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Read the article   “Economists find evidence for famous hypothesis of ‘comparative advantage’” by Peter Dizikes published on MIT News in 2012. 

This article discusses a paper by Arnaud Costinot and Dave Donaldson. In your submission, consider answering the following questions:

  • What hypothesis do the authors aim to test in this paper?
  • To test the hypothesis, what do they measure and using what data?
  • What is their main finding?
  • What are some caveats of the paper?

Also, note that the first paragraph of the article describes comparative advantage rather poorly. How would you rephrase to describe comparative advantage more accurately?

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Economists find evidence for famous
hypothesis of ‘comparative advantage’
By Peter Dizikes

June 20, 2012

Why do nations trade goods instead of producing more themselves? An old theory, that

countries specialize in the products they make well, may be on the money.

Christine Daniloff

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

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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.”

Why nations specialize

To arrive at this conclusion, Costinot and Donaldson identified a data source that let

them quantify nations’ potential productivity: The Food and Agriculture Organization

(FAO), an arm of the United Nations, analyzes farming conditions globally, estimating

potential agricultural productivity based on factors such as soil type, climate and water

availability.

Costinot and Donaldson looked at the numbers from an FAO model of yields of 17 crops

on 1.6 million plots of land in 55 countries to examine whether countries specialize in

the way Ricardo believed. That is, if a country’s terrain allows it to grow wheat more

productively than grapes, comparative advantage suggests that specialization will occur.

So Costinot and Donaldson compared the predicted output of crops in each of the 55

countries (based on the FAO data and on prevailing prices) with the actual output of

those crops.

The numbers show that Ricardo was right — to an extent, anyway. Costinot and

Donaldson analyzed the results so that if the real world worked just as Ricardo

supposed, the correlation between productivity and output would be 1.000. Instead, the

logarithmic correlation they found was 0.212, with a margin for error of 0.057.

“We found a positive and statistically significant correlation,” Costinot says.

‘Somebody should have done it 50 years ago’

The paper, “Ricardo’s Theory of Comparative Advantage: Old Idea, New Evidence,” was

published in the May issue of the American Economic Review. Pol Antras, a professor of

economics at Harvard University, has already assigned a version of the Costinot-

Donaldson paper as reading in an undergraduate class where students learn about

Ricardo’s ideas on international trade.

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“It’s an ingenious paper,” Antras says. “It’s not easy to shed new light on old ideas. They

came up with a very smart way to try to test a theorem. It’s one of these papers where

you think somebody should have done it 50 years ago, which is one of the highest pieces

of praise you can give to an article.”

To be sure, other scholars, Donaldson notes, have scrutinized Ricardo’s idea empirically,

if a bit more indirectly, especially in the 1950s and 1960s. Economists Daniel Bernhofen

and John Brown tackled the issue in a 2004 paper examining how Japan’s production

changed when it opened up to trade in the 19th century. But the current paper appears

to be the first to surmount what Donaldson calls “the missing data problem.”

“In a sense, all of economics is about choice,” Donaldson says. “But in many settings

economists know very little about the non-chosen elements of the choice set. For

instance, we would like to study farmers making decisions, but with conventional

datasets we can only see how good farmers are at doing what they chose to do, not what

they could have done but chose not to do.” The FAO data set allows the researchers to

circumvent that problem.

The nature of agriculture, Antras agrees, makes it ideal for scrutinizing Ricardo’s

hypothesis. “Ordinarily, countries that would be bad at producing things are not going

to produce them,” he says. “But in agriculture, we know how terribly things would go if

you tried to grow bananas in Iceland.”

Caveats and future directions

That said, Antras suggests a couple of caveats to the paper. One is that agricultural

productivity is not purely a function of environmental factors; technical know-how and

the availability of equipment also influence which crops are grown where. Secondly,

Antras notes, the less-than-total correlation indicates that additional factors affect

international trade as well. “The results suggest the theory is validated, but it is also

quite clear that there are many other things that drive trade patterns,” Antras says.

For their part, Costinot and Donaldson acknowledge these qualifications to their

findings. In the paper, they try to account for the technological and economic factors

that influence crop selection, but recognize such estimates are imperfect. And the MIT

economists add a third caveat: The data consist of productivity estimates made by

agronomists; if those estimates are a bit off, it would affect the bottom-line findings as

well.

Still, Donaldson says, “I was surprised at how, even with all the complexity in the real

world, there was still this positive correlation between the theory and reality.”

From MIT News

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