Myth 1: Free trade is beneficial only if your country is stronger enough to stand up to foreign competition.
This argument seems extremely plausible to many people. For example, a well-known historian recently criticized the case for free trade by asserting that it may fail to hold in reality: “what if there is nothing you can produce more cheaply or efficiently than anywhere else, except by constantly cutting labor costs?” he worried.
The problem with this commentator’s view is that he failed to understand the essential point of Ricardo’s model that gains from trade depend on comparative rather than absolute advantage. He is concerned that your country may turn out not to have anything it produces more efficiently than anyone else—that is, that you may not have an absolute advantage in anything.
It is always tempting to suppose that the ability to export a good depends on your country having an absolute advantage in productivity. But an absolute productivity advantage over other countries in producing a good is neither a necessary nor a sufficient condition for having a comparative advantage in that good. The competitive advantage of an industry depends not only on its productivity relative to the foreign industry, but also on the domestic wage rate relative to the foreign wage rate. A country’s wage rate, in turn, depends on relative productivity in its other industries. In our example, Foreign is less efficient than Home in the manufacture of cloth, but at even a greater relative productivity disadvantage in food. Because of its overall lower productivity, Foreign must pay lower wages than Home, sufficiently lower that it ends up with lower costs in cloth production.