COMPARATIVE
ADVANTAGE ON INTERNATIONAL TRADE
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Introduction
Most
countries maintain a liberalized external trade. Trade is as old as
civilization itself, but it is the most dynamic aspect of the economy. The
existence more trade opportunities across the world resulting from
technological aspects and availability material, has led to disparity in the
efficiency of production of good among countries. Competitive advantage
is a theory developed by David Ricardo in 1817 with an aim of explaining why
individuals, firms and nations engage in external trade. Ricardo’s theory is
about potential trade gains that rise from disparity in technological
advancement or factor of endowment (Andrea 1998, p.67). In Ricardo’s concept, a
nation or a firm can have a comparative advantage if she can produce a certain
good at a lower relative autarky price like lower marginal cost. The theory
does not put much consideration on the actual cost of production but to the opportunity
cost. Comparative advantage has been applied by most firms and nations for a
century. Although it is often related to absolute advantage, it is independent
from any other theory.
The
heckscher-ohlin theory is a variation of Ricardo’s theory was developed by Eli
huckster who was a Swedish economist. It states that a country will import
goods or services that use its abundant factors intensively and export goods
that use its scarce factors extensively. The assumption of the theory is that
two countries are equal except for differences in resources.
Comparative
advantage occurs when country A produces goods and services at a lower
opportunity cost than country B. The comparative advantage theory states that
if countries specialize in producing goods where they have a lower opportunity
cost then there will be an increase in economic welfare. On the other hand even
if one country is efficient in production of all goods (absolute advantage)
than the other, the two countries can gain by trading with each other so long
as they have different efficiencies.
How the
theory of Comparative theory forms the basis of international trade
No
country or region is going to be left out in international division of labor;
for the law states that even if a country is poor she can still trade. In this
regard, this paper further focuses on reviewing Ricardo’s theory juxtaposition
ally with Eli huckster and discuss its applicability in the modern trade fare.
Assumptions and weaknesses of Ricardian
theory
The
most dominant assumption of Ricardian theory is the assumption that two
countries produce a certain product, both countries using only labor as a
factor of production. There are significant aspects like technology and raw
materials that may have significant effect on the cost of the final products.
The theory also assumes that all nations maintain a liberalized external trade
where trade is no tightly pound by government regulation and treaties.
Countries may produce goods cheaply but the cost of trade may be way too high
to the point where goods are no longer price competitive. Governments have
favored local brands by heavily taxing imported cheaper goods. This regulation
makes the model to fail achievement of anticipated results. Ricardian model
assumes that labor is heterogynous across countries but homogenous within a
nation.
Another
assumption is that the goods here dealt in are homogenous. In today’s
industry that is driven by invention and innovation, goods have lots variation.
Ricardo’s assumption that goods can be transported freely and costless across
nations (suranovic 2013, p.98) can hold for neighboring nations but where
voyages are long across the seas, the assumption if taken cannot show a true
picture. Cost of transportation sometimes cost more than the entire cost of
production. In a classical trade situation, the cost will include exportation
expenses like transportation and custom duties.
Another
assumption is that labor and be freely relocated around the country across
industries. Product market is also assumed to be perfectly competitive in both
nations. Firms are assumed to make maximum profit while workers maximize
utility.With lengthy specialization of production of certain product, the
nations will meaningfully engage each other in trade.
Results of Ricardian model
Monetary
cost of producing goods is into considering ration. When the opportunity
cost is the base of decision making, it means that results are immediate and
specialization (maintaining production of certain product). Within a free trade,
a nation or a firm (agent) produces more that he can consumes less of good to
which he got a comparative advantage (Dixit, Avinash and Norman 1980, p.103).
Ricardo in his theory suggested that if two nations engage in business, even
when one nation has capabilities of producing all items cheaply that than
the other, the consumption exponentially goes up for the two nations
(O’sulivant Arthur 2002, p.54). In the short run, increased in consumption is
evident. The ultimate effect is specialization and economic status improvement.
Ricardo pointed out that comparative advantage is the motive behind external
trade.
If a
country receives a higher price for a comparative good, then it may want to
specialize in that particular good. This will force labor to move from the
disadvantaged industry to the comparatively advantaged industry. For that
reason one industry in a particular country has to go out of business. But then
the workers will be immediately employed in other industries.
When
opening free trade, no matter how superior one country is in technology it is
not a guarantee of continued production of a good. In that regard a country
must have a comparative advantage rather than an absolute advantage in order to
be able to assure continued production.
Comparative
advantage may survive in another country while it completely doesn’t work in
another country, even though the workers in the other country have low wages.
It implies that low wages in a particular country in a particular industry is
not enough to let us know which countries industry will perish. So free trade
may not result in industry decline simply because the firms pay their workers
lowly. In the case of the Ricardian model trade is always a win-win scenario.
