[Paleopsych] Buchanan and Yoon: Globalization as Framed by the Two Logics of Trade

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Buchanan and Yoon: Globalization as Framed by the Two Logics of Trade

Globalization as Framed by the Two Logics of Trade
JAMES M. BUCHANAN AND YONG J. YOON
The Independent Review, v.VI, n.3, Winter 2002, ISSN 1086-1653, 2002, pp. 
399-405.

[This should be read "sitting bolt upright in a hard chair," as Professor 
Vining used to say. It will take more than one reading. I redirects the 
debate.]

James M. Buchanan is the advisory general director of the Center for Study of 
Public Choice, George Mason University, and the 1986 recipient of the Alfred 
Nobel Memorial Prize in Economic Sciences. Yong J. Yoon is a senior fellow of 
the Center for Study of Public Choice, George Mason University.

Economists are professionally biased in favor of free trade and open markets. 
Indeed, normative support for open markets is so universal among practicing 
economists that the logical origins of their positions are often obscured. 
Observers and sometimes economists themselves may fail to recognize that two 
categorically different logical arguments inform economists’ thinking and that 
these arguments, these separate “logics,” may have different consequences for 
generalized public and political attitudes toward the openness of markets. 
Globalization, as a catch-all term for movements toward more inclusive trading 
networks, may be viewed quite differently by persons who, even if vaguely, 
locate its normative bases differently. Such differences may surface more or 
less directly as explicit policies for moving toward or away from further 
globalization become alternatives for choice in democratic polities.

For expository purposes, we may label the two logics of trade as Smithean and 
Ricardian, with reference to the two leading figures of classical political 
economy, Adam Smith and David Ricardo. Neoclassical economic analysis, which 
dominated the discipline of economics from 1870 to 1970, was informed during 
that century by the Ricardian logic before returning partially and somewhat 
reluctantly to the Smithean logic in the 1980s and later. As the scientific 
arguments spill over into public and political attitudes, however, the 
Ricardian logic continues to hold its place, with obvious implications for the 
public perception of the effects of policy alternatives.

Specialization and Exchange

The Smithean logic is straightforward. Why do persons trade with one another? 
They do so because specialization is productive; people can produce more 
economic value if each person does one thing instead of trying to do 
everything. Concentration of productive effort on one good followed by exchange 
for other goods becomes a means of getting more of all goods than can possibly 
be attained in autarky. Trading is, quite simply, a more efficient means of 
producing.

Note particularly that in this model of exchange people need not differ either 
in their relative capacities to produce goods or in their preferences for the 
goods in consumption. Specialization and subsequent trade emerge between the 
parties because of a recognition that mutual gains are available, that there 
are increasing returns to be secured from concentrating effort in one activity 
or the other. Note also that if people do not differ, it is impossible to 
identify in advance which persons will specialize in which activity involved in 
the production of which good. Specialization will be observed, but there will 
be no naturally specialized factors of production.

Comparative Advantage

The Ricardian logic that explains the origins of trade differs categorically 
from the Smithean argument just outlined. As noted, Adam Smith’s account of the 
benefits of specialization explains why exchange will be mutually beneficial 
even if the trading parties are initially identical in all respects. By 
contrast, the Ricardian logic locates the origins of exchange in the 
differences among persons—differences in their capacities to produce separate 
final goods. If such differences exist, specialization and exchange will always 
prove mutually beneficial. Trade emerges because different persons (or trading 
units, including countries) have different comparative advantages in producing 
different goods.

Consider what we might call a pure Ricardian setting in which there are no 
potential gains from specialization as such, even over small ranges of 
production. If persons are identical in both their capacities to produce and 
their preferences, trade produces no benefits. For mutually beneficial trade, 
persons must be presumed to differ in either productive capacities or 
preferences. Note the somewhat subtle reversal of the logical sequence in the 
two stylized settings outlined. In the Smithean setting, exchange emerges 
because of the advantages of specialization; in the Ricardian setting, 
specialization and subsequent trade become advantageous because of the inherent 
differences among potential trading parties.

