Comparative Advantage and the Common Man
Updated: Oct 28, 2020
People voice concerns that a free society could be a dog eat dog deal where only the more productive would benefit. The opposite is the case.
People voice concerns that a free society could be a dog eat dog deal where only the more productive would benefit. The opposite is the case. Everybody needs to use voluntary co-operation to improve their lot. The theory of Comparative Advantage explains that the less capable will benefit from participating in a free society.
A number of people have asked me the same question in various forms. They say that it’s all very well for capable, industrious, well-educated and trained individuals to prosper in a free society. But what would happen to the less capable, industrious and prepared individuals? This is quite a question to unpack because there are unspoken assumptions behind it. What could the assumptions behind concern for the lot of the ‘disadvantaged’ or the ‘common man’ or ‘woman’ in a free society be?
I have listed some possible reasons why people might ask me this question (please let me know if I have missed one):
1) There could be an expectation that a libertarian society would be poorer than a Democratic Socialist state. A poorer society would indeed offer less rewarding employment to everyone than a richer one. A forthcoming post will explain why free societies will be much more prosperous. State intervention must always impoverish people. It replaces voluntary cooperation by coercion. Anyway, people generally know that socialist economies have done worse than free markets historically.
2) There could be a commendable concern about people who are too disabled to work, though many disabled people do work. Those unlucky enough to need charitable assistance are not, I assume, relevant to the lot of the average guy, the ‘common man’ or ‘woman’, as it were.
3) Maybe people assume that nature ‘red in tooth and claw’ reigns in a free society and the average guy is defenseless. But the truth is the contrary. Members of a free society can only increase their well-being through cooperation not force. Law based on the Non-Aggression Principle prevents coercion. Individuals in Democratic Socialist societies however can sometimes profit from deploying violence, directly or indirectly. Much violent death in such societies stems from state intervention. In Totalitarian Socialist societies it has been much worse. Tens of millions died.
4) There may be a concern that the fall of Democratic Socialism will leave high and dry people who depend on welfare, pension and unproductive state employment. Cheques from government will continue to arrive. But they won’t buy much. Those who have been made dependent on the state will be in difficulty. It could not happen in a free society. What such people actually need is much more voluntary co-operation and therefore wealth creation in society. Most will turn out to be less helpless once they are no longer paid to do nothing.
5) For the avoidance of doubt, I assume that we regard the Marxist notion of savers and investors ‘exploiting’ workers in a free society as thoroughly exploded. If not, I can return to the topic in another note.
6) What is left as a possible explanation of these concerns about the lot of the common man in a free society? The answer must be a feeling that more productive members of a free society will have no reason to co-operate with the average or below average performers. Therefore, these latter individuals will be left out in the economic cold. This is not what will happen in reality. The idea that it would happen is tantamount to a rejection of the Theory of Comparative Advantage.
The Theory of Comparative Advantage is at once; unknown to the vast majority of people; misunderstood by most who have heard of it; and when correctly understood crucial to showing that everyone benefits from participating in trade (i.e. cooperation or voluntary exchange) including the less productive.
Adam Smith’s ‘The Wealth of Nations’ (1776) was a breakthrough in economic thought. Among other things it explained the benefits of the ‘specialisation and division of labour’. He depicted a lone maker of nails producing a handful of nails every day on his own. He laboriously performed every stage of the process himself. The result was a low income but expensive nails. Then he explained that in reality many people co-operated by dividing up the work and specialising in just one operation in the nail making process. The result was more nails per worker, higher wages and cheaper nails.
This understanding of the value of specialisation leads directly to the Theory of Comparative Advantage which was set down by David Ricardo in 1817. The theory was discussed in terms of trade arrangements between countries, specifically trade between England and Portugal in terms of wine and textiles. But it applies to all entities capable of engaging in production and able to benefit by specialising in a single area of activity. It applies to companies, areas and individuals. It is wholly counter-intuitive for most people. What then is this paragon of a theory?
The Theory of Comparative Advantage says that every person will benefit from trade if they specialize in the goods or services at which they are most productive compared to other goods or services they might produce.
Notice what it doesn’t say. It doesn’t say specialise in goods or services at which you are more productive compared with other producers. People think it says that. But it doesn’t. It says; specialise in your most productive activity compared to other things you could do. So that means less-effective producers find a market too. It may be time for an example:
Person A is a very capable person. She devotes half her time to making widget 1 and half to producing widget 2. Per hour of her limited daily work time she produces 25 units of value of widget 1 and 15 units of widget 2.
Person B is not so dynamic, bright or trained. She too devotes half her time to making widget 1 and half to producing widget 2. Per hour of her limited daily work time she produces 8 units of value of widget 1 and 12 units of widget 2.
Let’s say both can work ten hours a day. Person A can produce 5x25 units of value in widget 1 and 5x15 units of value in widget 2. Her total daily output is 200 units of value. Person B’s potential output is a much more modest at 100 units per day.
People who worry that Person B is going to be thrown on the societal scrap heap can stop fretting now. Trade between A and B is in both person’s interests even though B is frankly inferior at both activities. Both people will have employment and higher incomes than before. Here’s how:
A and B stop being alone. They become members of a productive voluntary arrangement. They are partners in trade. A specializes in widget 1 because she is comparatively better at making widget 1 than she is at making widget 2. She produces 250 (10x25) units of value per day.
B in turn only makes widget 2 because she is comparatively better at making widget 2 than making widget 1. She does so even though she is worse at making either widget 1 or 2 than Person A. B produces 120 units of value per day (10x12). Combined they have boosted production values from 300 (200+100) to 370 (250+120). Output is up nearly 25%. The increased value will be shared between A and B. If not, co-operation will stop.
In any society where voluntary cooperation is the rule everybody will be employed, trading happily and better off. Nobody would be left out who does not wish to be. It is true that many more mundane functions are performed by people who are not the best people for the job. However, such people do create value by releasing others to specialize in higher value activities. For this reason they are included in the network of exchange.
And by the way, being included in the network of exchange of a much richer, free society - even in a modest role - will be a good deal.