Such are the highlights of the attack on the absurdities of mercantilist restrictions, which had flowered too long to suit Smith's disposition.
Smith did not expand these ideas at much length; but David Ricardo, the second great classical economist, developed them into the "principle of comparative advantage", a principle still to be found, much as Ricardo spelled it out, in every textbook on international trade.
The principle of comparative advantage is based on what kind of product the country can produce best, in comparing not with other countries, but with the producing of other kinds of goods. In this case the country doesn't necessarily need an absolute advantage to specialize in producing and exporting it.
The major purpose of the theory of comparative advantage is to illustrate the gains from the international trade. Each country can gain by specializing in those occupations in which it is relatively efficient; it should export part of that production and take in exchange those goods in whose production it is, for whatever reason, at a comparative disadvantage. The theory of comparative advantage thus provides a strong argument for free trade - and indeed - for a laissez-faire attitude with respect to trade.
The supporting argument is simple; specialization and free exchange among nations yield higher real income for the participants.
The act that a country will enjoy higher real income as a consequence of the opening up of trade barriers does not mean, of course, that every family or individual within a country must share in that benifit. Producer groups affected by import competition obviously will suffer to at least some degree. Comparative-advantage theorists concede that free trade would affect the relative income position of such groups, and perhaps even their absolute income level. But they insist that the special interests of these groups clashes with the total national interest, and the most that they are usually willing to concede is the possible need for a temporary protection against import competition, in order that the persons affected may have sufficient time to move to another occupation.
In his theoretical researches D.Ricardo did not base apon extensive empirical researches but mainly engaged in abstract reasoning. In working out his international trade theory, he also founded his conclusions apon a set of postulates which he considered as first approximations of the real world. The conclusions he drew, being valid within the framework of his assumptions only, had of course to be modified before they could be applied to actual circumstances.
The same is also true for Jean-Stuart Mill, whose studies in international trade theory completed the framework built by Ricardo. In spite of many attacks and emandations, the main structure of the Ricardo-Mill theory of international trade remained basically unimpared untill well into the 20th century.
He left however, much unfinished business for his successors, since his statements did not explain how the actual ratios of international exchange determine international prices.
Ricardo has been attacked on many grounds: his statement of the doctrine in terms of labor costs only; his assumption of constant cost of production; and, of course, his artificial assumptions of perfect factor mobility within a nation as against complete factor immobility internationally. Many feel that these demerits are minor and are overshadowed by the fact that his new approach opened up entirely new vistas for further research, for example, a restatement of the principle in terms of opportunity costs.
Ricardo's contribution left unanswered the question of how the actual ratios at which goods exchange are determined. It was Jean Stuart Mill who explained the determination of the terms of trade and did so with great skill. He found that they are dependent on reciprocal demand and that the equilibrum exchange ratio is the ratio that equalizes the values of exports and imports for each country in a two-country two-commodity situation. With the "Equation of International Demand" as a tool, he proceeded to envisage more complicated situations and explain what modifications in assumptions their analysis necessitated. His work helped greatly in clarifying the intricate problems connected with the theory of international values and strengthened the foundations on which others could build.
Among the other representatives of classical school we can pick up such economists as Nassau William, Senior, John Elliot Cairness, the Irish one Charles Francis Bastable, whose apport in developing theory of international trade was, perhaps, the boldest, as they tried to modify the Ricardo-Mill theory in more realistic way.
This change of attitudes led to the signing of a number of agreements embodying the new ideas, among them the Anglo-French Treaty of 1786, which ended what had been an economic war between the two countries.
After Adam Smith, the basic tenets of mercantilism were no longer considered defensible. This did not, however, mean that nations abandoned all mercantilist policies. Restrictive economic policies were now justified by the claim that, up to a certain point, the government should keep foreign merchandise off the domestic market in order to shelter national production from outside competition. To this end, customs levies were introduced in increasing number, replacing outright bans on imports, which became less and less frequent.
In the middle of the 19th century, customs walls effectively sheltered many national economies from outside competition. The French tariff of 1860, for example, charged extremely high prices on British products: 60 percent on politique economique ig iron; 40 to 50 percent on machinery; and 600 to 800 percent on woolen blankets. Transport costs between the two countries provided further protection.
A triumph for liberal ideas was the Anglo-French trade agreement of 1860, which provided that French protective duties were to be reduced to a maximum of 25 percent within five years, with free entry of all French products except wine into Britain. This agreement was followed by other European trade pacts.
Resurgence of Protectionism
In the period of a whole triumph of the doctrine of classical economic liberalism, in the first part of 19th century, there appears in Germany a diametrically contraire (at least apparently) doctrine of economic protectionism. The brightest representative of this new theory is, no doubt, Friedrich List (1789-1846), son of a German leatherworker. Not studying at any university, he made an academic career to become active in German politics. In 1819, he became leader of the General Association of Manufacturers & Merchants and the very soul of the movement to confederate the German states.
Being controversed and pressed in course of his life, list was in no smaller measure appreciated and valued posthumously. Rare economists had such a great influence upon the course of economic events as List had, there are few systems of economic thought which were to such extend using in practice as the Listien one was.
