Ricardo’s Theory of International Trade
Over the last few weeks, I have been examining a “typical” industrial cycle. For sake of simplification, I have assumed the world was a single capitalist nation. In order to do this, I have abstracted the effects on the industrial cycle of the division of the capitalist world into different countries and currencies. But in reality, the capitalist world has always been divided into many nations and currencies. Therefore, no theory of real industrial cycles and crises can be complete without a theory of international trade and exchange rates.
Our starting point will be the theory of international trade put forward by the great English classical economist David Ricardo (1772-1823). The Ricardian theory of international trade is called by the modern bourgeois economists the theory of comparative advantage.
The theory of comparative advantage dominates the theory of international trade taught in the universities to this day. It forms the basis of the claim of neoliberal economists that free trade operates to the advantage of every nation, the capitalistically advanced nations as well as the capitalistically underdeveloped or oppressed nations. It is, therefore, particularly popular among neoliberal economists such as the followers of Milton Friedman. For reasons that will become apparent in the coming weeks, bourgeois economists inspired by the theories of John Maynard Keynes tend to be more critical of “comparative advantage” and “free trade” in general.
In the days before Marx and Engels, it was Ricardo who tried to develop, with considerable but not complete success, a truly consistent theory of labor value. (1) The theory of labor value was the starting point of Ricardo’s theory of international trade.
Suppose within a country, a group of industrial capitalists are in competition with one another. Let’s assume that our industrial capitalists are producing exactly the same type of commodity—for example, cloth—of exactly the same quality. Which industrial capitalists will win the battle of competition?
Since I am examining a single national market, I assume that all the cloth producing industrial capitalists have to pay the same prices for labor power—or “labor” as Ricardo would say—and the elements of constant capital. (2)
Suppose our industrial capitalists, though they produce exactly the same type of cloth of exactly the same quality, produce the cloth with different amounts of labor. One industrial capitalist might produce X quantity of cloth with 100 hours of labor, another with 75 hours of labor, a third 125 hours of labor, a fourth with 70 hours of labor. The cloth produced by each industrial capitalist, while identical as far as the use value is concerned, is produced with different quantities of labor. Or what comes to exactly the same thing, some produce the cloth more cheaply than others. Therefore, the individual value of the cloth produced by each industrial capitalist will be different.
Who will win the battle of competition? Ricardo, as well as Marx, would answer that the industrial capitalists who can produce X amount of cloth with the least amount of labor. The industrial capitalists who produce cheapest can always undersell the competition and drive them out of the market.
Given the assumptions I made above, these will be the industrial capitalists who use only 70 hours of labor to produce X amount of cloth. The other industrial capitalists will have to either adopt the same methods of production or adopt a method that uses even fewer hours of labor to produce X amount of cloth, or face the prospect of bankruptcy sooner or later.
As far as the national market is concerned, Ricardo would agree, it is absolute advantage that prevails. The industrial capitalists who can produce a commodity of a given type and quality with the least quantity of labor wins the battle of competition. To use everyday language, the industrial capitalists who produces cheapest will triumph in the market place.
But Ricardo claimed that what was true for the national market was not true for the international market. Instead, Ricardo claimed that in the international market the industrial capitalists who have the comparative advantage, not necessarily the absolute advantage, will prevail. (3)
How does “comparative advantage” differ from “absolute advantage”? Ricardo in chapter 7 of his main work, “Principles of Political Economy and Taxation,” gives the hypothetical example of Portugal and England.
Ricardo assumes that both England and Portugal produce both cloth and wine. “To produce the wine in Portugal,” Ricardo wrote in chapter 7, “might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time.” England “may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time.”
Portugal has an absolute advantage over England in both 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 in England to produce wine of the same quality, it takes the labor of 120 men for a year.
In both cloth and wine, Portugal has an absolute advantage over England. If the same law prevails in international competition as prevails 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
Portugal employs the labor of 80 men for one year to produce its annual wine supply. By a year of labor, I mean 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 years of labor, and the labor value of Portugal cloth production is 90 years of labor.
