A Marxist Guide to Capitalist Crises
“A Marxist Guide to Capitalist Crises,” an eBook created from the key posts on the Critique of Crisis Theory blog, is currently in production. We’ll be sharing the completed chapters between our regular postings.
Chapter 13: The Ricardian Theory of International Trade
Our examination of the laws governing international trade begins with David Ricardo’s theory of comparative advantage. This theory has dominated bourgeois political economy as regards the theory of international trade for the last two centuries. It has survived the transition from his theory of value based on the quantity of labor socially necessary to produce a commodity of a given use value and quality to the modern marginalist theory of value. It has also survived the transition from the gold standard to the universal use of so-called fiat money.
Marx did not live to write his planned book on the world market, but he did make many valuable observations about international trade, especially in Volume III of “Capital.” He accepted much of Ricardo’s work and built his critique of bourgeois political economy by extending as well as criticizing Ricardo’s work. Therefore, it forms the starting point of our examination of international trade.
Ricardo’s theory of value, money, and international trade
In the days before Marx and Engels, Ricardo attempted to develop a consistent theory of value based on embodied labor measured in terms of time. He, like other classical economists, realized what today’s (bourgeois) economists deny, that in a capitalist economy, the products of human labor are not consumed by their producers but are exchanged for other commodities of different use values that — on average — require equal quantities of labor to produce.
Ricardo also assumed that everyday market prices are regulated on average by labor values. In addition, he showed — basing himself on earlier classical economists — that the division of labor among the various branches of production is regulated by the relationship between market prices and values. Accordingly, value determines what Adam Smith called the “natural price” of commodities and what Ricardo called the price of production or cost of production.
Like other classical economists, he assumed that market prices fluctuate around commodities’ values — or the costs of production. Ricardo made clear that his version of the cost of production included the average rate of profit. His cost of production is not the same thing as the cost price — the cost for the capitalist. Ricardo called the difference between the cost of production and the cost price the net product, what Marx called surplus value.
The classical economist’s great accomplishment was to show that this was the mechanism that allows an unplanned capitalist economy where each person is pursuing only their private material interests to produce the commodities in the proper proportions — based on the capitalist relations of production — that the members of society need and desire so that capitalist society can reproduce itself.
Suppose a given commodity with a given use value and quality is produced in less than the desired proportion. Its market price will rise above its value, or in Ricardo’s terminology, its cost of production. If it were to be produced in more than the desired proportion, its market price would fall below its cost of production. With these assumptions, capital flows from branches of production where capital makes a less-than-average rate of profit to branches where capital makes a greater-than-average rate of profit.
Ricardo’s quantity theory of money
Ricardo assumed that money was a commodity, usually gold bullion, governed by the same laws that govern the production of any other commodity.
If gold is underproduced, gold will exchange with other commodities at a rate above its value. This will mean that gold miners and refiners will make a higher than average rate of profit. Ricardo assumed that, in this case, competition would equalize the supply and demand for gold bullion — money — because capital in search of an above-rate-of-profit would flow into the gold-producing industry. Then as gold production increases, the rate of profit in the gold mining and refining industry would then drop back to the average rate of profit.
Therefore, the effect on the real economy when commodity prices fall below values is that the capitalists invested in gold mining and refining will temporarily make a super-profit. Over time, a portion of the capital will be invested in gold mining and refining, where it will realize a higher-than-average rate of profit until the increasing quantity of gold (money) relative to other commodities causes the price of commodities to rise back to their values.
Until this happens, the quantity of money — gold — will grow faster than most other commodities. The increased production of gold will cause the exchange rate of gold with other commodities to fall back to its value. Until gold production increases, the falling prices will adjust the actual quantity of money to the needs of circulation. If money is overproduced relative to other commodities, rising prices adjust the amount to the needs of circulation at the temporarily higher prices. In neither underproduction nor overproduction of gold is the circulation of commodities disrupted. The only result will be that the general price level will temporarily deviate from the underlying value of commodities. When prices deviate from the value of any commodity, they are brought back into line with their value through the movement of capital from sectors where the rate of profit is below the average rate of profit to sectors where it is above.
