David Ricardo (1772–1823) showed that even if a country had no absolute
cost advantages, it would still be able to grow more wealthy through interna-
tional trade. We can demonstrate this by using a simple model involving two
countries (A and B) and two commodities (x and y). Country A produces both
Commodity x and Commodity y against the lowest possible costs.
Country A Country B
Commodity x costs 5 12.5
Commodity y costs 20 25The difference between Country A and Country B is larger for Commodity x,
however, than it is for Commodity y. If we consider the terms of exchange (the
number of units of Commodity x exchanged for one unit of Commodity y and
vice versa), we can construct the following table.
Country A Country B
1x =^14 y 1x =^12 y
1y = 4x 1y = 2xWe see that the inhabitants of Country A can profit by buying Commodity y
in Country B. In Country B they only have to pay 2x, while in their own country
they have to pay 4x. Inhabitants of Country B would do well to buy their
Commodity x in Country A. In doing so they only have to pay^14 y, while in
their own country it would cost them^12 y. We can say that Country A has a rel-
ative comparative cost advantage in producing Commodity x, while Country
B has a relative comparative cost advantage in producing Commodity y.
Inhabitants of Country A will therefore try to exchange their Commodity x for
the Commodity y of Country B. The inhabitants of Country B would be very
willing to do so because this exchange is also to their benefit. This is how inter-
national trade was born. To comply with the extra foreign demand, Country A
would have to specialize in producing Commodity x and Country B in pro-
ducing Commodity y. According to Smith and Ricardo, international trade
arose because of the existence of comparative cost advantages, whether
absolute or relative.
The Heckscher–Ohlin theoremThis brings us to the question: where do such cost differences come from? One
answer, known as the Heckscher–Ohlin (H–O) theorem, was introduced by the
Swedish economists Heckscher and Ohlin. Comparative cost differences are the
result of differences in factor endowments (labour, land and capital). Some coun-
tries, for example, have a relatively large quantity of capital and relatively small
The International Division of Labour 13