The differences in the constraints in the two models warrant attention. In the 
Smithean model, as stylized, persons can freely choose their specializations, 
and because they can do so, equilibrating forces are present to ensure against 
permanent differentials in rewards. Adam Smith’s familiar deer-beaver 
illustration is useful here. Because persons may become either deer hunters or 
beaver hunters, no differential in the net rewards of the two occupations need 
exist in the natural or long-term equilibrium. By contrast, in the pure 
Ricardian setting some persons are by nature relatively more adept at hunting 
deer than at hunting beaver, given any relative demand for the two goods. The 
net returns from the two occupations may remain different, even in a long-term 
equilibrium.

Generalization

Empirically, economic exchange, from its simplest to its most complex forms, is 
explained by some combination of the two elements emphasized in the contrasting 
logics we have just outlined. Specialization has inherent advantages, as each 
of us recognizes in managing our personal affairs. Each of us can produce more 
economic value by concentrating on one thing than by trying to do a little of 
everything. But people also differ: each of us presumably has a comparative 
advantage in one sort of productive activity or another. Each of the two basic 
arguments or any combination of them can be readily generalized into a 
normative defense of free trade. The articulation of this defense may be 
considered a fundamental task of economists, who may rest secure in their 
conviction that everyone’s well-being is advanced by generalized public 
acceptance of the elementary principles.

Our thesis here is that the relative weights assigned to the quite different 
Smithean and Ricardian logics, as they are transmitted from economists and 
ultimately translated into public attitudes, are important factors in 
determining the level of support for extensions of the trading network, 
especially as that support—or opposition— comes to be institutionalized in 
political coalitions in democracies. Specifically, we suggest that an 
incorporation of the basic Smithean logic generates stronger support for 
extensions of the market nexus than does a comparable incorporation of the 
Ricardian logic. Unfortunately, as we later discuss, neoclassical economics 
tends to assign almost exclusive weight to the Ricardian explanation.

Extending the Market

In discussions of globalization, the question is not whether or not to engage 
in trade, but whether or not to allow reciprocal entry and exit opportunities 
to a larger number of potential traders.

In any economy, trade is carried out primarily among persons and groups within 
a defined polity, and goods and services are produced largely by specialized 
producers. In the Smithean conception, production takes place under generalized 
increasing returns but without any natural or inherent differences among 
persons. How will an increase in the size of the nexus for potential exchange 
affect market participants? The additional exploitation of specialization will 
increase the ratio of output value to input value for all participants. Aside 
from possible transitional adjustments, there are no net losers, and ultimately 
everyone gains.

In the Ricardian conception, the observed preexpansion patterns of production 
and exchange reflect, in part, the prevailing differences in natural 
capacities. Differences in the net rewards of workers in separate occupational 
categories are determined by their relative capacities to produce and by the 
prevailing patterns of demand for final goods. In this setting, what are the 
predicted effects of extending the trading nexus?

Persons who find it advantageous to enter the now opened market and to offer 
goods for exchange will resemble some groups of internal or domestic producers 
more closely than others. Net losers in the process may be those persons who 
prior to the expansion had relative advantages in the production of goods that 
after the expansion are offered for importation, even after transitional 
adjustments, despite the aggregate gains resulting from the enhanced 
exploitation of comparative advantage. By comparison, those to secure net gains 
will be persons whose comparative advantage does not lie in the production of 
importable goods. In their role as consumers, all persons will secure gains, 
but those gains may be overwhelmed by losses as producers for the groups 
threatened by imports.

The Ricardian logic necessarily draws attention to the differential effects of 
extending market size on separate groups of specialized producers, a feature 
that is totally absent from the basic Smithean logic.

Economics within Neoclassical Limits

The possibly conflicting implications of the two basic logics of trade have not 
adequately informed the thinking of economists because economists implicitly 
have been quite willing to add up gains and losses, despite the putative 
rejection of naive utilitarianism in their normative judgments. Because the 
gainers from market extensions can, in principle, always overcompensate the 
losers, the fact that such compensation does not normally occur has not 
received much attention. Economists might therefore accept and employ the 
Ricardian explanatory framework without sensing the dramatic difference of 
normative implications between it and the Smithean framework.