Therefore, the Ricardian quantity theory of money will mean no shortage of money when gold is underproduced and no accumulation of idle money when gold is overproduced. Instead, we get a fluctuation of prices of commodities around their values. However, the production of real wealth is not affected by the fluctuation of prices around value, only the production of nominal wealth. The doctrine that fluctuations in the quantity of money affect only nominal wealth measured in terms of money but not real wealth measured in terms of use values is known as the neutrality of money.
Ricardo explained that capitalists do not get rich by building up idle hoards of gold but by throwing any surplus money that passes through their pockets back into circulation. Therefore the profit motive itself will ensure a “full circulation,” as 19th-century economists put it.
In equilibrium, the rate of profit is uniform in all branches of production, including the branch of production which produces the money commodity (1), and the general price level will coincide with the values of commodities. Ricardo assumes that such an equilibrium exists. This leads to his assumption that prices of commodities equal their values not only in relation to one another but also in relation to money.
Therefore, unlike the mercantilists, Ricardo and other liberal economists concluded that changes in the quantity of money within a country did not affect the country’s real wealth but only its nominal wealth as measured in terms of money. The mercantilists saw gold and silver as the essence of wealth, but Ricardo explained that the wealth of a nation consists of the total quantity of use values in the country. Therefore the flow of money into and out of the nation affected only nominal prices and wages but did not affect the real wealth of the nation.
The quantity theory of money and Say’s Law
The view that prices are susceptible to changes in the quantity of money and that these changes have no effect on real wealth represents the quantity theory of money in its pure form. This theory sees money as merely a means of circulation that can, in principle, be dispensed with. Commodities are seen in the final analysis as being purchased by other commodities. This leads to “Say’s Law,” which claims that a general overproduction of commodities is impossible. (2)
Ricardo supported Say against Sismondi and Malthus in the debate on whether a general glut of commodities — a crisis of general overproduction — was possible. Sismondi and Malthus argued that general commodity gluts were a real danger.
Ricardo’s theory of value and money applied to international trade
Ricardo drew counterintuitive conclusions about international trade using his combined law of labor value and the quantity theory of money. Do the same laws that govern prices within a nation govern international trade? Ricardo said no. Within a country, absolute advantage prevails — that is, the capitalist prevails who can produce a commodity of a given use value and quality with the least amount of labor, but in the home market only.
Suppose that within a country, a group of industrial capitalists compete with one another. We assume our industrial capitalists are producing the same commodity of the same quality. Which industrial capitalists will win the battle of competition?
Ricardo assumed that all capitalists must pay the same wages for labor. The price of labor, as he put it — he had no concept of the difference between labor and labor power — is determined by what is required to enable the workers to live and work and raise a new generation of workers.
Accepting Malthus’s law of population, he assumed that if wages were higher than this, the workers would increase their number until their wages again fell to what is required for bare subsistence and the raising of a new generation of workers. If wages were lower than this, a portion of the working class would starve to death, or at least the number of young workers offering their labor for sale would decline, allowing wages to rise to bare subsistence once again.
Through this Malthusian mechanism, the number of workers is determined by the needs of the capitalists for labor in the long run.
Ricardo also assumed that since the same Malthusian law operates in all countries, wages should be more or less equal in all countries — just enough for the workers to survive, labor, and raise a new generation, and no more.
Suppose our industrial capitalists all operate within the same country and produce the same product of the same quality. But they produce it with different amounts of labor. For example, one industrial capitalist might produce X quantity with 100 hours of labor, another with 75 hours of labor, a third with 125 hours, and a fourth with 70 hours of labor.
The product produced by each industrial capitalist, while identical as far as the use value is concerned, is produced with different quantities of labor; some produce the product more cheaply than others. Therefore, in Marx’s terminology, the individual value of the product produced by each industrial capitalist will be different.
Who then wins the battle of competition? That is a no-brainer. Ricardo, as well as Marx, answers that the industrial capitalists who can produce X amount of product with the least amount of labor will win. Those who produce the cheapest can always undersell the competition and drive them out of the market. The winners will be those who use only 70 hours of labor to produce X amount. The other industrial capitalists will have to either adopt the same methods of production or one that uses even fewer hours of labor to produce the same amount, or face bankruptcy.