England produces in use value terms the same amount of cloth and wine. However, cloth and wine have a higher labor value in England than in Portugal due to the lower productivity of labor in England, according to Ricardo’s assumption. To produce its annual supply of cloth, England must expend 100 labor years. It costs England 120 labor years to produce its annual quantity of wine.
If we assume for the sake of illustration that wine and cloth represent the total production of England and Portugal, England must expend 220 labor years of labor to produce its total annual product. Portugal, however, expends only 170 labor years to produce its annual product, which under our assumptions is in use value terms equal to that of England. Now taking Portugal and England together, a total of 390 labor years is expended on the total annual production of England and Portugal.
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 are instructed by the representatives of society to organize production on the most efficient basis possible in both England and Portugal. All the workers of the world, both Portuguese and English must be employed. No unemployment or idleness can be tolerated. The instructions of the representatives of society to the central planning board is to maximize annual production of both wine and cloth with the 390 years of labor that are available. The forces of production both in 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 would proceed exactly as you would if you were the manager of a factory that employed workers of different skills. You would assign each worker the tasks they were individually best at. For example, I a factory worker might be below average when it comes to sorting plastic parts into boxes, but I am still closer to the average than I am at any other job in the factory. Therefore, the factory foreman will assign me to that task. The Portuguese workers are better than the English workers in both wine and cloth production. However, we cannot just use Portuguese workers, we must put the English workers to work as well.
You will note that if you use the English workers to produce the wine, we will have to put them to work for 120 hours to produce a given amount of wine. But if we use the Portuguese workers, you get the same amount of wine with only 80 hours of labor. This is a difference of 40 years of labor. The Portuguese workers are 150 percent as productive as the English workers are in wine production.
In order to produce a given amount of cloth, however, we get the same amount of cloth in 100 hours with an English worker that we get with a Portuguese worker with 90 hours of labor. The English cloth workers are not as good as the Portuguese workers, but the gap is much less in cloth than it is in wine. (4)
In terms of cloth production, the Portuguese worker is only 11 percent more productive than the English worker. 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 both wine and cloth increase as a result of 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 sent to England, this means that Portugal will get to consume the amount of wine that it can produce with 85 years as opposed to 80 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 English cloth production, 110 labor years. Instead of getting to consume 90 years’ worth of cloth produced by Portuguese labor, they now consume 110 years of cloth produced by less productive English labor. However, the Portuguese workers are only 11 percent more efficient than the English 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 clearly benefits from this division of labor. It gets to consume 6.25 percent more wine and 11 percent more cloth.
The division of labor works fine for advanced Portugal, but how about backward England? Will it also benefit? England is now spending all its annual 220 hours of labor on the production of cloth. Half of this, 110 hours worth of cloth is sent to Portugal. This leaves 110 hours of cloth to be consumed in England compared to only 100 hours’ worth before the division of labor. England gets to consume 10 percent more cloth than it consumed before.
But what happens to England’s wine consumption? Before, England had to spend 120 hours of labor for its annual wine consumption. It now expends only 110 years of labor for cloth that will be exchanged for 85 years’ worth of Portuguese wine. England, therefore, consumes 70.8 percent (100*85/120) as much labor time embodied in wine than it did before. However, this comes to 6.20 percent more wine (.708 x 150).
So both in terms of wine and cloth consumption, not only “developed” Portugal but underdeveloped England benefited from an international division of labor organized on the principle of comparative advantage.
England exploited but still richer in use value terms
It is true that England is exploited by Portugal, because England must exchange 110 hours of its labor in cloth in order to enjoy 85 hours worth of wine. But England is still better off 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 for its annual wine consumption. And it gets 6.20 percent more wine in the bargain. Though England suffers from an unequal exchange of labor, it comes out ahead in terms of what really counts, material wealth, both in wine and cloth.
But how does comparative advantage assert itself on the basis of capitalism and free trade? Or does it?
