
Theory Meets Reality: On the Treaty of Methuen
Perhaps the best way to end this article is to compare what happened to Ricardo’s hypothetical England and Portugal with what happened in the real countries. In his example, Portugal gets rich by maximizing its comparative advantage in wine, while England gets rich by doing so with cloth. Both countries trade; both benefit. Reality is harsh.
In 1703, England and Portugal signed the Treaty of Methuen, which exempted English cloth from a Portuguese import prohibition. In the following decades, cheap English cloth destroyed Portugal’s textile industry. Portugal indeed resorted to exporting wine. It was not long before England won a textile monopoly in Portugal, which allowed her to charge monopolistic prices.
Ultimately, high demand for British textiles provided fertile ground for the Industrial Revolution, which Portugal could not benefit from, given that Portugal’s textile industry was dead. This is an example of path dependency in economic development: it is better to have a small slice of a technologically advanced and growing industry than a monopoly in a dead-end industry.
Ironically, the British used their profits to buy up Portugal’s vineyards. In the end, the Treaty of Methuen deal helped England industrialize and grow rich—at Portugal’s expense.
David Ricardo understood that comparative advantage, while an elegant theory, does not always apply. Specifically, it does not apply when buying goods with assets or debts, and it does not apply when capital is mobile. Given that both of these conditions are true today, it baffles me that supposed “experts” like Peter Schiff trot out this dead horse.
Comparative advantage is dead. Let it rest in peace.
Spencer P. Morrison is a lawyer,
sessional instructor of law, and independent intellectual with a focus
on applied philosophy, empirical history, and practical economics.
Author of Reshore: How Tariffs Will Bring Our Jobs Home and Revive the American Dreamand Editor-in-Chief of the National Economics Editorial. His work has been featured on major publications including the BBC, Real Clear Politics, Blaze Media, the Daily Caller, the American Thinker, and the Foundation for Economic Education.
Source: https://amgreatness.com/2025/04/21/debunking-comparative-advantage/
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