As far as the national market is concerned, Ricardo would agree that it is absolute advantage that prevails. But when applying his theories of value, price, and money to international trade, Ricardo concluded that what was true for the national market was not true for the international market. While absolute advantage prevails in the national market, Ricardo held that what today’s economists call “comparative advantage” prevails in the global market. What is comparative advantage?
In chapter 7 of his main work, “Principles of Political Economy and Taxation,” Ricardo examined a hypothetical example of a relatively advanced industrial Portugal and a relatively backward industrial England.
Ricardo’s example
Ricardo assumed that both England and Portugal produced both cloth and wine. “To produce the wine in Portugal,” Ricardo wrote, “might require only the labor of 80 men for one year, and to produce the cloth in the same country, might require the labor of 90 men for the same time.” England “may be so circumstanced, that to produce the cloth may require the labor of 100 men for one year; and if she attempted to make the wine, it might require the labor of 120 men for the same time.”
Portugal has, in this example, an absolute advantage over England in wine and cloth production. If the same laws that prevail within a national market also prevail in international trade, then England will face ruin if it adopts a policy of “free trade.” To produce a given quantity of cloth in a year, the labor of 90 workers is needed in England but only 80 workers in Portugal. Therefore, as far as cloth production is concerned, Portugal has an absolute advantage over England.
The situation is even worse for England when it comes to the production of wine. To produce a year’s worth of wine, it takes the labor of 80 men in Portugal, but England requires the labor of 120 men for a year.
If the same law prevails in international competition as in national competition, the industrial capitalists of Portugal should, in both the wine and cloth industries, drive English industrial capitalists out of business. International trade, therefore, seems like a losing proposition for England. To justify free trade, Ricardo tried to prove that a different set of laws govern international trade than the law of absolute advantage that governs the domestic market.
Ricardian comparative advantage
In this example, Portugal employs 80 men for one year to produce its annual wine supply. By a year of labor, Ricardo meant the amount of labor time the average worker performs in a given year, not a year of uninterrupted work. The labor value of Portugal’s annual wine production is 80 person-years of labor, and the labor value of Portugal’s cloth production is 90 person-years of labor.
Ricardo assumes England produces the same amount of cloth and wine in use value terms. However, cloth and wine have a higher labor value in England than in Portugal due to the lower productivity of labor in England. England must expend 100 person-years of labor to produce its annual supply of cloth — and 120 person-years of labor to produce its yearly quantity of wine.
Assuming for the sake of illustration that wine and cloth represent the total production of England and Portugal, England must expend 220 person-years of labor to produce its total annual product. Portugal expends only 170 labor years to produce its annual product, which is in use value terms equal to that of England. Taking Portugal and England together, a total of 390 labor years is expended on the annual production of both cloth and wine.
Suppose the world economy of wine and cloth were organized not on a capitalist but a planned basis. Imagine you worked on the central planning board and were instructed by the representatives of society to organize production on the most efficient basis possible in England and Portugal. All the workers of the world, both Portuguese and English, must be employed. No unemployment or idleness can be tolerated.
The forces of production in both England and Portugal are given; we cannot improve them. The productivity of labor is therefore fixed in both countries. Given these constraints, what is the most efficient way to organize production?
You proceed as you would if you were a factory manager that employed workers of different skills. You assign each worker the tasks they were individually best at. For example, a factory worker might be below average at sorting plastic parts into boxes but closer to average than any other job in the factory. The factory foreman will assign that worker to a sorting task.
The Portuguese workers are better than the English workers in wine and cloth production. However, we cannot just use Portuguese workers; we must also put English workers to work.
Note that if you use English workers to produce wine, they will need to work 120 labor years to produce the given amount. However, if we use the Portuguese workers, you get the same amount of wine with only 80 years of labor, a difference of 40 years of labor. Portuguese workers are 50 percent more productive than English workers in wine production.
To produce a given amount of cloth, we get the same amount in 100 labor years with English workers that we get with Portuguese workers in 90 labor years. The English cloth workers are not as good as the Portuguese, but the gap is much less in cloth than in wine. The Portuguese cloth workers are only 11 percent more productive than the English workers. Therefore, you will assign all the English workers to the task they are relatively best at, the production of cloth. You will also assign the Portuguese workers to the tasks that they are relatively best at, the production of wine.
