Look at the label on whatever you are wearing. The cotton may have been grown in one country, spun in a second, sewn in a third and sold in a fourth, and the price you paid moved a little this morning because a currency did. A Big Mac costs about 6.22 US dollars in the United States and about 9.04 dollars in Switzerland, in the Economist's July 2026 edition of its index, though it is the same sandwich made by the same company.
An economist looks at all of this and asks two questions. Why do countries trade at all, and who gains and who loses when they do? And why do prices in different currencies drift apart, and what happens when a government tries to hold its currency still? The first is trade theory. The second is international finance. Together they are the course.
The surprising result in the subject is also the oldest. In 1817 David Ricardo argued, in his Principles of Political Economy and Taxation, that two countries both gain from trade even if one is better than the other at making everything. His example was English cloth and Portuguese wine. By his figures, Portugal could make a unit of wine with 80 labour-years and a unit of cloth with 90. England needed 120 for the wine and 100 for the cloth. Portugal is better at both.
The trick is to count in opportunity cost, not hours. Every wine Portugal makes means giving up 80 ÷ 90 = 0.89 of a cloth. Every wine England makes means giving up 120 ÷ 100 = 1.2 cloths. Wine is cheaper, in what you give up, in Portugal. So Portugal should lean to wine and England to cloth, even though England is worse at both. Your lawyer may type faster than her assistant and still should not be typing. Time spent typing is time not spent on something worth more.
Each country has 1,000 labour-years and wants equal amounts of wine and cloth (a deliberately simple taste). Without trade each makes both. With trade each specialises where its opportunity cost is lower and swaps at the price you set.
Ricardo's 1817 labour figures. Portugal with trade: 12.5 wine, sells it at your price. England: 10 cloth. Each ends up consuming equal amounts of both. Try 0.70 and 1.40: outside the band one country loses and would refuse to trade.
The graduate's habit is to ask, before any claim about trade, "cheaper compared with what?" Comparative advantage is not about who is best. It is about what each side gives up.
Ricardo's model has one factor and no people. Real countries have farmers and teachers, owners and workers. When a country opens to imports of a good, the price falls to the world price. Buyers win, because the price is lower. Domestic makers lose, because they now sell at that lower price. In the standard supply-and-demand picture the gain to buyers is larger than the loss to makers, so the country as a whole is ahead. If the world price is above the home price the same logic runs the other way: makers win, buyers lose, and the total is again positive.
An illustrative market: demand is Q = 100 − P, supply is Q = P − 20, so with no trade the price is 60 and the quantity is 40. Move the world price and watch buyers' surplus (blue), makers' surplus (gold) and the net.
The line to remember is "the winners could compensate the losers and still be ahead." Could. Whether they do is politics, not the model. Trade theory is a statement about the total. The diagram is silent about whose street the factory was on, which is where the evidence in the next section starts.
China joined the World Trade Organization in December 2001, and its exports of manufactured goods surged. Economists David Autor, David Dorn and Gordon Hanson compared US local labour markets by how much of their industry competed with Chinese imports. In a 2013 paper, "The China Syndrome", they found that places more exposed had more unemployment, lower labour-force participation and lower wages, with a rise in welfare transfers. They attributed, conservatively, about one quarter of the fall in US manufacturing employment between 1990 and 2007 to Chinese import competition.
A 2016 follow-up, "The China Shock", found that adjustment was far slower than the textbook expects: wages and participation stayed depressed, and exposed workers faced more job churning and lower lifetime income. Their headline estimate is on the order of 2 million US jobs lost to Chinese imports in the years after 2000; the exact figure and its interpretation are disputed, and critics argue that the jobs lost in manufacturing alone are much smaller and that cheaper goods and new export jobs offset part of it.