There is a little problem with this pretty picture. While comparative advantage might be a guide for an individual factory owner in establishing the division of labor within his or her own factory, or for a future planned world economy under the management of associated producers, Ricardo is trying to analyze the workings of the international capitalist economy.
According to Ricardo’s own 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 always 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 hours 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 makes other assumptions, some of which are quite quaint today. Ricardo assumes 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 were higher in Portugal than in England, and a Portuguese industrial capitalist was likewise confined to Portugal.
However, Ricardo does assume that real wages are pretty much the same everywhere—that is, at rock bottom biological subsistence. The wages are just enough to keep the worker healthy enough to work and reproduce the “race” of workers. If wages were to fall below these levels, the “race” of workers would begin to die out and this would raise wages to the biological subsistence level once again.
Conversely, if real wages were to rise above the biological subsistence level, the Malthusian law of population, accepted by Ricardo, would increase the number of workers until once again real wages would fall to the biological level. Therefore, while in Ricardian times the English industrial capitalist didn’t have to worry about Portuguese multinational corporations invading England, he to pay pretty much the same real wage as his Portuguese counterpart.
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 10 hours of labor out of every hundred, not only hold on but actually 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 price
As we saw, according to Ricardo, the labor value of commodities only determines their cost of production, the price around which market prices fluctuate over the long run. But market prices can and indeed must diverge from the cost of production in the short run if the industrial capitalists are to produce commodities in the proportions demanded by society. Ricardo, Adam Smith and Marx all agree on this much. If a commodity is in short supply, the price will rise above its value, and if a commodity is in oversupply, its price will fall below its value.
Now, according to Ricardo, the same law applies to the commodity that functions as the money commodity. Suppose that gold functions as money. If gold is overproduced, its “price”—actually price lists read backwards—will fall below its natural price just like any other commodity. That is, the price of commodities reckoned in terms of gold will rise. If gold is underproduced, the converse is the case. The price of commodities will fall.
Ricardo on the neutrality of money
However, according to Ricardo, this will only be of interest to the gold producers, who, let’s assume, are located in neither England or Portugal but in a third country. High prices relative to labor values mean that the gold producers will make lower than the average rate of profit that prevails in their country, or perhaps no profits at all. If, on the other hand, market prices are low relative to natural prices—values—the gold producers will be making extra profits above and beyond the average rate of profit that prevails in their country. The movements of capital in out of gold mining and refining in response to changes in the rate of profit in the gold industry will see to it that prices pretty much correspond to values in the long run.
But according to Ricardo, whether prices stand above or below values or are equal to values in the short run will really only be of interest to the gold producers. Whether prices are inflated, meaning that both prices and wages stand above the value of commodities and “labor”—labor power—or deflated so that prices stand and wages are below the value of commodities and labor, respectively, the rate of profit and the real wage outside of the gold producing industry will not be affected. As liberal economists from Adam Smith and Ricardo to Milton Friedman like to say, money is neutral.
Suppose that England has been following a policy of strict protection in order to protect its inefficient industry, both its cloth producers and wine producers. Let’s assume for purposes of simplification that before free trade begins market prices correspond with their respective national values in both England and Portugal.
Now the great economic reform occurs. Under the advice of Ricardian economists, England adopts a policy of free trade. 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 looks very bad for England. Anti-Ricardian opponents of “free trade” predict disaster for England.
Suppose, in order to simplify, that the currency system of both England and Portugal consists only of full-weight gold coins. In other words, a “pure gold circulation” prevails, as the old-time economists liked to put it. Let’s continue with our assumption, that neither England nor Portugal produce gold, but instead it is produced by a third country.
As far as England and Portugal are concerned, gold is not only universal money, but 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, this means that 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
The money supply will start to fall in England but rise in Portugal. According to the quantity theory of money, accepted by Ricardo, the level of prices in terms of gold is determined by the quantity of money—gold—relative to commodities in a given country. Since the quantity of money will be falling in England, prices and money wages (though not real wages) will also start to fall there.