How much will the consumption of wine and cloth increase due to the introduction of a division of labor between England and Portugal? Instead of having 80 Portuguese workers producing wine, we will have 170 producing wine. If half this wine is consumed in Portugal and half is sent to England, Portugal will get to consume the amount of wine it can produce with 85 labor years as opposed to 80 labor years previously. Portugal’s wine consumption will rise by 6.25 percent.
How about cloth consumption? Portugal exchanges half its wine production, some 85 labor years, for half of the English cloth production, 110 labor years. Instead of getting to consume 90 years’ worth of cloth produced by Portuguese labor, they now consume 110 labor years of cloth produced by less productive English labor. However, Portuguese workers are only 11 percent more efficient than English workers in cloth production, so 110 years of English labor can still produce about 11 percent more cloth than 90 years of more productive Portuguese labor. Portugal’s cloth consumption rises by about 11 percent. Portugal benefits from this division of labor. It gets 6.25 percent more wine and 11 percent more cloth.
The division of labor works fine for advanced Portugal, but how about backward England? England is now spending all its annual 220 years of labor on cloth production. Half of this, 110 years, is sent to Portugal. This leaves 110 years of cloth for England compared to only 100 years before the division of labor. England gets 10 percent more cloth than it consumed before.
What happens to England’s wine consumption? Before, England had to spend 120 labor years for its annual wine consumption. It now expends only 110 labor years for cloth that will be exchanged for 85 labor years’ of Portuguese wine. Therefore, England consumes 70.8 percent as much labor time embodied in wine as before. However, this comes to 29.5 percent more wine for England in terms of bottles consumed.
So both in terms of wine and cloth consumption, not only developed Portugal but also underdeveloped England benefit from an international division of labor organized on the principle of comparative advantage in terms of use value.
England exploited, but still richer in use value terms
Portugal exploits England because England must exchange 110 years of its labor in cloth to enjoy 85 years’ worth of wine. Nevertheless, England is still better off regarding use values consumed than before the international division of labor was established.
Before, England had to spend 120 labor years for its annual wine consumption. Now it costs England only 110 labor years. Moreover, it gets 29.5 percent more wine in the bargain. Though England suffers from an unequal exchange of labor, it comes out ahead in terms of what counts, use value, in both yards of cloth and bottles of wine.
Ricardo proved that, assuming full employment, the most efficient results are obtained by assigning all the available workers on the world market to the tasks they are best at. For example, I might be both a terrible carpenter and a below-average assembler, but I am not as far below average as an assembler than as a carpenter. Therefore I am assigned work as an assembler rather than a carpenter if production is to be maximized with a given quantity of labor with a given set of skills.
Alternatively, I might be an excellent carpenter and an above-average assembler. But I am much better than the average worker as a carpenter and only moderately above average as an assembler. So, I should be assigned work as a carpenter in this case.
How does comparative advantage assert itself based on capitalism and free trade? Or does it?
While comparative advantage might guide an individual factory owner in establishing the division of labor within one factory or for a future planned world economy under the management of associated producers, Ricardo was trying to analyze the workings of the international capitalist economy.
According to his labor law of value, the amount of labor needed under given conditions of production to produce a commodity establishes its natural price around which market prices fluctuate. Within a country, one industrial capitalist who can produce a certain amount of cloth of a given quality for 90 hours will be able to undersell a rival who must spend 100 hours of labor producing the same amount of cloth of the same quality. The inefficient rival wastes 10 hours of labor. Free competition will sooner or later eliminate such an inefficient industrial capitalist.
Yet in world trade, an inefficient English industrial capitalist who spends 100 years of labor producing a given amount of cloth of a given quality is supposed to beat out a more efficient Portuguese industrial capitalist who can produce the same amount of cloth of the same quality for 10 percent less labor. How, according to Ricardo, can the English cloth-making industrial capitalist pull this off?
Ricardo’s world and assumptions
Ricardo made other assumptions, some of which are considered quaint today. He assumed that while profits tend to equalize in the home market, there is no tendency for an equal rate of profit to form internationally. In his time, there were no multinational industrial corporations but only family firms and partnerships, tiny by today’s standards. An English industrial capitalist was extremely unlikely to set up shop in Portugal, even if the rate of profit was higher in Portugal than in England, and a Portuguese industrial capitalist was likewise confined to Portugal.
