Comparative advantage

A comparative cost advantage ( from Latin: comparare = compare ) is in the context of economic theory, if a country, a region, a company or a person is able to produce a particular good at a lower opportunity cost ( opportunity cost ) than the competition.

The core idea

The theory of comparative advantage states that the advantages of trade between two countries does not depend on the absolute cost of production, but to each other on the relative costs of goods produced. In principle, therefore, the trade between two countries is always advantageous if both trading partners different production cost structures exist, that is, if the will be without a country for a good produced on fewer units of another good than the other country (lower opportunity cost ). In this case, each country should specialize in the good that it can be relative ( comparative ) cheaper to produce. Thus, according to the theory of international trade and international division of labor even for those countries an advantage that can produce all goods at lower costs than abroad. In reality, this can be applied particularly on trade relations between high and low industrialized countries. The Ricardian theory generally includes a call for a world free trade based on their comparative advantage to the benefit of specialization is in the States of all.

It should be noted that nothing is said about the distribution of commercial gain or the effects of specialization.

Historical classification

The theory of comparative advantage goes back to David Ricardo, a representative of classical political economy. In his main work "On the Principles of Political Economy and Taxation ", which appeared in 1817 and in 1821 expanded and revised in its third edition, Ricardo sat particularly in the 7th chapter " foreign commerce " with the favorability of foreign trade apart. Following Adam Smith's approach to the international division of labor that constitutes the trade between two countries with their absolute differences in production costs, extended Ricardo 's theory to the effect that specialization even then it is advantageous if a country has in all sectors of the higher labor productivity.

Historical Background for Ricardo's theory was the lifting of the Continental Blockade against Britain by the Congress of Vienna in 1815, but which do not correspond to the interests of the British government in all respects. This intended namely to limit the imports to necessary raw materials and to promote exports to other countries. Therefore, high protective tariffs were introduced in order to protect the domestic economy from foreign imports ( " protective policy "). This limited especially the import of agricultural products such as wheat. Thereby, the grain price was artificially high. This mainly benefited the landowners who possessed particularly fertile soil and served ( as Ricardo ), less the protection of the British economy. Because of the advent of industrialization and the high population growth in England, he held a specialization in agricultural products as inefficient. Against this historical background Ricardo published his theory of comparative advantage to show that the mercantilist trade protectionism, contrary to the opinion of the Government, the local economy does not protect, but only the consumption possibilities of Britain limited, which could maximize the free trade.

Economic classification

Ricardo's model of comparative advantage provides the theoretical basis for the explanation of foreign trade between economies, even if one of them absolute advantage in the production of all goods has. It is a simple and basic presentation of the favorability of free trade for all nations involved.

A country can achieve gains from trade even if it is ineffective in producing both goods than the other. Each country should specialize in the good that it can be relatively ( comparatively ) cheaper to produce. Trade between two countries is always beneficial when a country has to do without for a produced commodity on fewer units of another good than the other country (lower opportunity cost ).

Applications

The Ricardian model

The Ricardian model explains the emergence of foreign trade between two countries. Here, the foreign trade is attributed solely to the different labor productivities in the participating countries. Will result in different opportunity costs. The main assumption is that labor is the only factor of production. In the simplest case, comparative price advantages to comparative cost advantages are returned.

The Heckscher -Ohlin Model

The Heckscher- Ohlin theorem is a model of an economy with two factors of production. These can be, for example labor and capital. They differ in their factor intensity. It will therefore specialize economies with relatively large amount of capital in capital-intensive products; States with relatively many workers will specialize in labor-intensive products. Each country exports the good in whose production the relatively abundant factor of production used intensively.

The Leontief model

The Leontief paradox is an analysis of flows of goods and services between the producing and consuming sectors of an economy based in a given period. It combines "economic facts and economic theory " to each other by representing the entire economy into a single matrix ( input-output analysis). The input-output analysis provides the framework for an exact description of the economic structure and allows predictions about the effects of economic policy interventions in this structure.

Returns to scale

Two countries also operate foreign trade with each other to exploit economies of scale ( "economies of scale "). Most accept returns to scale with increasing production volume to; therefore it does not assume constant returns to scale. This means that the doubling of the use of factor production volume more than doubled. In this case, larger companies are usually at an advantage over smaller; therefore adopts this model is that there is a Monopolistic competition between producers. Since both countries produce different goods ( " differentiated products "), a trade between them is possible.

Comparative Advantage with several estates

So far, a simplified model will be produced and consumed in the only two goods represented. In reality, countries trade with many goods. This makes but little difference to the simplified model considered above. Each country specializes in the production of goods in which it has the lowest opportunity cost and therefore a comparative advantage. The only difference is that the relative wages must be determined directly from the relative demand for labor. In the simplified model we have determined the relative wages based on the relative demand for goods.

Example, using the model of Ricardo

Consider a model with only two countries with two products: France and Turkey. France has 10 bread bakers, each of which can produce 20 loaves per day. The ten French fishermen can catch each 20 fish per day. Turkey has 30 bread bakers and anyone can make 4 loaves per day. In addition, there are 10 fishermen that catch of 12 fish per day. If now the two countries specialize in, where their productivity advantage is greatest and where their productivity disadvantage is lowest, they can add up to produce more with an exchange (trade ). And, although France is more productive in both areas: the French fishermen are more effective performance by 67 % than the Turkish, but in bread baking, they are five times as productive ( effective performance by 400 %). This means that the comparative advantage of the French baking bread is and the Turks while fishing. Therefore, both together make an overall increase in production by swapping a part of the goods produced by them with the trading partner (whether by means of barter ( goods for goods ) or by money). For the French fishermen must begin to bake bread, and the Turkish baker need to go fishing.

