On absolute and comparative advantage in international trade: A Pasinetti pure labour approach

Highlights

• Pasinetti's insights into international trade are formalized.

• Absolute advantage is rehabilitated based on wage disparities.

• Absolute advantage is important to the realization of comparative advantage.

Abstract

This paper builds upon Pasinetti's pure labour model, formalizing some of the insights that he has provided into the structure of international trade. A systematic approach is followed, starting with restrictive assumptions that are relaxed in subsequent stages of analysis. The starting point is a model in which two countries, one advanced and the other underdeveloped, have equal costs of production. This implies that there are no incentives for trade. At a second stage, we introduce and formalize the conditions required for these countries to exhibit absolute cost advantages, based on wage disparities. Finally, the paper establishes the conditions required for comparative advantage, based on relative differences in technology. Building on an interpretation of Ricardo's writings on trade, it is shown that absolute advantage is critical for the two countries to realise potential cost reductions afforded by comparative advantage. This abstract insight, based on the Pasinetti pure labour system, suggests that absolute advantage has a more fundamental role in international trade than given by previous studies, which focus more on either the international mobility of money capital or the international fragmentation of production.

Introduction

The main legacy of Ricardo's contribution to international trade theory is the theory of comparative advantage. Samuelson (1969, p. 9), for example, calls it one of the few propositions “in all of the social sciences which is both true and non-trivial”. And for Krugman (2002, p. 35), “Ricardo's idea is truly, madly, deeply difficult. But it is also utterly true, immensely sophisticated – and extremely relevant to the modern world”.

The usual interpretation is that comparative advantage represents a major analytical improvement over absolute advantage theory. Ruffin (2005, p. 746), for example, argues that Ricardo's true genius is to work out that a country can gain an advantage, compared to other countries, in its relative costs of production, as opposed to the ‘fallacy of absolute advantage’. The bulk of the economics profession thus views absolute advantage as a mere stepping stone for trade theory.

There has, however, been some questioning of this deprecation of absolute advantage in studies of classical political economy, as associated with the production-based approach of Sraffa (1960).¹ One particular strand of this literature has developed an external critique of Ricardo's model that abandons the assumption of immobility of money capital between countries (Shaikh, 1999, 2016; Parrinello, 2010; Bellino and Fratini, 2019; Crespo et al., 2020). The introduction of free international mobility of money capital implies that capitalists can move their capital to other countries in search for higher rates of profit. The idea is that countries with lower costs of production, however defined, will support higher rates of profit and hence attract capital. In this way, it is suggested that the driver of international trade and specialization could be lower absolute costs.

An alternative study advocating the importance of absolute advantage is that of Baldone et al. (2007). Here, the criticism of comparative advantage is not based on mobility of money capital, but rather due to the complications associated with trade in (physical) intermediate goods. With the fragmentation of production there is a “lessening of the power of the concept of comparative advantages (…) while it is the concept of absolute advantage that becomes increasingly relevant” (Baldone et al., 2007, p. 1727). Traditional measures of comparative advantage might suggest that a country should specialize in the production of a particular final commodity; but with fragmentation it might be cheaper for the country to export the intermediate inputs necessary for another country to produce the final commodity – which the original country then imports. It is argued, using a two-country model, with zero profits and traded intermediate capital inputs, that trade patterns can thus be explained by actual costs of producing the commodities: absolute advantage.

There is, however, a dimension to this analysis that has been somewhat neglected: it rests on a fundamental assumption that each country has a given money wage, both measured in a common unit of account (Baldone et al., 2007, p. 1733). This modelling of wage disparities allows for a comparison between money costs (and absolute advantage) between countries which, it may be argued, is more fundamental than Baldone et al.’s focus on intermediate inputs.

The contribution of this paper is thus to further investigate the role of wage disparities and absolute advantage in a production system with international trade that is more abstract than Baldone et al.’s formulation. The framework employed is perhaps the most abstract available in classical political economy, the two-country system developed by Pasinetti (1993) under pure labour technology, with zero profits and labour the only input to production. Our approach is to emphasize the role of money wage disparities in determining trade patterns and world prices. It will be shown that even in this simplified model absolute cost advantages can dominate competition between countries under given money wages. What sets our contribution apart is that we need not rely on either free mobility of money capital or trade in intermediate capital goods in order to establish a role for absolute advantage in international trade.

Though Pasinetti has much to say about international trade there has been very little attention to this aspect of his work. International trade is not, for example, considered in the intellectual biography of Pasinetti's work and the secondary literature provided by Baranzini and Mirante (2018). A further contribution here is thus to introduce a formalisation of the model of international trade developed in Chapter 9 of Pasinetti (1993).² It will be argued that Pasinetti's step-by-step approach, with the systematic relaxation of restrictive assumptions at each stage of the analysis, can throw light on some of the core aspects of complex trade relationships.

The structure of the paper follows a step-by-step approach. Section 2 starts by setting up Pasinetti's two-country model of trade in its most concise form. By starting with Pasinetti's assumption of a uniform ten-fold disparity in technology and wage rates, between the two countries, costs are shown to be the same, providing no inducement to trade. Section 3 then introduces absolute advantage into the model by relaxing the assumption of a ten-fold difference in wages. It is shown that under wage disparities one of the countries will have cheaper production costs across all commodities. Finally, by then relaxing the assumption of uniform differences in technology, the possibility of comparative advantage is introduced in Section 4, together with a consideration of how absolute advantage may also retain its relevance. The final section provides a summary of the contribution and some concluding remarks.