The Rational Optimist and Ricardo

I'm about halfway through The Rational Optimist and have to say that it's a bolstering case for the phenomenal power of markets and trade in human society. It's not exactly erudite, but it's a well versed look at the way trade and specialization have massively improved the lot of the average human in the past few million years and enabled us to grow to a population of several billion. Some of the points I like the most revolve around Ricardo's Law of Comparative Advantage, which the book describes as "the only result of social science that is both surprising and true". In honor of the recent free trade agreement between the US and several countries, I want to take a moment on this little law.

Briefly, the law states that if two individuals, nations, companies, whatever, have a different relative ability to produce a pair of different items, then one or both of the actors will be better off if they trade. So, for example, even if France is better at making both wine and cheese than England (probably true), both England and France will still benefit from trade if the relative cost of producing wine vs. cheese in the two countries are different.

What if France makes wine much more efficiently than cheese, and England does as well? It turns out, it doesn't matter. If the tradeoffs of wine vs. cheese are just different, that's all it takes for both countries to benefit.

What's marvelous about The Rational Optimist is that it couches these modern conceptions of economics in the ancient environment, before they were even realized. Let's say I make spears incredibly well, and I also run down and spear bison incredibly well (probably not true). I take a day to make a high quality spear, and a day to run down a bison. You, sadly, are terrible at both, taking 2 days to make a high quality spear, and 4 days to run down a bison.

Now we could both spend time in our own little spheres, making spears and running around all day. At the end of 6 days, you would have one spear, which you will have used bringing down a bison. I will have made 3 spears and brought down 3 bison.

After those 6 days, you have a brilliant idea. A brilliant idea that will keep you from running around all day and instead put my hands at work for you. Let's say that the next 2 days  look a lot like the 6 days before. I make a spear, and go skewer a bison with it. You're just be polishing off that first spear when I bring the bison home.

But now you throw your incredibly brilliant plan into effect. "Ugg!" you say, (we're cave man, that's the my moniker)  "I'll give you that spear for just 1/3 of your next bison!".

I think it through. 1/3 of my next bison? But I can have all the bison if I make the spear myself. But if I make my next hunting spear myself, I have to sit around all day making it, and won't be able to hunt until tomorrow. If I take this spear, I can hunt now. Let's see... 1 bison in 2 days, or 2/3rds of a bison in 1 day. I might not be able to figure out the fractions, but I know that I'm getting more. I take your spear, head out for the hunt, and that night I come back with my prize. You get 1/3 of a Bison, and never had to run around on the hot plains.

I won't belabor the point, but if you work out the math, over 6 days with the occasional spear trading hands, you still get your one bison by making 3 spears instead of 1 spear and one hunting trip. I am doing a lot more running, but I get 3 hunting trips without having to stop to make spears, and can make one hunting trip with my own spear and still have a day to spare. Calculated out, I get the same 3 bison, and a free vacation day!

Consider that this example is the most meager form of Ricardo's comparative advantage. Imagine that after a year of this arrangement, you get absurdly good at spear making. You've been doing it every day of the week after all, and you've had a chance to try some things out. Now, after figuring out how to use a rock to sharpen the tips and finding the best source of branches in the woods, you're turning out 2 or 3 a day! You're still only trading one for 1/3 of a buffalo, but now you can stock up on spears the first 2 days of the week and spend the rest of the time figuring out how to corral a buffalo calf and save it for later.

Clearly I've just sketched the barest bones of the argument here, and I highly recommend the book for a better treatment. The point, though, is that specialization and trade are massively powerful ways to improve our own lives and those of our trading partners. Imagine, in your own life, how difficult it would be to independently  create all the wonderful artifacts of human productivity you enjoy. What you get out of voluntary trade makes possible the life you lead today.