[SOUND] [MUSIC] One of the main characteristics of the current global economy is the increased trade between countries. Trade, we might say, is the most basic element of globalization. Countries buying and selling things to each other. Now, why do nations trade, and who benefits out of trade? [MUSIC] Why nations trade might sound maybe as one of the most obvious questions here. But there have been many people, many thinkers for centuries, trying to understand this. Because once we understand this, we also can discuss who benefits from trade and who loses out of trade. So let's start with some of the most influential, classic explanations of trade. The first classic explanation we are going to study here is a school of thought known as mercantilism. Probably the best representative of this school of thought is French economist Jean-Baptiste Colbert. What the mercantilists argued was the following. They believed that in international trade, you can only benefit if you export more than what you import. The point was to accumulate gold. So this school of thought then advocated for policies that maximized exports and minimized imports, because they believed in trade, it's always somebody who wins and somebody loses, and you want to be one of the winners by selling more than what you buy and keep a constant surplus. Now, this was the foundation of the philosophy, the economic philosophy that was used by many empires, European empires, in the 18th century. Basically, if selling more than what you buy is what leads you to a higher welfare, higher levels of welfare, then it makes more sense to invade another country, take it over, instead of buying from that country, and in that way, whatever you take over is actually domestic production rather than an import. So this was a way of looking at the world that, again, was extremely influential for a long time, but was challenged by the late 18th century. The challenge against mercantilism leads us to explore the second interpretation of international trade. This time, we are going to talk about the very influential work by Scottish economist and philosopher Adam Smith, who published a book called The Wealth of Nations in the year of 1776. Very tellingly, the same year of the independence of the United States. Now, what Smith argued here is the following. Contrary to the mercantilists, he believed in the following mechanism. He thought that the source of the wealth of a nation does not rely on protectionism as the mercantilistic people believed, but rather on whether or not it focused on producing whatever they were best at producing. Let’s put it in this way. He believed that in any society, the source of increased welfare relies on labor division. In fact, this is the title of the first chapter of The Wealth of Nations. The logic goes in this way. Let's say you're alone after a shipwreck in a desert island. A person that is in that situation will have to build his or her own housing, fish, hunt, create his own or her clothes, do everything. When you do everything, you will not be efficient at doing anything. So, everything will be mediocre for this person living in a small desert island. If a second person comes, then they can divide work and change the products of his work. If a third, or fourth, or more people come, then each of them can specialize on whatever they're best at producing or at doing, and exchange this service or product with the other members of that society. So he believed in order for a society to prosper, we need to destroy all the obstacles that do not allow people to focus at doing whatever they're best at doing. And this same logic for a society he thought applies for the world as a whole. If we reduce the obstacles of trade, nations then would specialize of producing whatever they're more efficient at producing than other countries of the world, and then exchange with these other countries. Production will increase for everybody, and as a result, consumption will also increase for everybody. So, this is where we see a difference with the mercantilist school. First, he's seen that both sides can gain from trade if each side specializes at doing whatever they're best at doing. And second, the way to measure how prosperous a society is, is not by looking at the surplus of how much they sell in contrast to whatever how much they buy, but how much they consume and the price of whatever they consume. If they're consuming more at lower prices, this would lead to prosperity more than just buying less and selling more. This theory, the Adam Smith theory, is the one known as the theory of absolute advantages, because he thought a country should specialize in the production of whatever product they have an absolute advantage with respect to another country. Meaning, I am more prosperous than the other country. If all countries start doing this, they all would benefit out of trade. The theory of Adam Smith is appealing. And as we know, Adam Smith is often quoted as the father of capitalism and free markets. But actually, when we look at another theory that challenged him later on in the 19th century, we can find a theory that even more strongly defends free markets. And here is when it is worth talking about another British economist named David Ricardo, who lived in the 19th century and developed a theory now known as the theory of comparative advantages, in contrast to the absolute advantages that Adam Smith talked about. What did Ricardo want to say here? Ricardo said, okay, Smith is telling us that we should specialize in the production of the good that we're more efficient at producing with respect to another country, and trade with that country. But then Ricardo asked himself, what if I'm more efficient than anybody else? Or I'm more efficient than another country at producing the two goods that we can exchange, does it make sense to trade or not? His answer was yes. And the logic was the following one. He said, look, under the Smith model, you only benefit from trade if you're better at producing something than the other country. But Ricardo believed that anybody, any country, can still benefit out of trade, as long as we allow trade to operate freely. What was his logic? He said, let's say you are a country that produces two goods that are produced more efficiently than the way a second country produces them. He said, this is a situation in which both countries can still win from trade. Because what he advocated for was, if you are more efficient than another country at producing two goods, you should still specialize in the production of the good you are more efficient at producing with respect to the other goods you can produce in your own economy. The reason is, if you only trade whatever you're more efficient at producing, you're sacrificing the use of some resources, and you would put them to work in a sector in which you are not the most efficient. So basically, what Ricardo is advocating here is, a country, and any country, would benefit from trade if they focused on whatever they're better at producing within its own borders. Smith mentioned it. You should specialize in producing whatever you're better at producing in comparison to the other country. Ricardo said, no, you should focus on producing whatever you're more efficient at producing at your own country. What will be the effects of this? You would liberate resources and focus on whatever you're more efficient at producing, and would allow the other country to also specialize in the production of their goods they're more efficient at producing. In the end, what he said is, we will all still produce more, and we can exchange then the goods, and production will increase, efficiency will increase, and consumption for everybody will increase. So he said, what countries should do is open the borders to trade. I mean, in a non-discriminatory way, because once you are facing competition from abroad, your country will focus all its resources on whatever it's better at doing within its own borders, not only with respect to the other countries. And in this way, the efficiency of the sector in which it is producing will be even higher. Well, if the other countries do not supply you with all that you need, okay. You can still produce a little bit of what is necessary to satisfy your demand. But the point is, here, the theory of comparative advantages by David Ricardo is the one that really advocates for free trade, withdrawing the government from most obstacles to trade and just open the borders. Every country, he believed, has a comparative advantage on something. Even if it's a tiny island, okay, maybe it has an advantage in tourism for instance, in comparison to a colder, more industrial place. But the point is that once you open the borders, resources will flow to whichever sector you're better at doing, and this in the end leads to a higher welfare of the whole society, not only of the country, but of the world as a whole. [MUSIC]