The economic and political unity that characterized much of Europe in the first half of 19th century was totally absent from Germany. The peace treaty that ended Germany's participation in Napoleonic wars left that country divided into 39 different states, most of which were individual monarchies economically and politically isolated from one another. Such isolation was primarily the result of a complex system of interstate tariffs that impaired the free and easy exchange of goods. At the same time, however, no import duties existed. Thus British surplus products (and those of other countries) found their way into German markets, where they were offered at extremely low prices.
Under these circumstances the very existence of German manufacturing and mercantile interests was threatened, and by the 1830, there arose among the German states a general clamor for economic unity and uniform tariffs. It was this movement that consumed List's interests and energy.
In his analysis of national systems of political economy, List applied a method of inquiry originated by Saint-Simon: the idea that an economy must pass through successive stages before it reaches a "mature" state. The historical stages of development detailed by List were:
1. Barbaric
2. Pastoral
3. Agricultural
4. Agricultural-Manufacturing
5. Agricultural-Manufacturing-Commercial
Like Sismondi and Saint-Simon, List was as much interested in transition between stages of economic development as in the end result. He felt that passage through the first three stages will be brought about most speedily by free trade between states and nations, but that economies in transition between the last two stages required economic protection until the final stage was reached.
Free trade justified once again, however, when the final stage of development was attained, "in order to guard against retrogression and indolence by the nation's manufacturers and merchants".
By List's classification and testimony, only Great Britain had attained the final stage of economic development. While the Continental and American nations struggled to reach this apogee, however, cheap British imports were thwarting the development of domestic manufacturing. List felt that until all nations reached the final stage of development, international competition could not exist on an equal footing. Thus he favored protective tariffs for Germany until its greatest national economic power was attained.
It is important to note that List was not an outright protectionist; rather, he felt that protection was warranted only at critical stages in history. His writings are replete with examples borrowed from history and experience showing that economic protection is the only way for an emerging nation to establish itself. List felt that the American experience offered vindication of his views, and he of course found ready support among United States protectionists, particularly Alexander Hamilton and Henry Carey.
List's Criticism of Classical Economics
List strongly opposed the absolutist, cosmopolitian tendencies of the classical economists. They derived principles, he maintained, which were then assumed to hold for all nations and all times. By contrast, List's theory and methodology were strongly nationalistic and historical. His theory of stages in economic development, for example, was calculated to demonstrate the insufficiency of classical economics to recognize and reflect the variety of conditions existing in different countries and, most especially, in Germany.
Like Sismondi, List subordinated economics to politics in general. In his view, it was not enough for the statesmen to know that the free interchange will increase wealth (as demonstrated by the classical economists); he must also know the ramifications of such action for his own country. Thus List argued that free trade that displace either population or domestic industry is undesirable. Moreover, List would not sacrifice the future for the present. He maintained that the crucial economic magnitude in economic development is not wealth (as measured by exchange values) but productive power. In his own words, " The power of producing wealth is...infinitely more important than the wealth itself". Thus economic resources must be safeguarded so that their future existence and development are assured. This view constitutes further justification for List's protectionist arguments; it also lies at the root of the popular "infant-industry" argument in support of protective tariffs.
For List, the ultimate goal of economic activity should be national development and the accretion of economic power. In this, he (as Marx was to do later) perceived industry as more than the mere result of labor and capital. Rather, he conceived industry as a social force that itself creates and improves capital and labor. In addition to effecting present production, industry gives an impetus and a direction to future production. Therefore, List recommended the introduction of industry into underdeveloped countries even at the expense of temporary loss.
List's originality in economic theory and method consisted in his systematic use of historical comparison as a means of demonstrating the validity of economic propositions and in his introduction of new and useful points of view in contradistinction to the economic orthodoxy of classical liberalism. In stretching the dynamic fabric of classical economic growth by representing economic development as a succession of historical stages, he provided a methodological rallying point for the economists of the German historical school. Thus List may appropriately be considered the forerunner of that school.
This reaction in favor of protection spread throughout the Western World in the latter part of the 19th century. Germany adopted a systematically protectionist policy and was soon followed by most other nations. Shortly after 1860, during the Civil War, the United States raised its duties sharply; the McKinley Tariff Act of 1890 was ultra-protectionist. England was the only country to remain faithful to the principles of free trade.
But the protectionism of the last quarter of the 19th century was mild by comparison with the mercantilist policies that had been common in the 17th century and were to be revived between the two World wars. Extensive economic liberty prevailed by 1913. Quantitative restrictions were unheard of, and customs duties were low and stable. Currencies were freely convertible into gold, which in effect was common international money. Balance-of-payments problems were few. People who wished to settle and work in a country could go where they wished with few restrictions; they could open businesses, enter trade, or export capital freely. Equal opportunity to compete was the general rule, the sole exception being the existence of limited customs preferences between certain countries, most usually between a home country and its colonies. Trade was freer throughout the Western World in 1913 than it was in Europe in 1970.