Economic History

If Smith and Ricardo were right, what patterns of economic specialization should we observe under free trade?

By Catherine De Las Salas. Fall 2014. New York City.

By Catherine De Las Salas. Fall 2014. New York City.

Many orthodox economists claim that the works of Adam Smiths and David Ricardo -the Wealth of Nations and On the Principles of the Political Economy- form a set of ideas that can be articulated perfectly in order to explain an alleged reality. However, it is the empirical verification what proves weak such a coherent set of concepts. I was recently asked by one of these economists, “How does Smith understand the relationship between deepening division of labour and the extent of the markets to which producers may sell their goods? If Smith was right, what patterns of economic specialization should we observe across national economies under free trade? In what ways does this differ from the account provided by Ricardo?” Here I answer the question, in first place, by briefly articulating both works throughout the relation between deepening division of labor and the extent of the markets. For the second part of the question, I look at some historiography works in order to identify economic specialization patterns across national economies under free trade as the question requires it. In other words, I propose to map Smiths’ and Ricardo’s’ insights over a brief selection of economic historiography. The first section of this essay adjusts both authors’ theories into four basic working concepts. The second section identifies six possible scenarios that could have been fostered by those four basic concepts, and matches them into selected titles of the economic historiography. Finally, the essay concludes on the theoretical and empirical grounds.

I

A straight forward answer to the question above would be not only restricted, but also unfair with Adam Smith while comparing his insights on commerce to the ideas put forward by David Ricardo about trade. In that regard, what would do justice to such a comparison is Ronald Meek’s consideration of the work of the latter in terms of an update of the work of the former (Meek, 1956). Hence, whatever analysis on the relationship between the deepening division of labor and the extent of the markets will inexorably revolve around Ricardo’s theory of Comparative Advantages. Nonetheless, there are few core elements on Smith’s labor theory of value that are taken as departures for the analysis made by David Ricardo. Those departures make the connection between both authors as well as the foundations for a cogent answer about the relationship between division of labor and free trade. Basically, the link lies on both author’s ideas about the origin of profits, which Ricardo addresses by claiming profits can only increase when trade makes basic consumption cheaper for labourers. This in turn leads to a decrease in wages, and therefore the labor theory of value rises through as the linking concept between Smith and Ricardo.

First, the core idea in Smith used by Ricardo as departure is the definition of the division of labor, to which Ricardo seems to agree. For Smith the division of labor arises from a unique human nature propensity to exchange (Smith, 1994. Page 16-17), which in a higher scale leads to international trade and specialization of production via difference of talents among agents (either individuals or nations). The extent of the market for Smith sets the limit of such differences of talents that utmost foster division of labor. The greater the market, the greater the chances for finding different human talents; thus, the greater the division of labor. Additionally, for Smith, markets are augmented by improvements in infrastructure, which for Ricardo almost represents a mean for the incorporation of new fertile land into production.

In spite of the apparent agreement between both authors on the notion of division of labor, Ricardo expands the understanding of it by unfolding the division of labor through social classes. In Smith the division of labor is defined as a list of advantages of it, and by a naturally “given” predisposition to trade taken from nowhere. Following Smith, the advantages fostered by the division of labor are at least four: dexterity, specialization, technology improvements, and savings (Smith, 1994. Page 8-9). For David Ricardo instead, the division of labor not only fosters the mentioned advantages, but also it is composed of by factors of production: capital, labor, and land. Thus, for Ricardo the labor theory of value is incomplete given that “not only the labour applied immediately to commodities affect their value, but the labor also which is bestowed on the complements, tools, and buildings, with which much labor is assisted” (Ricardo, 2001. Page 16). For Ricardo division of labor starts with the use of capital rather than from specialization as in Smith. This opens the way for the second departure in Smith and Ricardo’s debate.