| Question | What the evidence says |
|---|---|
| Did trade raise total income? | Most economists say yes: cheaper inputs and goods for everyone, and more exports for some. |
| Did everyone gain? | No. Exposed US regions lost jobs and income, and recovery was slow. |
| Is it the same everywhere? | No. A study of German labour markets (Dauth, Findeisen and Suedekum, 2014) reports net employment gains there, because German firms sold into the same new markets. |
| Where do economists disagree? | On how large the US job losses were, how much was trade versus automation, and what policy should have done. |
A tariff is a tax on an imported good. The politician's picture is that the foreign seller pays. The economist's first question is "who ends up with the higher price, and who is paid less?" That is incidence, and it does not depend on who writes the cheque. If the country is a small buyer in a big world market, the foreign seller will not cut its price, so the domestic price rises by the whole tariff. If the buyer is large, the seller may cut its pre-tax price to keep the sale, and some of the tax lands abroad.
Recent history put this to a test. In a 2019 paper on the 2018 US tariffs, Mary Amiti, Stephen Redding and David Weinstein found "complete passthrough" into US import prices: foreign sellers did not cut their prices, and US buyers bore the cost, about $1.4 billion a month of lost real income by the end of 2018. The tariffs from 2025 onward are a much larger test, and the research on them was still arriving when this was written.
Same market, world price fixed at 40. A tariff of t per unit; the pass-through is the share of it that shows up in the domestic price (100% = the foreign seller does not budge).
Net welfare = buyers' loss + makers' gain + tariff revenue. At full pass-through it is always negative (the "deadweight loss", two small triangles). With low pass-through the country can come out ahead, but that is a transfer from foreigners, it invites retaliation, and retaliation is not modelled here.
The case for tariffs that economists take seriously is narrower than the political one: a young industry that needs time to learn (the "infant industry" argument, going back to Alexander Hamilton and Friedrich List), national security, or a country large enough to push some of the cost abroad. Each has costs, and the evidence for the first is mixed.
Trade needs a price between two currencies: the exchange rate. If a given basket of goods cost the same everywhere once converted, the rate would be at purchasing power parity (PPP). The Economist's journalist Pam Woodall invented a light-hearted test in 1986: use a Big Mac as the basket. Divide the local price by the US price and you get the exchange rate at which a burger would cost the same. Compare it with the real rate and you can say a currency looks "cheap" or "dear".
Data: The Economist's Big Mac index, July 2026 edition (published on GitHub by The Economist). Positive slider = the currency strengthens. Raw index, not GDP-adjusted.
Do not take the burger too seriously. It is a thing made with local rent and local wages, so it should be cheaper in poorer countries: a Big Mac in India costs less partly because Indian wages are lower. That is why the Economist also publishes a GDP-adjusted index. The deeper lesson is that over many years exchange rates tend to drift toward PPP, but slowly and noisily, and for a few years they can sit far away.
The balance of payments is an accounting identity wearing a suit. Every transaction between a country and the rest of the world is recorded twice: what was bought or sold, and how it was paid for. So a country's current account (trade in goods and services, plus income and transfers) and its financial account (buying and selling of assets) must mirror each other. A country that buys more than it sells must pay with borrowing or by selling assets.
Stylised countries, for the identity only; the presets are not any real country's figures.
A deficit is not automatically a disease. A fast-growing country that borrows to build factories runs one for good reasons; a country that borrows to consume, or whose lenders lose their nerve, is in a different position. For scale: the US current account deficit in the second quarter of 2026 was about $246 billion, or 3.0% of GDP, per the US Bureau of Economic Analysis (release of 24 September 2026), and it has been in deficit for decades. The mirror image is that foreigners keep buying US assets.