However, Ricardo did assume that real wages were almost the same everywhere — at rock-bottom biological subsistence.
Low wages, therefore, will not be able to save our cloth-producing English industrial capitalists. Yet, how can our inefficient English cloth producer, who wastes ten years of labor out of every hundred, not only hold on but drive the more efficient Portuguese cloth producers out of business? Don’t we have to turn the laws of capitalist production, as analyzed by Ricardo himself, on their head to achieve these results?
Ricardo’s theory of money and international prices
Suppose the gold producers are not in England or Portugal but in a third country, as they were both in Ricardo’s time and our own. In Ricardo’s time, gold (and silver) mines were generally located in colonial countries.
Assume that prices are equal to labor values. Suppose England has been following a strict policy of protecting its inefficient industry, both its cloth and wine producers. Market prices correspond with their respective national values in both England and Portugal.
Now, great economic reform occurs. Under the advice of Ricardian economists, England adopts a free trade policy. What will happen according to the Ricardian theory?
Since we assume that prices directly reflect labor values, the price of wine will be 50 percent higher in England than in Portugal, and the price of cloth in England will be 10 percent higher. This doesn’t look good for England. Anti-Ricardian opponents of “free trade” predict disaster for England.
To simplify as much as possible, suppose the currency system of both England and Portugal consists only of full-weight gold coins that can circulate internationally. As far as England and Portugal are concerned, gold is not only universal money; unlike the case with cloth and wine, gold has the same labor value, though not purchasing power, in both countries.
Since gold is universal money on the world market, Portugal and England share a common currency system. As free trade begins, England will run a massive trade deficit with Portugal since English prices are higher than Portuguese prices. Currency in the form of gold coins will flow out of England into Portugal.
The quantity theory of money to the rescue
Remember, Ricardo applied the quantity theory of money to metallic money. The money supply, which consists of circulating gold coins, will start to fall in England but rise in Portugal. According to this quantity theory of money, the level of prices in terms of gold is determined by the quantity of monetary gold relative to commodities in a given country. Since the quantity of money will fall in England, prices and money wages (though not real wages) will also start to fall.
In Portugal, the reverse situation will occur. Gold coins will be imported from England, swelling the money supply of gold coins. Prices and money wages will start to climb in Portugal. There will be inflation in Portugal and deflation in England. Soon the price of English-produced cloth will be lower in both England and Portugal than the price of Portuguese-produced cloth, even though the labor value of Portuguese cloth is still about 10 percent lower than the labor value of English cloth.
Therefore, English cloth producers will begin to win the battle of competition in both England and Portugal. Indeed, England will start to export cloth to Portugal. As a result, Portuguese cloth manufacturers will either shift to wine production or go out of business.
The price of wine in Portugal will also rise due to the inflation there, but it will still be below the price of English wine. Portuguese wine producers, therefore, will continue to win the battle of competition against English wine producers in both countries. Deflation in England and inflation in Portugal will not be enough to save the English wine producers.
Portuguese wine is still cheaper. However, with the collapse of the Portuguese cloth-manufacturing business, a vast new market has opened up for English cloth manufacturers. Not only is the English market theirs but now the Portuguese market as well.
According to the Ricardian theory, English cloth producers are doing vastly more business under free trade than they ever could under protection. The English wine producers will either go out of business or shift to cloth manufacturing. Soon nobody will be producing wine in England or cloth in Portugal. Therefore, assuming the truth of the quantity theory of money, England’s comparative advantage in cloth production overrides Portugal’s absolute advantage in that industry.
The quantity theory of money crucial to Ricardian comparative advantage
Notice that the ability of comparative advantage to prevail over absolute advantage depends entirely on the validity of the quantity theory of money. If the quantity theory is invalid, as both Marx and Keynes held, though these two economists had very different theories of value and money, the wonders of comparative advantage under the capitalist system fall to the ground. Like the Christian God, the god of free trade of the liberal economists consists of a trinity — Say’s Law, comparative advantage, and the quantity theory of money.
