LAW OF NATURE:Theory of Absolute Advantage, Comparative Advantage

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Business Ethics MGT610

LESSON 16

LAW OF NATURE

"A state also of equality, wherein all the power and jurisdiction is reciprocal, no one

having more than another... without subordination or subjection [to another].... But...

the state of nature has a law of nature to govern it, which obliges everyone: and

reason, which is that law, teaches all mankind, who will but consult it, that being all

equal and independent, no one ought to harm another in his life, health, liberty, or

possessions."

Thus, according to Locke, the law of nature teaches us that we have a natural right to liberty.

But because the state of nature is so dangerous, says Locke, individuals organize themselves

into a political body to protect their lives and property. The power of government is limited,

however, extending only far enough to protect these very basic rights.

Locke's views on property rights have been very influential in America. The Fifth Amendment

to the U.S. Constitution even quotes Locke directly. In this view, government does not grant or

create property rights. Rather, nature does, and government must therefore respect and protect

these rights. Locke's view that labor creates property rights has also been influential in the U.S.

Although Locke never explicitly used his theory of natural rights to argue for free markets,

several 20th-century authors have employed his theory for this purpose.19 Friedrich A. Hayek,

Murray Rothbard, Gottfried Dietze, Eric Mack, and many others have claimed that each person

has the right to liberty and property that Locke credited to every human being and

consequently, government must leave individuals free to exchange their labor and their

property as they voluntarily choose. Only a free private enterprise exchange economy, in which

government stays out of the market and in which government protects the property rights of

private individuals, allows for such voluntary exchanges. The existence of the Lockean rights

to liberty and property, then, implies that societies should incorporate private property

institutions and free markets.

It is also important to note that Locke's views on the right to private property have had a

significant influence on American institutions of property even in today's computer society.

First, and most important, throughout most of its early history, American law has held to the

theory that individuals have an almost absolute right to do whatever they want with their

property and that government has no right to interfere with or confiscate an individual's private

property even for the good of society. Second, underlying many American laws regarding

property and ownership is Locke's view that when a person expends his or her labor and effort

to create or improve a thing, he or she acquires property rights over that thing.

Theory of Absolute Advantage

In 1776 Adam Smith asserted that the wealth of a nation consisted of the

goods and services available to its citizens. His theory of absolute

advantage holds that a country can maximize its own economic well being

by specializing in the production of those goods and services that it can

produce more efficiently than any other nation and enhance global efficiency

through its participation in (unrestricted) free trade. Smith reasoned that: (i)

workers become more skilled by repeating the same tasks; (ii) workers do

not lose time in switching from the production of one kind of product to

another; and (iii) long production runs provide greater incentives for the

development of more effective working methods. Smith also asserted that

country-specific advantages can either be natural or acquired.

Business Ethics MGT610

1. Natural Advantage. A country may have a natural advantage in the production

of particular products because of given climatic conditions, access to particular

resources, the availability of labor, etc. Variations in natural advantages among

countries help to explain where particular products can be produced most

efficiently.

2. Acquired Advantage. An acquired advantage represents a distinct advantage

in skills, technology, and/or capital assets that yields differentiated product

offerings and/or cost-competitive homogeneous products. Technology, in

particular, has created new products, displaced old products, and altered trading-

partner relationships.

3. Resource Efficiency Example. Real income depends on the output of products

as compared to the resources used to produce them. By defining the cost of

production in terms of the resources needed to produce a product, the production

possibilities curve shows that through the use of specialization and trade, the

output of two countries will be greater, thus optimizing global efficiency.

Comparative Advantage

In 1817 David Ricardo reasoned that there would still be gains from trade if

a country

specialized in the production of those things it can produce most efficiently, even if other

countries can produce those same things even more efficiently. Put another way, Ricardo's

theory of comparative advantage holds that a country can maximize its own economic well-

being by specializing in the production of those goods and services it can produce relatively

efficiently and enhance global efficiency through its participation in (unrestricted) free trade

Locke's critics focus on four weaknesses in his argument:

The assumption that individuals have natural rights: This assumption is unproven and assumes

that the rights to liberty and property should take precedence over all other rights. If humans do

not have the overriding rights to liberty and property, then the fact that free markets would

preserve the rights does not mean a great deal.

