DOMESTIC PRODUCTION AND FOREIGN TRADE: THE AMERICAN CAPITAL POSITION REEXAMINED

Abstract

COUNTRIES trade with each other because this enables them to participate in and to profit from the international division of labor. Not unlike businesses and individuals, each area specializes in those lines of economic activity to which it happens to be best suited and then trades some of its own outputs for commodities and services in the production of which other countries have a comparative advantage. The word comparative is in this connection of particular significance. The United States, for example, exports automobiles and imports newsprint. It does so because the quantity of Canadian paper which we can obtain in exchange for, say, a million dollars' worth of American cars is larger than the additional amount of newsprint which we would be able to produce at home if we withdrew the capital, labor, and other resources now absorbed in the manufacture of one million dollars' worth of automobiles and used it instead to increase the output of our domestic paper industry. Canada, for analogous but in a sense opposite reasons, finds it advantageous to obtain its automobiles from the United States in exchange for newsprint rather than to divert resources from their present employment in its paper industry into an increased domestic production of cars. This explanation of the international exchange of goods and services in terms of the comparative advantage of the alternative allocation of resources in each of the trading countries, was originally developed in the writings of David Ricardo and other so-called classical economists of the late eighteenth and the early nineteenth centuries. It still constitutes the basis of the modern theory of international trade. The theory of comparative costs-as many other economic theories-reigns, however, in the pages of college text books without actually governing the practice of emipirical economic analysis. Until recently, we had so little systematic knowledge of the productive structure of our own or of any other national economy that the application of such general theoretical principles to the analysis and explanation of actual foreign trade relationships has been practically out of the question. M-ost of what has been said on that subject consisted of reasonable common sense conjectures or of plausible examples which-like the automobile and newsprint reference used above-serves well enough to illustrate the logic of the theoretical argument, but had hardly any specific base in detailed facts and figures.2 A widely shared view on the nature of the trade between the United States and the rest of the world is derived from what appears to be a common sense assumption that this country has a comparative advantage in the production of commodi-

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