Everybody benefits from free trade. From the below example;
Cost of
production (labor time)
Country
a
|
Country
b
|
Glass(1
unit) 1 hour
|
2
hours
|
phones(1
unit) 2 hours
|
6
hours
|
Comparing
the two countries, country A and B, country B is productively inefficient. Its
workers will need a lot more time to produce a unit of glass. This may result
from a number of reasons. Country A has absolute advantage in production of
both goods.
Significance
of Ricardian model in international trade
Adam
smith in his 1776 book the wealth of nations alluded the principal of
comparative advantage model. Comparative advantage model has a bigger role in
today’s international trade.
"If
a foreign country can supply us with a commodity cheaper than we ourselves can
make it, better buy it of them with some part of the produce of our own
industry employed in a way in which we have some advantage. The general
industry of the country, being always in proportion to the capital which
employs it, will not thereby be diminished ... but only left to find out the
way in which it can be employed with the greatest advantage" (Smith 1776,
p.56).
Later
in 1817 Ricardo published his theory in the book on the principles of political
economy and taxation. The theory is commonly known as comparative model theory.
International trade is guided by principles conforming to the comparative
theory and the effects of such economic engagement are specialization,
increased consumption and improvement of life standard.
Critical Analysis
With
current advancement in technology, labor is no longer a major factor of
production because machines have replaced humans. Labor forms a very small
portion of input. Without considering aspects like technology
independently may not give a true perspective of opportunity cost especially
one technologically advanced nation is compared to a third world country.
Although labor may be cheaply available in developing countries, the
introduction of machines into production of goods May create an imbalance that
give an absolute advantage to the technologically processed country.
Absolute advantage will give results that are more immediate and the
anticipated results of Ricardo’s model will be overtaken. Maximizing total
output in the world we should either, employ fully all resources, allocate the
resources to each other countries industries, and allow the allocated countries
to freely trade.
Ricardian model in contemporary world
Dynamics
in trade in today’s world and advancement in technology that affect labor, to
some extent weakness the labor base that Ricardian model is dependent on. The
assumption that goods move freely with no cost across borders of the two
nations engaging in free trade, is not a common phenomenon because governments
have their own interests including protection of their local companies and this
may translate to higher taxes to imported goods. A nation can engage in free
trade with any nation despite the industrial development of one nation.
Some
modern technology is a replacement of human labor and should therefore be put
into consideration by any model that seeks to represent the contemporary
business environment. Although most nations are engaged in a free trade,
interests of agents and governments affect the terms of engagement, and
therefore the principle of free liberalized external trade may not uniformly
hold across the two nations. Treaties signed by governments also
affect terms of engagement and keeping a pure comparative model environment is
difficult. Technological disparity has been defended by that countries do not
compete in international market. Technology increases efficiency hence high
quality and low price.
Heckcher-ohlin theorems assumption
The
critical assumption that has been translated into a weakness is thetwo
countries engaging in trade are equal in technological; and labor intensity but
different in resource endowment. This assumption hold presumed that after the World
War II, all countries will have the same technology. This is not the case in
the contemporary world and there is a big disparity in technological
advancement. The price of capital intensive products in the country with
abundant country will be lower compared to prices of goods in the other nation
and the price of goods in a labor abundant nation will be lower that goods in
capital abundant nation.
Results of Heckcher-ohlin theorems
After
the two nations open a free trade, firms will take their products to the
market. The market price will be initially higher and the end is that, the labor
intensive goods will be exported by the country with abundant labor and the
nation with abundant capital will export goods of intensive capital.
Heckcher-ohlin theorem in contemporary business
environment
Heckcher-ohlin
theorem do not contradict any economic
models and has not had a lot of criticism but in contemporary business
environment, countries with abundant capital
do not necessarily import labor intensive goods as found out by Wassily
Leontief in 1951. United States of America despite being the most capital
abundant country in the world did not import labor intensive goods but actually
exported labor intensive and imported capital intensive good (Leontief 1954, p.69). This contemporary situation
contradicts heckcher –Ohlin theory. If labor is however divided to skilled and
unskilled, the theorem becomes more reliable.
Conclusion
Ricardian
model can be easily dismissed because of its assumption; only two nations
engaging in trade, a perfectly competitive market while there are many
industries and assuming only one factor of production. The model was developed when there was no
technology that could replace human labor and the dynamics of trade and arrival
of new products make the principal inapplicable in the contemporary business
world. Today’s external trade is motivated by thing which differs from the expectation
of Ricardian model. New motive may include balance of trade and balance of
payment, fulfillment of treaties and agreement. Change of nature of goods and
purpose of businesses has made the Ricardian model inapplicable especially
where technologically advanced nations are involved.
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