The conflict between natural (negative) rights and positive rights: Why should negative rights

such as liberty take precedence over positive rights? Critics argue, in fact, that we have no

reason to believe that the rights to liberty and property are overriding.

The conflict between natural rights and justice: Free markets create unjust inequalities, and

people who have no property or who are unable to work will not be able to live. As a result,

without government intervention, the gap between the richest and poorest will widen until large

disparities of wealth emerge. Unless government intervenes to adjust the distribution of

property that results from free markets, large groups of citizens will remain at a subsistence

level while others grow ever wealthier.

Individualistic assumptions and their conflicts with the ethics of caring: Locke assumes that

people are individuals first, independent of their communities. But humans are born dependent

on others, and without caring relationships, no human could survive. The degree of liberty a

person has depends on what the person can do. The less a person can do, the less he is free to

do. But a person's abilities depend on what he learns from those who care for him as well as on

what others care to help him to do or allow him to do.

Business Ethics MGT610

Free Markets and Utility: Adam Smith

Modifying Locke's views on free markets, Adam Smith's arguments rest on utilitarian

arguments that unregulated markets and private property will produce greater benefits than any

other system. According to Smith, when private individuals are left free to seek their own

interests in free markets, they will inevitably be led to further the public welfare by an

"invisible hand:"

By directing [his] industry in such a manner as its produce may be of the greatest

value, [the individual] intends only his own gain, and he is in this, as in many other

cases, led by an invisible hand to promote an end that was no part of his intention.

By pursuing his own interest he frequently promotes that of society more effectively

than when he really intends to promote it. Free markets, according to Smith, ensure

that buyers will purchase what they need at the lowest prices they can find, and

business will correspondingly attempt to satisfy these needs at the lowest prices they

can offer. Competition forces sellers to drop their prices as low as they can and to

conserve resources while producing what consumers actually want.

Supply and demand, according to this view, will help allocate resources efficiently. When the

supply of a certain commodity is not enough to meet the demand, buyers bid the price of the

commodity upward until it rises above what Smith called the natural price (i.e., the price that

just covers the costs of producing the commodity, including the going rate of profit obtainable

in other markets). Producers of that commodity then reap profits higher than those available to

producers of other commodities. The higher profits induce producers of those other products to

switch their resources into the production of the more profitable commodity. As a result, the

shortage of that commodity disappears and its price sinks back to its natural level. Conversely,

when the supply of a commodity is greater than the quantity demanded, its price falls, inducing

its producers to switch their resources into the production of other, more profitable

commodities. The fluctuating prices of commodities in a system of competitive markets then

forces producers to allocate their resources to those industries where they are most in demand

and to withdraw resources from industries where there is a relative oversupply of commodities.

The market, in short, allocates resources so as to most efficiently meet consumer demand,

thereby promoting social utility. The best thing for government to do is nothing; the market, on

its own, will advance the public welfare, giving people what they want for the lowest possible

cost. It is important to note that, although Adam Smith did not discuss the notion of private

property at great length, it is a key assumption of his views. Before individuals can come

together in markets to sell things to each other, they must have some agreement about what

each individual "owns" and what each individual has the right to "sell" to others. Unless a

society has a system of private property that allocates its resources to individuals, that society

cannot have a free market system.

Smith's utilitarian argument is most commonly criticized for making what some call unrealistic

arguments. First, Smith assumes that no one seller can control the price of a good. Though this

may have been true at one time, today many industries are monopolized to some extent.

Second, Smith assumes that the manufacturer will pay for all the resources used to produce a

product, but when a manufacturer uses water and pollutes it without cleaning it, for example,

someone else must pay to do so. Third, Smith assumes that humans are motivated only by a

natural, self-interested desire for profit. This, say his critics, is clearly false. Many humans are

concerned for others and act to help others, constraining their own self-interest. Market

systems, say Smith's critics, make humans selfish and make us think that the profit motive is

natural.

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