In Portugal, the reverse situation will occur. Gold coins will be imported from England swelling the money supply—the quantity 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, despite the fact that 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. 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, continue to win the battle of competition against English wine producers in both countries. Deflation in England and inflation in Portugal is not enough to save the English wine producers. Portuguese wine is still cheaper. But 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 the production of cloth paralyzes Portugal’s absolute advantage in that industry.
Quantity theory of money crucial to Ricardian comparative advantage
But notice that the ability of comparative advantage to prevail over absolute advantage all depends on the validity of the quantity theory of money. If the quantity theory of money 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 is made up of three components: Say’s Law, comparative advantage, and the quantity theory of money. Using these alleged laws, the economic liberals—including today’s neoliberals—draw the conclusion that free trade, in both the national and international markets, is in the interests of all individuals regardless of class, and of all nations regardless of their degree of economic development.
A modern version of comparative advantage
In the example above, Ricardo assumes a currency system made up of circulating full-weight gold coins. How do today’s neoliberal economists imagine that comparative advantage works in the currency system of legal tender token money?
Suppose for the sake of argument we assume that both Portugal and England use different paper currencies. (6) Now the supporters of the quantity theory of money apply the same laws to metallic money—full-weight gold coins—as they apply to paper or token money. According to the quantity theory, assuming the quantity of commodities in circulation is fixed, nominal prices—and wages—will fluctuate according to changes in the quantity of money.
Let’s retain all the other assumptions that Ricardo made above. The only difference is that both England and Portugal are using paper currency 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 will run a massive trade deficit in both cloth and wine. As the trade deficit continues, England’s paper money will fall relative to the Portuguese paper currency. As this continues, the English currency becomes cheaper relative to the Portuguese currency. Therefore, in terms of Portuguese currency, the prices of English wine and cloth will be falling. In terms of English currency, the price of imported Portuguese commodities 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.
Just like in the original Ricardian example using a pure gold currency, 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.
Just like with the gold coin currency, England, according to our present-day neoliberal economists, will end up specializing in cloth production and Portugal will specialize in wine production with exactly the same benefits to both countries in terms of real wealth that prevailed under the pure gold currency. (7)
Our modern neoliberals conclude that no matter how far behind a nation is in terms of the productivity of its capitalist industry, free trade is always in its interests. Even if it is at an absolute competitive disadvantage in all lines of production, there will always be some industries where it has a comparative advantage. (8) There is therefore, according to the “neoliberal economists” who uphold Ricardo’s law of comparative advantage, no country that does not benefit from free trade.
Notice how the “modern” version of the law of comparative advantage just like the original Ricardian version depends on the quantity theory of money. Ricardo held that there is always a distribution of gold that will ensure that comparative advantage works. To achieve that distribution of gold, all that is necessary is for all countries to adopt a policy of free trade. The market will automatically take care the rest.
Today, the supporters of comparative advantage hold that there is always a set of exchange rates among the various paper currencies that will guarantee that comparative advantage, not absolute advantage, rules on the world market. And just like free trade guaranteed the proper distribution of gold among the trading nations, so free trade will establish exactly the right rates of exchange among the countries engaged in world trade if the central banks and governments allow exchange rates to float freely against one another. That is, free trade must apply not only to the commodity markets but to the international currency markets as well.
Just like free trade in the original Ricardian example meant that the movement of gold coins, like all other commodities, was not subject to any government-imposed limits, so free trade, according to today’s neoliberal economists, means that there are no “dirty floats”—where the central banks or governments buy and sell currencies in order to manipulate exchange rates—and no exchange controls.
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 not only imported commodities in England such as Portuguese wine, but also domestically produced commodities such as cloth as well?
For example, won’t the price not only of imported Portuguese wine but also the price of domestically produced English cloth 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 not only of imported English cloth but also the price of domestically produced wine also fall, since each unit of the Portuguese currency will now represent more gold—real money—than before? So doesn’t absolute advantage rather than comparative advantage win the day after all?