Importantly, acceptance of the Ricardian explanatory logic became necessary for 
economists once the classical intellectual enterprise was replaced by the 
neoclassical analytical structure, a shift that dates roughly from the 1870s. 
The presumed lasting contribution of early neoclassical analysis was its 
success in “closing the circle,” by which we refer to the incorporation of a 
theory of distributive shares into the general theory of prices. Neoclassical 
economics offered a theory of both input prices and output prices.

In order to effect this contribution, however, the so-called imputation problem 
had to be resolved. How were economists to prove that the amount paid for 
inputs equaled the amount paid for the total product created by those inputs? 
How were they to explain the absence of either a surplus or a deficit? 
Economists resolved this problem by imposing the constraint that the market 
economy was characterized by constant returns to scale, that production 
functions were everywhere “linear and homogeneous.” In arriving at this 
solution, however, they almost universally failed to recognize that the 
constraint of constant returns conflicted with Adam Smith’s basic precept about 
specialization. Smith’s principle was placed in the dustbin, to be dredged up 
only now and again over the course of a century until being recovered in the 
last decades of the twentieth century.

The neoclassical constraint of constant returns forced economists to adopt the 
Ricardian logic as their basic explanation of trade. In their textbook 
examples, trade emerges under conditions of comparative advantage even when 
constant returns are imposed down to the level of individual effort. In other 
words, there is no inherent conflict between the Ricardian principle of 
comparative advantage and the neoclassical constraint of constant returns. It 
is small wonder that economists subconsciously locate the origins of trade in a 
Ricardian framework.

From Markets to Politics

Our elaboration of the distinction between the two basic logics of trade might 
be viewed as an esoteric intellectual exercise if the subject of concern were 
only the natural emergence and operation of markets. The distinction becomes 
more significant, however, when we recognize that ultimately the extent of the 
effective market nexus is determined politically—that is, through explicit 
collective action. Nation-states exist and draw boundaries. Almost everywhere 
throughout history, the activities of participants in markets within the 
boundaries of the polity have been treated differently from the activities of 
participants in markets that extend beyond political borders. Only in a 
relatively few instances have markets been opened to all who might choose to 
enter into trading relationships, regardless of political identity.

Because “the extent of the market” is subject to political choice, questions 
about its appropriate size are central to present-day discussions of 
globalization, a term that has become a catchall for a whole set of related 
issues. We suggest that people’s understandings of the two separate logics of 
trade may, and perhaps do, exert an important influence on public attitudes and 
hence on political attitudes toward restrictions or expansions of markets, 
toward immigration policies, and toward the increasing integration of 
historically separated national economies, as exemplified by attitudes toward 
such institutions as the European Union, the North American Free Trade 
Association, Mercosur, and others.

The basic Smithean logic lends more or less direct and more or less universal 
support for market extension. The central principle of this logic, enunciated 
by Smith himself, states that the division of labor is limited by the extent of 
the market, with the implication that the “wealth of nations” increases 
directly with the size of the market nexus. Importantly, in this 
intellectual-analytical structure, no need arises for a measure of gains to 
gainers as against losses to losers. Basically, there are no permanent losers, 
and everyone is a gainer. The expanded market nexus makes for further 
specialization, with generalized gains in economic value.

In contrast, the Ricardian logic offers a much more questionable rationale when 
a polity faces a necessary political choice concerning a proposed extension of 
the scope of the market. Overall, the gains in aggregate value consequent on a 
fuller exploitation of comparative advantages may be acknowledged, but 
identifiable persons and groups may be affected differently by the extension of 
the market precisely because persons differ among themselves in productive 
capacities. Persons and groups who possess comparative advantages internally in 
the production of the same goods in which potential entrants possess 
comparative advantages may be damaged by the proposed extension of the market. 
Members of such groups would tend to oppose proposals for integration of 
markets across national boundaries, and their opposition would influence the 
formation and impact of political coalitions.

