Economists have had an enormous impact on trade policy, and they provide a strong rationale for free trade and for removal of trade barriers. Although the objective of a trade agreement is to liberalize trade, the actual provisions are heavily shaped by domestic and international political realities. The world has changed enormously from the time when David Ricardo proposed the law of comparative advantage, and in recent decades economists have modified their theories to account for trade in factors of production, such as capital and labor, the growth of supply chains that today dominate much of world trade, and the success of neomercantilist countries in achieving rapid growth.
One of the better-known advocates of this philosophy, known as mercantilism, was Thomas Mun, a director of the British East India Company. In a letter written in the 1630s to his son, he said: “The ordinary means therefore to increase our wealth and treasure is by Foreign Trade, wherein wee must ever observe this rule; to sell more to strangers yearly than wee consume of theirs in value. . . . By this order duly kept in our trading, . . . that part of our stock which is not returned to us in wares must necessarily be brought home in treasure.”[1]
Mercantilists believed that governments should promote exports and that governments should control economic activity and place restrictions on imports if needed to ensure an export surplus. Obviously, not all nations could have an export surplus, but mercantilists believed this was the goal and that successful nations would gain at the expense of those less successful. Ideally, a nation would export finished goods and import raw materials, under mercantilist theory, thereby maximizing domestic employment.
Then Adam Smith challenged this prevailing thinking in The Wealth of Nations published in 1776.[2] Smith argued that when one nation is more efficient than another country in producing a product, while the other nation is more efficient at producing another product, then both nations could benefit through trade. This would enable each nation to specialize in producing the product where it had an absolute advantage, and thereby increase total production over what it would be without trade. This insight implied very different policies than mercantilism. It implied less government involvement in the economy and a reduction of barriers to trade.
Smith and Ricardo considered only labor as a “factor of production.” In the early 1900s, this theory was further developed by two Swedish economists, Bertil Heckscher and Eli Ohlin, who considered several factors of production.[4] The so-called Heckscher-Ohlin theory basically holds that a country will export those commodities that are produced by the factor that it has in relative abundance and that it will import products whose production requires factors of production where it has relatively less abundance. This situation is often portrayed in economics textbooks as a simplified model of two countries (England and Portugal) and two products (textiles and wine). In this simplified portrayal, England has relatively abundant capital and Portugal has relatively abundant labor, and textiles are relatively capital intensive whereas wine is relatively labor intensive. With these conditions, both nations would be better off if they freely traded, and under such a situation of free trade, England would export textiles and import wine. This would maximize efficiency, resulting in more total production of textiles and wine and cheaper prices for consumers than would be the case without trade. Through empirical studies and mathematical models, economists almost universally believe that this model holds equally well for multiple products and multiple countries.
Furthermore, some products do not utilize the same factors of production over their life cycle.[6] For example, when computers were first introduced, they were incredibly capital intensive and required highly skilled labor. Over time, as volume increased, costs came down and computers could be mass produced. Initially, the United States had a comparative advantage in production; but today, when computers are mass produced by relatively unskilled labor, the comparative advantage has shifted to countries with abundant cheap labor. And still other products may use different factors of production in different countries. For example, cotton production is highly mechanized in the United States but is very labor intensive in Africa. The fact that factors of production may change does not nullify the theory of comparative advantage; it just means that the mix of products that a nation can produce relatively more efficiently than its trade partners may change.
