The Concept And Criticism Of The Theory Of Comparative Advantage
The theory of comparative advantage has played a major role in shaping world economies and constructing current international trading relations. In 1817 David Ricardo, an English economist, introduced to the world the idea that a country producing a good or a service at a lower opportunity cost as compared to another is being more economical and efficient. According to the theory of comparative advantage, a country’s increase in economic welfare is directly proportional to its ability to specialize in producing goods with a lower opportunity cost. It is widely believed that James Mill, Ricardo’s mentor, originated the analysis and is specifically mentioned in Ricardo’s book “On the Principles of Political Economy and Taxation. ” Once a company or a country achieves comparative advantage, it attains the ability to offer the service or good at a lower price that its competitors all the while maintaining or even at times, attaining stronger sales margins. (Investopedia, 2019)
Comparative advantage gives rise to the concept of opportunity cost. Opportunity cost is the next best alternative option that is foregone while making a decision. If a company produces two goods, X and Y, and then chooses to increase the production of good X while decreasing the units of good Y, the opportunity cost is the number of units of good that will no longer be produced. For instance, a professor is better at producing educational services than the junior professor and is also more natural with his lecture skills. The professor therefore. holds an absolute advantage in both service providing and quality of education he is delivering. Suppose, the professor produces $120 per hour in regular university hour services and $25 per hour in secretarial duties. The junior professor can produce $0 in university hours and $25 in secretarial duties in an hour. Here, the role of opportunity cost is crucial. Also, to understand this better, we need to look at the concept of competitive advantage. It refers to a company, economy, country, or individual's ability to provide a stronger value to consumers as compared with its competitors. It is similar to but distinct from comparative advantage. In order to assume a competitive advantage over others in the same field or area, it's necessary to accomplish at least one of three things: the company should be the low-cost provider of its goods or services, it should offer superior goods or services than its competitors, and/or it should focus on a particular segment of the consumer pool.
David Ricardo depicted how England and Portugal both benefit by specializing and trading according to their comparative advantages. Here, Portugal produced wine at lower cost, while England was able to inexpensively manufacture cloth. Ricardo predicted that each country would eventually recognize these factors and stop attempting to make the product that was costlier to create. Of course, as time went on, England curbed its wine production, and Portugal stopped manufacturing cloth. Both countries realised the fact that it was better to trade with each other rather than producing these items in their own motherland.
A more recent and contemporary example of comparative advantage can be seen in the symbiotic relationship shared between China and USA China’s comparative advantage with the United States is in the form of cheap labour. Chinese workers produce simple consumer goods at a much lower opportunity cost. The United States’ on the other hand, are specialized and capital-intensive labour. American workers produce erudite and sophisticated goods or investment opportunities at lower opportunity costs. Specializing and trading along these lines benefit each. Also, India’s call centres are the main hub portraying the best of comparative advantage. U. S. companies buy this service because it is cheaper than locating the call centres in America. Indian call centres are in no way, better than U. S. call centres. Their workers don't always speak English very clearly or fluently but the plus point is that they provide the service cheaply enough to make the trade-off worth it. Trade protectionism doesn't work in the long run and this is the conclusion of comparative advantage. Finding measures to protect jobs from international competition by increasing taxes is just a temporary fix. , It not only hurts the nation's competitiveness but allows the country to waste resources on unsuccessful industries. It also forces consumers to pay higher prices to buy domestic goods which is absolutely not in favour of a healthy economy.
Comparative advantage has influenced the way economies work from the time when countries first started to trade with each other many centuries ago. It is all due to Globalization that countries have started this phenomenon of mutual trade which has eventually resulted in opening up of financial institutions and easy flow of capital investment across international borders. Countries and businesses are much more intervened that ever before. Rapid and efficient transportation networks have enabled the cost-effective shipment of goods across the world. The global integration of financial markets has dramatically minimised the so called barriers to international investment. Internet, on the other side is acting as an information source, allowing companies and businesspeople to share knowledge about products, production procedures and pricing in real time. In totality, these developments and evolutions improve economic output and opportunities for developed and developing nations.
Less-developed countries have benefited from globalization by leveraging their comparative advantage in labour costs. Corporations have shifted manufacturing and other labour -intensive operations to these countries to take advantage of lower labour costs. For this reason, countries such as China have seen exponential growth in their manufacturing sectors in recent decades. Countries with the lowest labour costs have a comparative advantage in basic manufacturing. Globalization has benefited developing countries by providing jobs and capital investments that would not have otherwise been available. Consequence of this has been fruitful - developing countries have been able to progress more quickly in terms of job growth, educational providence, and infrastructural progresses. Developed economies like the United States, Japan and much of Europe, have benefited from globalization in various ways. The concept of comparative advantage has provided the intellectual basis for most trade policy changes in developed nations over the past half-century. These capital- and knowledge-intensive industries, such as the professional services sector and advanced manufacturing have been their most popular areas of development. They have also benefited from low-cost manufactured components that can be used as inputs into more advanced devices. Furthermore, shoppers in advanced economies save money when they are able to grab consumer goods that cost less to others.
There are a number of areas where this theory is criticised. China is aware that it might lose its comparative advantages of low labour cost and big markets, so they are making massive investments in technology for the future to be able to handle hi tech businesses. Real comparative advantages on a country level are for example the production of grapes for making wine. It’s possible to grow grapes and make wine in Scandinavia, but it does not make sense to do it when countries like France, Spain, Italy etc. are so much better. Today, there are no real comparative advantages in business, since everything today can be derivative regarding technology. Comparative advantages should not be mistaken with establishing market barriers because of size. Knowledge is the only resource that cannot be copied. So it’s all depends on how one uses the given resource. As such, having exclusive knowledge based on experience in certain process and large scale unit manufacturing industries can be regarded as a comparative advantage like China cannot copy how to produce an Airbus airplane no matter how much it tries. So having a comparative advantage in some way does create self-satisfaction and it becomes harder to innovate because you are locked in large scale investments. Sooner or later, competitors will catch up in those fields were it makes sense to catch up.
Hence, to maximise world output we need to employ all worldwide resources, allocate those resources within countries industries to each country’s comparative advantage industries and finally, allowing all countries to trade freely further. In this way, we can raise the living standards of people despite their productive relativity disparities. As a conclusion, we can say that the theory of comparative advantage can only predict what might be the result when two countries trade but, cannot give any surety that the result shall not be altered. To use comparative advantage as a boon and not a curse, countries need highly educated policy makers and good human resource because ultimately, it all depends on the people how they wish to use the given resource.