The second departure Ricardo takes from Smith is the labor theory of value, which Ricardo seems to question, at least partially. For Smith, given the division of labor every man must live in exchange, and therefore, society must agree on the fairest exchange measure tool. The closest tool for standardizing value in exchange is labor (Smith, 1994. Page 33). For Smith, labor is the most invariable measure individuals can rely on while exchanging. On the other hand, Ricardo seems to not only disagree on the fact that labor appears to be constant across nations (Ricardo, 2001. Page 34, 58), but also surrenders labor to the laws of supply and demand, which is Ricardo’s pillar for his distinction between Natural price of labor (Subsistence) and Market price of labor (Supply and demand). Furthermore, the fact that capital and labor compose the value of commodities -in Ricardo’s view of the division of labor- makes labor’s value relative to capital. In other words, labor varies through Supply and Demand, and through its relation to capital employed in production. Therefore, for Ricardo it is money –currency- what would make it into a standard for exchange by forging some sort of exchange parity conditions (Ricardo, 2001. Page 101).

The third departure Ricardo takes from Smith is the assumption that human beings have a natural tendency to exchange. For Smith -as we mentioned before- that is the trigger for division of labor. Likewise, it is possible to infer from such assumption that free trade is just a macro manifestation of such natural tendency. Ricardo modifies Smith’s assumption by rooting it under what he calls the “happiness of mankind”. In Ricardo’s words:

“it is quite as important to the happiness of mankind, that our enjoyments should be increased by better distribution of labour, by each country producing those commodities for which by its situation, its climate, and its other natural or artificial advantages, it is adapted, and by their exchanging them for the commodities of the other countries, as that they should be augment by the rise in the rate of profit” (Ricardo, 2001. Page 88).

In other words, foreign trade manifests throughout an inexorable human desire to maximize profits –or enjoyments- and this desire in turn unveils national “strengths” or comparative advantages. Foreign trade changes its definition from being the result of a “unique human gift” to a more refine definition that involves certain notion of opportunity cost (Paradoxically, “maximizing profits” becomes Smith’s “unique human gift” for Ricardo –it comes from nowhere).

The forth departure Ricardo takes from Smith regards the extent of the markets and its incorporation into the late XVIII-English-economy. This departure is less clear due to a gap in both authors’ work when both explore incorporation of new markets. For Smith economic integration depends on connectivity and infrastructure (Smith, 1994. Page 20-24); whereas for Ricardo economic integration gets mediated by some sort of land quality which somehow gives degrees of production (e.g. land of first, second, third… degree). Thus, we can infer that for Smith quality of the land being economically integrated correlates to the infrastructure it benefits from; whereas, for Ricardo the quality of the land being integrated depends on its soil’s fertility (Ricardo, 2001. Page 41). In that regard, it is evident that Ricardo does not make an extension of Smith’s ideas of new markets, but creates his own. There is not a shared concept so that we can compare.

II

So far, it is clear that the connection between division of labor and free trade will be driven by Ricardo’s extension of Smith’s ideas. Basically the theoretical extension goes like this:

ADAM SMITH. DAVID RICARDO.
DEPARTURE CONCEPTS. Extended concepts.
DIVISION OF LABOUR. Comparative Advantage.
LABOUR THEORY OF VALUE. Money-Currency.
TENDENCY TO TRADE. Maximizing profits “Opportunity cost”.
NEW MARKETS-INFRASTRUCTURE. New Markets- soil fertility.

Based on this logic we may now tackle the inquiry for the implications over the economy that derive from Ricardo’s extensions of Smith’s ideas. Under free trade then we should expect an excursion of events that leads to six different outcomes. First, we should expect a better distribution of labor, which basically means a global scale of the division of labor (division of labor-comparative advantage). Second, deeper specialization given by the natural development of comparative advantages (division of labor-comparative advantage). Third, we should also expect economic gains when tradables affect basic consumption of the workers (tendency to trade-profit maximization). In other words, we should expect to have lower levels of inflation and higher levels of employment. Fourth, we should experience and increase in profits as a result of lower levels of subsistence wages (tendency to trade-profit maximization). Fifth, we should expect a forged standard exchanges patron (labor theory of value- Standard patron of exchange). Finally, sixth, we should expect more economic integration among nations (new markets, infrastructure-new markets, soil fertility).

