Comparative Advantage: Increased Efficiency of Trading Globally

Comparative Advantage: Increased Efficiency of Trading
Globally
Global trade, in theory, allows wealthy countries to use their resources—whether labor,
technology, or capital— more efficiently. Because countries are endowed with different
assets and natural resources (land, labor, capital, and technology), some countries may
produce the same good more efficiently and therefore sell it more cheaply than other
countries. If a country cannot efficiently produce an item, it can obtain the item by
trading with another country that can. This is known as specialization in international
trade.
Let's take a simple example. Country A and Country B both produce cotton sweaters and
wine. Country A produces ten sweaters and ten bottles of wine a year while Country B
also produces ten sweaters and ten bottles of wine a year. Both can produce a total of 20
units without trading. Country A, however, takes two hours to produce the ten sweaters
and one hour to produce the ten bottles of wine (total of three hours). Country B, on the
other hand, takes one hour to produce ten sweaters and one hour to produce ten bottles of
wine (a total of two hours).
But these two countries realize by examining the situation that they could produce more,
in total, with the same amount of resources (hours) by focusing on those products with
which they have a comparative advantage. Country A then begins to produce only wine,
and Country B produces only cotton sweaters. Country A, by specializing in wine, can
produce 30 bottles of wine with its 3 hours of resources at the same rate of production per
hour of resource used (10 bottles per hour) before specialization. Country B, by
specializing in sweaters, can produce 20 sweaters with its 2 hours of resources at the
same rate of production per hour (10 sweaters per hour) before specialization. Total
output of both countries is now the same as before in terms of sweaters—20—but they
are making 10 bottles of wine more than if they did not specialize. This is the gain from
specialization that can result from trading. Country A can send 15 bottles of wine to
Country B for 10 sweaters and then each country is better off—10 sweaters and 15
bottles of wine each compared with 10 sweaters and 10 bottles of wine before trading.
Note that, in the example above, Country B could produce wine more efficiently than
Country A (less time) and sweaters as efficiently. This is called an absolute advantage in
wine production and at an equal cost in terms of sweaters. Country B may have these
advantages because of a higher level of technology. However, as the example shows
Country B can still benefit from specialization and trading with Country A.
The law of comparative advantage is popularly attributed to English political

economist David Ricardo and his book On the Principles of Political Economy and
Taxation in 1817, although it is likely that Ricardo's mentor James Mill originated the
analysis. David Ricardo famously showed how England and Portugal both benefit by
specializing and trading according to their comparative advantages. In this case, Portugal
was able to make wine at a low cost, while England was able to manufacture cloth
cheaply. Indeed, both countries had seen that it was to their advantage to stop their efforts
at producing these items at home and, instead, to trade with each other to acquire them.
A contemporary example: China’s comparative advantage with the United States is in the
form of cheap labor. Chinese workers produce simple consumer goods at a much lower
opportunity cost. The United States’ comparative advantage is in specialized, capital-
intensive labor. American workers produce sophisticated goods or investment
opportunities at lower opportunity costs. Specializing and trading along these lines
benefit each.
The theory of comparative advantage helps to explain why protectionism is typically

unsuccessful. Adherents to this analytical approach believe that countries engaged in
international trade will have already worked toward finding partners with comparative
advantages. If a country removes itself from an international trade agreement, if a
government imposes tariffs, and so on, it may produce a local benefit in the form of new
jobs and industry. However, this is not a long-term solution to a trade problem.
Eventually, that country will be at a disadvantage relative to its neighbors: countries that
were already better able to produce these items at a lower opportunity cost.

Comparative Advantage: Increased Efficiency of Trading Globally

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Comparative Advantage: Increased Efficiency of Trading Globally

Uploaded by

Copyright:

Available Formats

Comparative Advantage: Increased Efficiency of Trading

The law of comparative advantage is popularly attributed to English political

The theory of comparative advantage helps to explain why protectionism is typically

You might also like