David Ricardo’s concept of “comparative advantage” is one of the most famous and venerable ideas in economics. Dating to 1817, Ricardo’s proposal is that countries will specialize in making the goods they can produce most efficiently — their areas of comparative advantage — and trade for goods they make less well, rather than making all kinds of products for themselves.
As a thought example, Ricardo proposed, consider cloth and wine production in England and Portugal. If English manufacturers are relatively better at making cloth than wine, and Portugal can produce wine more cheaply than England can, the two countries will specialize: England will concentrate on making cloth, Portugal will focus on making wine, and they will trade for the products they do not produce domestically.
Neat as this explanation may seem, it is by definition hard to prove. If England does not make wine, and Portugal does not make cloth, it is very hard to say how efficiently they could produce those goods. The same applies to any country not manufacturing any given product. So does Ricardo’s idea resemble reality?
A recent paper by MIT economists Arnaud Costinot and Dave Donaldson uses a novel approach to suggest that Ricardo’s hypothesis is buttressed by real-world evidence.
“The basic insight of David Ricardo holds up pretty well,” says Costinot, the Pentti J.K. Kourri Assistant Professor in MIT’s Department of Economics. “As simple as the theory is, it still has substantial explanatory power in the data.”