Using these alleged economic laws, the economic liberals, including Ricardo and today’s neoliberals, conclude that free trade in the national and international markets is in the interests of all individuals regardless of class and all nations irrespective of their degree of economic development.
Comparative advantage and marginalism
While economists dropped Ricardo’s theory of value soon after his death, they kept his theory of comparative advantage. All that is necessary to show that a “high-cost producer” can win the battle of competition in international trade as long as that producer has a “comparative advantage” is the quantity theory of money. The entire Ricardian law of value can be dispensed with.
It does not matter whether you see “cost” in terms of the quantity of labor measured in terms of time, as Ricardo saw it, or in terms of “opportunity costs” that reflect relative scarcities, as the modern bourgeois economists see it, or leave the concept of “cost” undefined as the economists who wrote between the death of Ricardo in 1823 and the “marginalist revolution” of the 1870s did.
As long as the international gold standard prevailed, the quantity of money within a nation was still primarily determined by the fluctuations of its balance of trade — leaving aside the question of its internal gold production. In the form of the currency school, the theory now known as comparative advantage became the basis for the legislation governing Britain’s central bank, the Bank of England. Comparative advantage was therefore put to the test in practice. The results of this economic experiment will be the subject of our next chapter.
Comparative advantage and fiat money
In the example above, Ricardo assumed a currency system of circulating full-weight gold coins. So how do today’s neo-liberal economists imagine that comparative advantage works in a currency system of legal tender token money or fiat money? In this system, (bourgeois) economists explain that the level of gold production has nothing to do with the quantity of money. Instead, quantity is determined by the “monetary authorities.”
For the sake of argument, we will assume that Portugal and England use different paper currencies. The quantity theory of money supporters apply the same laws to paper or token money as to metallic money’s full-weight gold coins. According to this theory, assuming the number of commodities in circulation is fixed, nominal prices and wages will fluctuate according to changes in the quantity of money.
Retaining Ricardo’s other assumptions, the only difference is that England and Portugal use paper currencies instead of full-weight gold coins. England has been following a protectionist policy, but now it adopts free trade.
As trade begins between England and Portugal, England runs a massive trade deficit in cloth and wine. As the trade deficit continues, England’s paper money falls relative to the Portuguese paper currency. As this continues, the English currency becomes cheaper relative to the Portuguese currency. Therefore, the prices of English wine and cloth will fall in terms of Portuguese currency. In terms of English currency, the prices of imported Portuguese commodities, whether wine or cloth, will rise.
Therefore, according to the modern champions of the law of comparative advantage, England’s trade deficit or Portugal’s trade surplus will continue only until the price of English cloth falls below the price of Portuguese cloth in Portugal and England while the price of Portuguese cloth rises above the price of English cloth in both countries.
The English industrial capitalists producing cloth will start to win the battle of competition in both England and Portugal, while the Portuguese industrial capitalists engaged in wine production will win the battle of competition in that industry in both countries.
According to present-day neo-liberal economists, as with the gold coin currency, England will specialize in cloth production, and Portugal will specialize in wine production, with the same benefits to both countries regarding real wealth that prevailed under the pure gold currency.
Our modern neoliberals conclude that no matter how far behind a nation is in the productivity of its capitalist industry, free trade is always in its interest. Even if it is at an absolute competitive disadvantage in all lines of production, there will always be some industries with a comparative advantage. Therefore every country, whether capitalistically advanced or backward, benefits from free trade.
Notice how the modern version, as well as the Ricardian version, of the law of comparative advantage depends on the quantity theory of money: There is always a distribution of gold among the capitalist nations that will ensure that comparative advantage prevails, and the way to achieve this distribution of gold is through free trade. The market automatically takes care of the rest — no need for tariffs, quotas, or other trade regulations, which simply get in the way.
Today, the supporters of neoliberalism hold that there is always a set of exchange rates among the various paper currencies that will guarantee that comparative advantage rules on the world market. To ensure this happy outcome, trade must not only be free in the sense of no tariffs, quotas, and so on, but trade in currencies must be also be free. There should be no restrictions on buying and selling currencies, and the governments and monetary authorities stay out of the currency markets. Or, to use economic slang, the currency float must be “clean,” not “dirty.”