The first theoretical proposition will manifest as a spillover of trade on labor. We said we should expect better distribution of labor under free trade. Although the adjective “better” complicates any sort of scientific confirmation, we will assume that as the division of labor foster specialization, the better the distribution of those jobs are. On the other hand, there is an even worst situation. I currently lack data that may allow us to either confirm or deny empirically such a spillover. Nonetheless, the last resort for unveiling and matching an economic pattern will be to bend historiography so that it fits. Therefore –with some freedom of interpretation- I can equalize this expected spillover with the British process of enclosures during XVII and XVIII centuries. It is basically, the process of deepening the division of labor via the foreign demand for wool that led England’s yeomen to change not only the nature of land’s property but also cloth production (Moore, 1966). The British yeomen became part of a chain of production by selling his wool as a commodity for foreign trade and cloth production. The first division of labor fostered by trade is the differentiation between who grows the wool in the country and who sews it in a loom.

By Catherine De las Salas. Fall 2014. New York City.

By Catherine De las Salas. Fall 2014. New York City.

The other way to interpret history in terms of Ricardo’s theory of trade, is by looking into the latest wave of globalization. The division of labor will manifest globally through a geographical distribution of labor given an increasing outsourcing practices along the production process (Castells, 1996). Thus, division of labor under free trade will characterize some countries as firms’ “headquarters” and others as firms’ “industrial facilities”. This phenomenon materialize in Apples’ products “Design in California/Assembled in China”. “Headquarter” labor activities are being kept in American cities such as Boston, Cambridge, New York, San Francisco and Los Angeles. These same cities have been at the same time experiencing net losses in manufacturing jobs -up to a 20% in the period starting in 1977 to 1987 (Pollard & Storper 1996). Likewise, within the country such division of labor will lead to a trend of inner structural change of labor given the cost of transaction in trading. Following the logic of the changes in labor due to so-called Information Age proposed by Castells, we may claim in addition that developed countries will develop toward an over specialization in transaction services (Wallis and North, 1986). Others will join the so-called late industrialization process (i.e. South Korea).

The third spillover we should expect from an increasing division of labor and a deepening process of economic integration in Ricardian conditions are economic gains in consumption when tradables make them cheaper. Basic consumption should lower nominally speaking while increasing disposable income. Once again, empirical evidence for verifying such a correlation will consume more time than the time provided for this essay. However, we can bend history again to make it fit Smith and Ricardo’s theory. A good fit for an approximation will be the case of the United States consumer spending trends during the twenty century. We can claim –with some more elasticity in interpretation- that part of the U.S disposable income tripling-purchase-power from 1901 to 2003 (Dolfam and McSweeney, 2006) is an outcome of free trade. By riding a trade deficit United States has made cheaper the basic consumption of U.S. workers. Furthermore, we may also claim as a spillover of trade that there has been the so-called “The hidden prosperity of the poor” (Cutler and Katz, 1992), in which prices have favored the poor.

In the fourth scenario propelled by division of labor and international trade we should expect an increase in profits as a consequence of a drop in subsistence level wages. Little doubt there has been an increase in profits for developed countries in general and multinational corporations in particular. However, the controversy lies on the actual gains of their counterparts: both, developing countries and citizens. In the context of an asymmetric trade relation, international trade should bring prosperity through an equalizing process of wealth spreading, allegedly. One more time we face the imperative to bend historiography so that Ricardo’s theory matches empirical evidence. That being said, we can infer in this instance that the increasing foreign trade as well as division of labor have brought a process of economic convergence. Internationally, there has been a process of knowledge-technology sharing and capital mobility that has increased the living standards of the nations that willingly have engaged themselves into open markets (Spence, 2012). Within boundaries though, such process of convergence takes more relevance since in this fashion not only capital and technology, but also labor are mobile. The phenomenon of convergence among United States’ regions and sectors weighs heavily positive, at least for the period ranging from 1880 to 1988 (Barro and Sala-i-Martin, 1991).

In the fifth scenario we must expect a global exchange currency that goes beyond the alleged parity of labor. That simply means the rise of the American currency as the standard for international transactions.