Those economists locked implicitly into the Ricardian framework may still be 
willing to defend the proposed expansion of markets by resort to concealed 
utilitarian evaluation, even if they acknowledge the improbability of 
compensation payments. But even such economists will for the most part accept 
that the defense of “economic efficiency” in the abstract is a weak reed for 
political argumentation.

The Mind-Set of the Market

The Smithean and the Ricardian models offer differing lenses through which we 
may view the observed processes of market exchanges. The phenomena themselves, 
of course, are the same, and empirically observed exchange relationships surely 
embody elements of both explanatory models. Persons specialize (including 
specialization in the organization of institutions) because specialization as 
such produces gains. As Adam Smith noted, the differences between the 
philosopher and the street porter may be small prior to their commitments to a 
specialty.

But persons also differ in their relative capacities to produce economic value. 
Presumably there exist noncompeting groups that would retain relative 
advantages even after a full temporal adjustment to reach equilibrium. Only a 
few persons are seven feet tall and adept at playing basketball.

The two contrasting mind-sets about the origins of trade are important in 
determining how people evaluate the composite reality they observe. Persons 
will be observed to differ, perhaps widely, in income and wealth. In the 
stripped-down Smithean model, in which exchange is explained exclusively by 
choice-driven specialization, people will tend to view the observed differences 
as temporary and subject to elimination as market prices move toward their 
“natural” levels. If philosophers currently earn much more than street porters, 
we can predict that more persons will begin to specialize in philosophy. 
Moreover, because the Smitheans’ mind-set suggests that street porters indeed 
can become philosophers, they feel no need to express great concern about the 
immigration of additional street porters or about the importation of goods that 
are or might be produced domestically.

The Ricardian mind-set, by contrast, leads people to make a quite different 
evaluation of the observed reality that contains major differences in incomes 
among persons in differing occupational categories. Ricardians will view those 
economic differences as more permanent and the forces of adjustment that tend 
to reduce them as less effective. In particular, as may be the case in the 
United States, if the opening of markets suggests that more of the types of 
goods currently produced by relatively unskilled members of the domestic labor 
force will be imported, political coalitions organized in opposition to market 
extension will find support among unions and their political representatives. 
Further, schemes for payments of compensation to those that seem likely to 
suffer from the opening of markets will command more sympathetic hearings.

Thus, the basic mind-set about the origins of exchange may exert important 
effects on public and political attitudes toward globalization and therefore on 
the ultimate political choices that may be made. By exclusively following the 
Ricardian digression, economists have perhaps been responsible for unwittingly 
making movements toward open markets more difficult than they otherwise would 
have been.

Smitheans, Ricardians, and Democracy

Finally, a note about politics and economics in general. The “open politics” 
that democrats putatively hold as an attainable ideal depends on the 
presumption that all persons in the polity are competent to participate fully 
in collective choices. Democracy, as a plausible ideal, seems much more 
compatible with the Smithean conception of personal capabilities than with the 
Ricardian. If our mind-set allows for equality among all persons in their 
ultimate competencies as citizens, should not our mind-set also allow for 
equality among all persons in their ultimate competencies as creators of 
economic value?

An Adam Smith “democrat” is not at all self-contradictory. But what about a 
David Ricardo “democrat,” who is forced, willy-nilly, to judge that some of us 
are more equal than others?1

References

Buchanan, James M., and Yong J. Yoon, eds. 1994. The Return to Increasing 
Returns. Ann Arbor: University of Michigan Press.

Yang, Xiaokai. 2001. Economics: New Classical versus Neoclassical Frameworks. 
Oxford: Basil Blackwell.

1. The argument in this article implicitly incorporates our interpretation of a 
research program that has emerged since the early 1980s. For a collection of 
the important contributions to this program, including relevant precursory 
materials, see Buchanan and Yoon 1994. For the most comprehensive treatment of 
the approach, see Yang 2001.