Econ 4130

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Topic 10: The Transition Period

I. The Free Trade Era in Europe. During the mercantilist era, trade was seen as a zero-sum game: one country’s gain was another country’s loss. If Spain imported more from England that she exported to England, she had to send specie to England to make up the difference. In the mercantilist view, this was viewed as a loss for Spain and a gain for England. So, countries established policies to encourage favorable trade balances: they subsidized export industries and restricted imports through tariffs and quotas.

The foundation of modern trade theory though was provided by David Ricardo (1772-1823) in his Principles of Political Economy (1819).

A.Ricardo and comparative advantage.
Suppose there are only two countries, Portugal and England and two goods, wine and corn. The following table provides the yield per acre for each good in each country:


Wine30 jugs15 jugs
Corn60 bushels45 bushels

1.Portugal can produce more of both goods per acre than can England. So Portugal has the absolute advantage in both goods: for a given amount of inputs, Portugal can achieve higher output in wine (or corn) than can England. 2.Comparative advantage is determined by the “price” of one good in terms of the other good within each country.

3.Law of comparative advantage: A country in its trade with another country will export the good at which it has a comparative advantage in producing and import the good in which it has a comparative disadvantage in producing. By trading along the lines of comparative advantage, both countries can experience gains.

So by trading with each other, both countries are able to push out their consumption frontiers. The aggregate consumption of both goods can increase.

B.Where does a country’s comparative advantage come from?

1. Technology differences.

2. Hecksher-Ohlin theory of comparative advantage. Two Swedish economists, Hecksher and Ohlin writing in the 1940s proposed an alternative theory. They assumed that every country had access to the same technology. However, factors of production cannot move easily across national boundaries and so cannot be used in the proportions needed to maximize productivity. The relative scarcity of productive inputs differs from region to region and from country to country.

C.Is everyone made better off by trade?

D.The rise of free trade policies in Europe. Despite the logic of Ricardo’s argument, Britain and other European countries did not rush to abolish protectionist trade policy. The end of protection and the rise of free trade required shifts in opinions and power. This is where there is a relationship between the Industrial Revolution and trade policy changes: those who promoted free trade policy were manufacturers and industrialists. In Britain, the names associated with the abolition of protectionist policy were Richard Cobden and Robert Peel. Richard Cobden was an industrialist from Manchester; Robert Peel was the son of a textile manufacturer. The rise to power of groups that directly benefited from free trade was key to the liberalization of trade policy in Britain.

1. The shift to free trade policies in Britain
a. Corn Laws repealed in 1846.

b. The Navigation Acts were repealed in 1849.

2. Customs unions.

a.The most famous customs union established during this time was the Zollverein in Germany.

b.Switzerland created a customs union in 1850.
c.The Austro-Hungarian Empire abolished the customs frontier between its two halves in 1850. 3. Bilateral Treaties -- Cobden-Chevalier Treaty of 1860

a. This treaty provided that Britain would remove all tariffs on imports of French goods with the exception of wine and brandy.

b. France removed prohibitions on the importation of British textiles and reduced tariffs on a wide range of British goods.

c.The innovation...
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