Not according to the quantity theory of money it doesn’t. According to that theory, assuming the quantity of commodities in circulation remains unchanged, the general price level is not affected by changes in exchange rates or the gold value of the currency. The devaluation of the English paper currency will raise the price of imported Portuguese cloth allowing English cloth producers to beat the Portugese competition, but the price of English cloth will not rise. (9)
Under a paper system, our modern economists explain, gold is no longer money but simply another commodity. If the price of gold in terms of the currency rises, at most the price of gold jewelry and other commodities that use gold as a raw material will rise.
The neoliberal supporters of the quantity theory of money, such as the followers of Milton Friedman, insist that it is only changes in the quantity of money relative to commodities, not changes in the value of the currency relative to other currencies, still less the change of the currency relative to gold, that affects the cost of living in a given country. With a fall in the exchange rate of the currency, therefore, any rise in the price of imported commodities will be offset by a corresponding fall in the price of domestically produced commodities.
According to the supporters of Friedman and other modern champions of the quantity theory of money, a fall in the exchange rate of the currency is not inflationary as long as there is no increase in the quantity of money relative to the quantity of commodity in circulation. Therefore, the Friedmanites 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. According to Friedman, it is exactly the ever-changing exchange rates that allow the law of comparative advantage to work under the current system of pure paper currencies.
Notice how the whole modern case for comparative advantage and free trade lies in the 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 did not remain merely of theoretical interest. It not only became the basis of Britain’s adoption of “free trade” following the repeal of the “corn laws” in 1846. It also formed the basis of the British Bank Act of 1844. Using the Ricardian theory, the supporters of this legislation claimed that crises that had hit Britain in 1825 and 1837 would not recur if the act was passed.
Therefore, Ricardo’s theory of comparative advantage forms not only the basis of the neoliberal economists’ argument for “free trade” to this very day, it was also the basis of the first attempt to abolish periodic capitalist crises without transforming capitalism into a higher mode of production.
The subject of next week’s post will be the consequences of this first attempt to put Ricardo’s theory of prices, money, and comparative advantage into practice.
First, if commodities sell at their values how can the capitalists make a profit and still pay the full value of the workers’ labor. It was Marx who finally solved this contradiction in Ricardian value theory. He solved it through his distinction between labor and labor power.
Marx explained that the capitalists don’t purchase the workers’ labor, but rather the labor power, or the ability of the worker to perform labor. The value of the labor power of the workers—the amount of labor socially necessary to reproduce the ability of the worker to work—and the labor actually performed by the worker, are two quite different magnitudes. The labor the worker performs in a given amount of time must always be greater than the labor that is socially necessary to reproduce the ability of the worker to work for that amount of time. If it isn’t, no surplus value is produced.
The other problem that neither Ricardo nor his followers were able to answer involved the question of different relative quantities of what Marx was later to call constant capital and variable capital, as well as the different turnover times of capital in different branches of production. It had long been realized by political economy that competition will tend to produce a more or less uniform rate of profit across different lines of production. Why would an industrial capitalist invest in a line of production that yields a lower rate of profit than that yielded by an alternative line of production?
But if prices were directly proportional to labor values, industries that employed more variable capital relative to constant capital—were more labor intensive—would earn a higher rate of profit than those industries that used relatively more constant capital—were more capital intensive.
Free competition will drive the the economy toward an equilibrium where equal quantities of capital yield equal amounts of profit in equal periods of time. Therefore, assuming identical amounts of labor are needed to produce the commodities, prices will be higher in industries that use more constant as compared to variable capital and lower in industries that use more variable as opposed to constant capital. Since Ricardo did not distinguish between production prices and values, his law of value broke down at this point.
A related question involved the question of commodities that needed identical quantities of labor to produce in industries where the turnover of capital was low compared to industries that produced products where turnover of capital was rapid. The classic example given was the case of fine wines that had to age for years in old oak barrels. Such wines are very expensive, yet they may not take more human labor to produce than much cheaper wines that aren’t aged for years.