In the sixth scenario, we should expect an increase trend of new markets incorporations. This phenomenon may range from colonialism to bilateral free trade agreements. The former mechanism being even a source for increasing profits since -following Marx- colonialism represents one of the two sources of the origin of capital accumulation. The latter mechanism can be made evident by the institutional evolution of foreign trade. Early since the XVIII century when mercantilist demanded regulation of trade (Irwin, 1996), and British nationalized merchants’ interests in the debate about the Corn Laws (Schonhard-Bealy, 2006), the word “free” trade has meant anything else but free due to the high volume of regulation. Starting with the clause of Most Favorite Nation created by the British regime during the XIX century, foreign trade has forged an institutional arrangement across regions (e.g. ECOWAS in West Africa, European Union and APEC for the countries in the Pacific Rim, among others); between countries (e.g. Bilateral Free trade agreements); and globally (World Trade Organization and the General Agreement on Tariff and Trade GATT) (Krueger, 1999). Furthermore, trade agreements have even been used as tools for foreign policy as the case of the United States (VanGrasstek, 2007).

III

Some concluding remarks:

The first big challenge of this essay was to address the way some ideas about the labor theory of value of the Wealth of Nation interact with selected ideas about foreign trade in On the Principles of Political Economy. In that regard, this essay adhered to Ronald Meek’s proposition of understanding Ricardo’s work as an update of Smith’s. In terms of the concept of Division of Labor and its empirical confirmation, it is easy to conclude that such phenomenon not only is a good representation of the reality, but also a good extrapolation for macro-economic analysis. However, the portion of the concept that still hovers above is the notion on both authors about a “natural” tendency to trade and a “natural” tendency to maximize. Likewise, the perspectives of both authors on market incorporation require more detail and elaboration, perhaps on their end. Both works are theoretically consistent and coherent.

The second challenge of this essay was to find some sort of verification either through empirical data or secondary sources. Resources constraints obviously limited our chance to organize and validate the theory empirically. Therefore, it was necessary to bend historiography in order to prove right or wrong Smith’s and Ricardo’s theoretical propositions. Nevertheless, the essay made an attempt to cogently address six possible economic pattern under free trade. First, a theoretical expected better distribution of labor; a deeper economic specialization across nations; also, alleged economic gains derives from a decrease in cost of basic consumption; an increase in profits; the rise of a forged standard exchanges patron; and, a trend in incorporation of new markets. Generally speaking, both works are difficult to support empirically.

References:

Barro, R. and Sala-i-Martin, X. (1991). Convergence across states and regions. Brookings papers on Economic activity.

Castells, M. (1996). The rise of the network society. Wiley-Blackwell Publishers. Malden MA.

Cutler, D. and Katz, L.F. (1992). Rising Inequality? Changes in the Distribution of Income and Consumption in the 1980s. National Bureau of Economic Research, Inc, NBER Working Papers: 3964.

Dolfam, M. and McSweeney, D. (2006). 100 Years of U.S. Consumer Spending: Data for the Nation, New York City, and Boston, BLS Report 991. http://www.bls.gov/opub/uscs/report991.pdf

Krueger, A. (1999). Are Preferential Trading Arrangements Trade-Liberalizing or Protectionist? Journal of economic perspective. Vol. 13. no. 4. Fall.

Irwin, Douglas. (1996). Against the tide. An intellectual history of free trade. Princeton University. New Jersey.

Meek, R. (1956). Studies in the labor theory of value. Monthly Review Press. United States.

Moore, Barrington (1966). Social Origins of Dictatorship and Democracy: Lord and Peasant in the Making of the Modern World, Beacon Press, Boston.

Wallis. J and North, D. (1986). Measuring the Transaction Sector in the American Economy, 1870-1970. NBER. Cambridge. Massachusetts.

Pollard, J. and Storper, M. (1996). A tale of twelve cities: metropolitan employment change in dynamic industries in the 1980’s. Economic Geography. Vol. 72. No. 1.

Ricardo, D. (2001) On the Principles of the Political economy and taxation. Batoche Books. Canada.

Smith, A. (1994). The wealth of Nations. Random House. Inc. United States.

Spence, M. (2012). The next convergence: the future of economic growth in a multispeed world. Picador.

Schonhardt-Bailey, C. (2006). From Corn Law to Free Trade. MIT press. Cambridge, Massachusetts.

VanGrasstek, Craig. (2007) U.S. Trade Policy and Developing contries. International Center for Trade and Sustainable Development. Geneva, Switzerland

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