But won’t the depreciation of the English paper currency against gold — implied by the fall of the English paper currency against the Portuguese paper currency — tend to raise the prices of imported commodities in England, such as Portuguese wine, and domestically produced commodities, such as cloth? For example, won’t the prices also rise in terms of the now devalued English currency? And won’t this negate the whole law of comparative advantage and instead impose absolute advantage?
Conversely, won’t the appreciation of paper money against gold in Portugal lower prices in terms of paper currency there? For example, won’t the price of imported English cloth and domestically produced wine also fall since each unit of the Portuguese currency will now represent more real gold money than before? So doesn’t absolute advantage rather than comparative advantage win the day after all?
No, because according to the quantity theory of money, assuming the number of commodities in circulation remains unchanged, the general price level is unaffected by changes in exchange rates or the gold value of the currency. Therefore, the devaluation of the English paper currency will raise the price of imported Portuguese cloth allowing English cloth producers to beat the Portuguese competition. However, the price of English cloth will not rise.
And as long as we retain the quantity theory of money — and not all modern bourgeois economists do — the theory of comparative advantage can also make the transition from the gold standard world of the 19th century to today’s paper currency system fully intact.
Milton Friedman’s theory of international trade
The neoliberal supporters of the quantity theory of money — sometimes called monetarists — such as the followers of Milton Friedman, insist that it is only changes in the quantity of money relative to commodities, not those in the value of the currency relative to other currencies, still less the change of the currency relative to gold, that affect the cost of living in a given country. With a fall in the currency’s exchange rate, any rise in the price of imported commodities will be offset by a corresponding fall in the price of domestically produced exported commodities in countries whose currency exchange rates are falling.
Friedman and his supporters held that a fall in the currency’s exchange rate is not inflationary as long as there is no increase in the quantity of money relative to the number of commodities in circulation. Therefore, they claim currency devaluations are not inflationary and are of no concern as long as they are determined by free trade, including free currency markets where exchange rates are determined only by the market. Indeed, the ever-changing exchange rates allow the law of comparative advantage to work under the current system of pure paper currencies.
Friedman reasoned that since comparative advantage works only if the exchange rates are determined solely by market forces, governments, and central banks should not maintain reserves of gold — which is just another commodity once it is no longer used as currency — or other currencies. If this is done, neither the government nor the monetary authority — the central bank — will be tempted to interfere with currency exchange rates since they would no longer have any foreign currency to buy or sell.
Notice how the whole modern case for comparative advantage and free trade lies in the assumed complete insensitivity of prices in terms of a paper currency to changes in the gold value of the paper currency and the complete sensitivity of prices to changes in the quantity of the currency relative to that of commodities.
Ricardo’s theory of comparative advantage has therefore survived both the abandonment of his theory of value shortly after his death by his liberal supporters and then the downfall of the international gold standard in the 20th century. It formed the theoretical basis of Britain’s adoption of free trade following the “Corn Laws” repeal in 1846.
It also formed the basis of the British Bank Act of 1844. Using the Ricardian theory, the supporters of the currency school claimed that crises that had hit Britain in 1825 and 1837 would not recur if the act were passed. This is particularly important to crisis theory since the British Bank Act of 1844 was the first legislative attempt to suppress crises of overproduction within the capitalist economy.
Therefore, Ricardo’s theory of comparative advantage forms not only the basis of the neoliberal economists’ argument for “free trade” to this very day but is of particular interest to us since it was also the basis of the first attempt to abolish periodic capitalist crises without transforming capitalism into a higher mode of production. This attempt will be the subject of our next chapter.
(1) This is a simplification. In the sectors of production where there is a greater risk, the rate of profit will tend to be higher than average, while in sectors where risk is lower, the rate of profit will tend to be lower. However, this does not affect the basic argument. Also, for simplification, we are ignoring the problems of ground rent in gold mining. Again the basic argument is unaffected. (back)
(2) Say’s law claims that commodities are bought by means of other commodities. A doubling of commodities would double the effective demand for commodities. Therefore, according to Say’s Law, a generalized overproduction of commodities is impossible. At most, a partial overproduction of some commodities backed by a shortage of commodities is possible. Say’s so-called law ignores the role of money. It is possible to have a generalized overproduction of commodities relative to the money commodity. (back)
A Critique of Crisis Theory 