Marx solved this problem by distinguishing between values that represent a given amount of abstract human labor measured in terms of time and prices—whether prices of production or market prices—that are quantities of gold—or other precious metals that function as money material—measured in terms of weight. The equalization of the rate of profit given different organic compositions of capitals and turnover periods will mean that long-term equilibrium prices—prices of production—will not be directly proportional to values but will be modified by competition so that equal amounts of capital will yield equal profits in equal periods of time.
Marx solved the contradictions of the Ricardian theory of value by deepening Ricardo’s theory and correcting the defects in Ricardo’s theory of money and prices. In contrast, the post-Ricardian bourgeois economists scrapped the labor theory of value completely. Eventually, they replaced it with the theory that objects of utility have value because they are scarce. When formalized mathematically, this rather commonplace notion gives rise to the marginalist theory of value that has dominated academic economics since the end of the 19th century.
2 Ricardo assumed that the “price of labor”—wages—would pretty much be at rock bottom subsistence in every country. This alleged law was supposedly enforced through the Malthusian law of population that was accepted by Ricardo.
3 Ricardo built his theory of comparative advantage on the basis of his concept of labor value. While many modern bourgeois economists accept Ricardo’s law of comparative advantage, they completely reject his concept of labor value. However, our apologetic economists find the alleged law of comparative advantage so appealing—preaching free trade to oppressed countries when all of today’s imperialist countries resorted to protectionism when they were developing countries—they are unwilling to give it up. So they assume that labor is the only “scarce” factor of production in order to explain Ricardian comparative advantage to themselves and their unfortunate college economics students.
4 This isn’t necessarily because the English workers are less skilled than the Portuguese workers. Portugal’s mild climate is ideal for growing many wine producing grapes, while England’s cool, wet climate is marginal at best for grape growing.
5 In the real world of the early 19th century, England, the leading industrial country, could produce cloth with far less labor than Portugal could. Due to natural conditions of production, Portugal could produce fine wines that could not have been produced in England at all, since grape vines simply don’t thrive in the English climate. Therefore, in terms of the conditions prevailing in his own day, Ricardo’s example was totally unrealistic.
7 Modern bourgeois economists generally assume that if there is a trade imbalance between two countries, the surplus country has an “undervalued” currency while the deficit country as an “overvalued” currency. In the original Ricardian version, comparative advantage was supposed to trump absolute advantage due to a correct distribution of gold among the trading nations. This correct distribution of gold was supposed to be achieved automatically as long as all nations practiced free trade.
Today’s neoliberal economists imagine that if only exchange rates are at the the right level, comparative advantage will kick in and trade deficits and surpluses will disappear. The economists of the neoliberal school claim that the correct exchange rates will be established if all countries adopt free trade, including free currency markets and no exchange controls. Following this logic, the late Milton Friedman saw no reason why governments or central banks should hold any type of reserves behind their currencies, either in the form of gold or in the form of so-called reserve currencies.
8 In reality, almost every country has an absolute advantage in some branches of industry, extraction, or agriculture because of the natural conditions of production. For example, despite the fact that Saudi Arabia lags far behind the United States in most branches of industry and agriculture, it can produce crude oil much more cheaply than the United States can, simply because a huge amount of oil produced by the forces of nature happens to lie beneath the Arabian desert. Similarly, in pre-revolutionary days, Cuba could produce sugar much more cheaply than the United States, despite the extreme “underdevelopment” of the Cuban economy compared to that of the United States. Cuba’s climate and soil happened to be ideal for the production of sugar.
9 According to modern bourgeois economists, under a system of “paper money” such as prevails universally at present, gold is not money but “just another commodity.” Therefore, the concept of “prices in terms of gold” is meaningless according to our present-day bourgeois economists. To them, price is simply how many dollars, yen, pounds, euros, and so on are necessary to buy a given commodity at any given time.