Of course there are far more than two countries and two goods. In reality, act 150 countries with millions of different goods and services. The commercial possibilities are enormous at the present time. Thus, a country can import something from another without there having to directly export something; it creates a cycle; see figure on the right " Multilateral Trade". In order to achieve better results, it takes many different trading participants. Multilateral trade agreements are essential in today's world to efficiently use the respective resources.

Barriers to comparative advantage

The comparative advantages of a country are hampered by so-called barriers to trade and / or limited. High transport costs are a barrier to trade, if they more than offset the cost advantage. Other barriers or barriers resulting from policies of a government. You can be aimed at limiting the bilateral or international trade and / or to other targets. They all work on the same principle: data are collected types of costs that increase the price of a traded good.

When trade barriers following variants are possible:

• Tariff barriers ( tariff policy ): Safeguard duty and anti-dumping duty to protect domestic production against the favorable foreign production. The tariff of the interior increases the prices of goods of cheap, imported goods from abroad. This makes the domestically produced products relatively cheap; they can recover a cost advantage.

In recent years, many tariffs were replaced by non -tariff barriers to trade.

• Non -tariff barriers: This term refers to the quantitative restrictions on trade and the requirements for the imported goods.
• These goods flows directly influencing government policies (eg registration formalities for import, technical quality requirements for products ) as well as the measures that affect trade flows without commercial motives (eg environmental product standards ) to count.
• Furthermore, the domestic industry is protected by specific subsidies and import quotas (quantitative import restrictions ). These are implemented by the State and are not under the control of the GATT or the WTO.
• Voluntary restraint agreements, to be understood as voluntary export restraint, is a special form of the quota (eg, quantity or value restriction, even fixing a minimum price for export goods ), which is best applied to the elimination of foreign competition pressure.
• In the monetary field, while the depreciation of the domestic currency ( exchange rate protectionism ) because of differences in the monetary system has a meaning.
• Moreover, the differences in culture, living environment and law affect the comparative advantage of an economy.

Critical review

The comparative cost advantage can only lead to an international division of labor and welfare gains if the free trade is allowed. Due to International regulations such as the WTO ( World Trade Organization), through TRIPS and GATS (General Agreement on Trade in Services ), an attempt to prevent barriers to trade. 1980 subsidies were, for example, prohibited by the GATT rules, yet there is the subsidy practice.

In political discussions is always advised that you have to protect the domestic economy, particularly jobs, " cheap goods " and related foreign low wages (see also exploitation ).

Arguments for free trade from a politico - economic perspective

• Free trade is efficient
• The ability to export promotes the innovative power of the company and leads to further gains, for example, through economies of scale. The theoretical justification for the profitability is based on the cost-benefit analysis.

Arguments against free trade from a politico - economic perspective:

• However, the comparative advantage ( free trade ) can also be to the detriment of economically weaker countries. For example, if a large country ( in economic terms ) a duty (import duty ) introduced for a particular good, the world price of this good is greatly reduced and the domestic can buy the goods cheaper than in the previous free trade state. Thus, the terms-of- trade effect can increase the welfare of the interior. In a small country whose demand has no influence on the world market, according to the customs collection in the world market price of the imported goods remains constant. This consideration is based on the theory of optimal tariff.

• Subsidies may pose serious consequences for free trade. Although subsidies to protect domestic workers, but distort competition, since the non-subsidized companies at a disadvantage. Subsidies cripple the performance and innovation and impede the progress and structural change. Export subsidies also complicate possible opportunities for prosperity worldwide.

• Ricardo's statement about the relative merits of improved Smith, who said, absolute cost advantages determine external trade. Historically, the exchange English cotton cloth against Portuguese wine - Ricardo's example - a colonial relationship, as England Portugal before protected, to be conquered by Spain. British weapons also helped Latin American landowners to get rid of Spanish rule, and free from and to England to import and export. Adam Smith and others observed that larger markets reduce the cost of industrial products, as they deepen the division of labor. The landowners thus won over the falling prices of industrial products and the growing British demand for their raw materials. But the falling prices of English industrial products worldwide ruined the traditional industry and made England the workshop of the world. This gave the unions - were legalized since 1867 - a bargaining power that agricultural workers can never reach. The prices of exported industrial goods now included the high wages of industrial workers, while the imported raw materials often only covering Subsistenzlöhne. The former dynamic change in the exchange rates of raw materials for industrial products was turned upside down and it developed underdevelopment.

Samuelson's appreciation of the theory of comparative advantage

Stanislaw Ulam, mathematician and co-inventor of the hydrogen bomb used to tease Samuelson: " ' Give me a determination of the social sciences which is both true and non- trivial '. That was the test I [ Samuelson ] never existed. But now, some thirty years later ... reminds me a suitable answer: Ricardo's theory of comparative advantage. That ... it is logically true, you need a mathematician not to tell; that it is non- trivial witness the thousands of important and significant people who were never able to comprehend this doctrine itself, or to believe, after it was explained to them. "