Imagine a Stone Age family: Papa Stone, Mama Stone, and their two little pebbles. Suppose that, as befits pre-women’s-lib Neanderthals, Papa Stone is initially more competent at every prehistoric survival skill: hunting, fishing, nut-and-berry gathering, firebuilding, tool-making. Despite his superior talents, it does not make sense for other family members to sit around waiting for him to do everything. Instead the family is better off if dad does those things that only he can do—hunting perhaps—while the others tackle those tasks that they can do well enough.
In this example Papa Stone has what economists call a “comparative advantage” in hunting while the children have a comparative advantage in collecting firewood. Even though dad can collect firewood more efficiently than the children, the family’s opportunity cost in lost game outweighs its benefit from the incremental tinder he could collect were he to forgo hunting in favor of gathering wood.
Once tasks are divided up among the members of the family, each will soon become more adept at his or her work until dad ceases to be the preeminent expert in all things Stone Age. Family productivity will increase and the Stones will become materially better off.
Suppose the members of a neighboring family, the Gravels, are far less capable than the Stones. Despite the disparity in skills, or rather because of it, each family can still gain by trading goods and services—just as the Stones benefitted individually by in effect trading goods and services among themselves. For example, let’s say it takes the Gravels two hours to gather a stack of wood and ten hours to capture a rabbit, while it takes the Stones only one hour of labor per stack of wood and three per rabbit. If the Gravels give the Stones four stacks of wood in exchange for one rabbit, they save two hours of labor while the Stones save one.
The exchange creates wealth. Both families gain time they can spend in leisure or in increasing their own material well-being. Note that no trade will occur unless each family benefits. Because of the opportunity for gain that trade offers, though, each family has an incentive to discover its comparative advantages with respect to the other and to find those things that can be exchanged to their mutual benefit. Through trial, error, and observation they will quickly learn the ways in which they can best serve each other.
Not only does trade increase the families’ wealth, it also makes them more resilient in hard times. If Papa Stone’s hunt goes badly today his family may have better luck gathering nuts and berries. If not, the Gravels might have fared better and be willing to exchange some of their harvest for a garment or tool that Mama Stone crafted. The community becomes more resilient as additional families are included in the circle of trade, allowing the realization of economies of scale and a finer division of labor.
Perhaps most important trade brings with it new knowledge and new thoughts. Far more valuable than a tool is the idea of a tool—a rock is just an inert lump until, mixed with knowledge, it becomes a hammer, club, or building block. Without knowledge there are no resources. Throughout history communities on or near trade routes have advanced far more quickly than have isolated peoples. Isolation yields ignorance and ignorance yields not bliss but poverty, disease, and death.
Jumping ahead a few score millennia, suppose that today’s Japanese are far more competent at every imaginable task than the citizens of any other country. Despite the disparity of skills, it would not make sense for Japan to produce all of the world’s goods while everyone else remains idle. Rather, the Japanese should do those things that only they can do, or for which they are best suited, while others do what they can. After such an international division of labor, people from other countries will become increasingly proficient in their work to the point that the Japanese are no longer the world’s experts in everything. People will grow into their niches, world productivity will rise, and poverty will decrease.
Comparative advantage is rooted in differences: differences in skills, culture, interests, location, climate, geology, geography. These differences lead to specialization, which in turn leads to still more differences and still more advantages. Comparative advantage and division of labor are locked in a virtuous cycle of ever-increasing productivity.
Who should determine those tasks for which the Japanese are best suited—to say nothing of the Australians, Brazilians, and Icelanders? Perhaps their respective governments can get together and determine how to best divide up the work. Unfortunately governments have had a dismal record of picking industry winners and losers.
Four decades ago, for example, Japan’s vaunted Ministry of International Trade and Industry (MITI) thought that the Japanese were best suited to building ships and actively discouraged the nation’s companies from trying to compete with American automobile and electronics firms. Had MITI’s view prevailed, the loss to Japan and to the rest of the world would have been incalculable. On the other hand, suppose that the Japanese auto and electronics companies had been mistaken and their attempt to break into American markets had failed miserably. The losses would have been substantial, but they would have been far less than those that would have stemmed from MITI’s error. Mistakes made on a small scale are far less costly than those made on a national or international level. They are easier to stop, too.
Far better to let individuals, with local knowledge and a stake in the outcome, decide how best to employ their own time, skills, and property. Prices will reveal the comparative advantages these individuals enjoy as they compete with each other in the marketplace.