In the early 1960s Marcus Fleming and Robert Mundell (separately) showed that a government cannot have all three of: a fixed exchange rate, free movement of capital and its own interest-rate policy. Any two, never three. It is also called the trilemma, and the reason is mechanical. Suppose you peg to the dollar and cut your interest rate below the dollar's. Savers sell your currency to earn more elsewhere, which pushes it down. To hold the peg you must spend reserves buying your own currency. Reserves are finite.
| Gives up | Keeps | Example |
|---|---|---|
| Own interest rate | Fixed rate, open capital | Eurozone members; Hong Kong, whose dollar has been linked to the US dollar since 1983 |
| Fixed rate | Own rate, open capital | US, UK, Japan, Canada (floating) |
| Open capital | Fixed rate, own rate | China, for long periods (Paul Krugman's example) |
A central bank holds its currency fixed. How long do its reserves last if it also cuts rates below the world rate? Outflow per day is assumed proportional to capital mobility × the rate gap. Invented numbers, honest logic.
Real attacks are faster than this model, because the moment traders think a devaluation is coming, selling becomes self-fulfilling.
Three real cases in one table. They are the classic stories, not the only ones.
| Case | What happened |
|---|---|
| UK, 16 Sept 1992 | Britain's pound was held inside the European exchange-rate mechanism. On "Black Wednesday" the base rate rose from 10% to 12% in the morning, a rise to 15% was promised the same day, yet selling continued, and by evening the UK left the system. The rate returned to 10% the next day. The Treasury later estimated the cost at about £3.3 billion; George Soros made over £1 billion on the other side. |
| Thailand, 2 July 1997 | The baht had been fixed at about 25 to the US dollar. Without the reserves to defend it, Thailand floated it. It fell by more than half, to a low of 56 per dollar in January 1998, and the crisis spread across East Asia. The IMF announced a rescue package of more than $17 billion in August 1997. |
| Argentina, 2001-02 | A one-peso-to-one-dollar link with open capital flows (Krugman's example in 1999) was abandoned in January 2002, in the middle of a deep recession. |
The pattern: a peg is a promise to spend reserves to keep a price. It is credible as long as reserves look large next to what could flee, and it fails fast once people stop believing it. Not every float is calm either. The point is not that pegs are bad or floats are good. It is that you have to pick which of the three you give up.
Trade is gainful because countries differ in what they give up to make things, so everyone can be better off, but only on average and only if someone is willing to pay the losers. Currencies add a second lesson: a government can fix the exchange rate, keep money flowing freely, or run its own interest rate, and must give up one. Cheap imports, a strong currency and a trade deficit are three views of the same set of accounts.
Try this: pick one item you bought this week and find where it was made. Ask who in that country gained from the sale, and who in yours gained or lost from its being made there.
Sources. Ricardo's cloth-and-wine figures (80/90 and 120/100 labour-years) are the standard textbook version of Principles (1817), chapter 7. Autor, Dorn and Hanson, "The China Syndrome" (NBER w18054; quote: "conservatively, it explains one-quarter of the contemporaneous aggregate decline in US manufacturing employment", 1990-2007) and "The China Shock" (NBER w21906, January 2016). Amiti, Redding and Weinstein, "The Impact of the 2018 Trade War on U.S. Prices and Welfare" (NBER w25672, March 2019). The German comparison is Dauth, Findeisen and Suedekum, Journal of the European Economic Association (2014); this piece relies on the paper's stated focus on "employment effects and net gains". Big Mac data: The Economist's published index (github.com/TheEconomist/big-mac-data), July 2026 edition; origin credited to Pam Woodall, 1986. Balance of payments: US BEA release of 24 September 2026. Trilemma: Fleming (1962) and Mundell (1960-63); Krugman's examples of China, Britain, Canada and Argentina. Black Wednesday and Thai baht details from the standard accounts summarised on Wikipedia (Treasury cost estimate £3.3 billion revised 2005; Soros over £1 billion; baht low of 56 in January 1998; IMF package above $17 billion, 11 August 1997). Every interactive number was computed in node: for example, Ricardo's no-trade consumption is 5.88 (Portugal) and 4.55 (England) of each good, and the break-even prices are 0.889 and 1.2; with the world price at 40 the market gains 400 in total (buyers +1,000, makers -600); a 10-unit tariff with full pass-through costs buyers 550, gives makers 250, raises 200 and loses 100 net.