Does Trade Always Follow Comparative Advantage?

Introduction

Comparative advantageas a justification for free trade has seen a alteration in position. Until late, it was the lone footing on which economic experts studied trade. However, alterations in the universe economic system and engineering have led to events that make the theory appear weak and irrelevant. This paper shall analyze the strengths and failings of comparative advantage.

Cardinal to the theory of free trade based on comparative advantage is that there are intrinsic differences in the states ‘ resource gifts. While there are legion strengths of this theory in explicating and assisting us understand trade forms, the premier justification for free trade based on comparative advantage is that it leads to efficient allotment of resources, lifting incomes, and betterment in the life criterions among all trading spouses.

Another strength of the theory is that it allows states to use and work their natural wealth and abundant resources. So, states with long shorelines that are filled with marine life have a comparative advantage in bring forthing sea nutrient while those with mines rich with minerals gain from exporting ores and chemicals.

This theory besides helps explicate the majority of the trade that takes topographic point between advanced Western states and the less developed universe. Given the blunt differences in the resource structures among the two groups – the West with advanced engineering and highly-skilled workers export and the less developed states with traditional agribusiness and cheap unskilled labour – it is easy to understand why the former export sophisticated equipment and capital goods to the latter, who, in bend, export agricultural merchandises and inexpensive manufactured goods. This sort of trade – affecting goods produced by really different industries – is called ‘inter-industry trade. ‘

The past two decennaries have seen the outgrowth of new trade theories that have undermined the domination of comparative advantage as the principle for free trade. In add-on, alterations in engineering and in the economic environment have exposed certain failings in the traditional trade theoretical account and given rise to the demand for alterations. As a consequence there are new justifications for free international trade that make the original comparative advantage theory appear instead simple and with limited relevancy.

One major failing of the comparative advantage theoretical account is that it can non explicate as to why a lifting fraction of universe trade is taking topographic point among Western developed states. Given that such states ( e.g. Western European spouses of the EU ) have really similar engineerings and resource constructions, the justification for trade has to be something other than comparative advantage. The majority of this trade is of the ‘intra-industry ‘ assortment, i.e. states export and import similar merchandises. There are factors related to demand and supply that cause intra-industry trade. On the demand side, for illustration, consumers in the U.S. might wish to purchase luxury autos from Europe while purchasers in the latter import cheaper autos from the former. On the supply-side, certain sorts of capital-intensive industrial engineering is such that as end product rises the mean costs, and, therefore, monetary values, autumn due to economic systems of graduated table. As a consequence, European houses that produce larger measures of luxury autos like Mercedes have relatively lower costs and monetary values doing them more attractive to purchasers in, say, U.S.

Another trade form thatcomparative advantagefails to warrant is the turning intra-industry trade that takes topographic point between developed states and less developed states. This phenomenon is due to ‘fragmentation ‘ of the fabrication procedure whereby parts of manufactured points like cars that need labor-intensive production or assembly are made in labor-rich states and exported to capital-rich states where the merchandise is completed. Even though the trading states have really different resource constructions, unlike in comparative advantage, such trade involves the flow of goods within the same or related industries. A good illustration of such trade is within NAFTA whereby the more complicated car constituents necessitating advanced engineering are produced in the U.S and exported to Mexico where the fabrication of little parts and assembly of the units takes topographic point and the concluding merchandise is shipped back to the U.S.

There are other grounds for failing in the theory. The traditional theory of comparative advantage assumes important differences in states ‘ natural gifts and available resource bases. However, new thought is that authorities intercession can be used to get the better of what might be called natural disadvantages by constructing comparative advantages in technologically sophisticated economic activities related or unrelated to their natural resource wealth. [ 2, p.2, Ch. 1 ] This means that authoritiess can pass money to import engineering and make modern fabrication ability through investing even though a state did non possess these abilities. As the World Bank suggests, this manner a state can get comparative advantage. A all right illustration is how India has managed to get a comparative advantage in IT because of immense investings in instruction and engineering. Besides, the comparative advantage theory fails to admit transit costs.

Critics of comparative advantage have focused on some of the unsought results of free trade and on the theoretical defects discussed above.

The cardinal unfavorable judgment against free trade is that poorer and less developed states are truly at a disadvantage if they export goods in which they have a comparative advantage. Typically, less developed states with hapless instruction, trust on traditional agribusiness, and deficiency of modern engineering are restricted to the export of agricultural merchandises, minerals, and low-end manufactured goods that require labour-intensive methods of production. Critics say that for such states poverty is their comparative advantage and that exporting based on comparative advantage does non take to betterment in life criterions and, in fact, causes a turning spread relation to the developed universe and prevents them from acquiring developed.

For one, the demand for the kind of goods that poorer states is instead limited in the developed universe ( e.g. nutrient merchandises ) and even if they try to export more, it leads to falling monetary values and hence lower incomes. Second, the low-wage type of fabrication activity does non ensue in betterment in engineering or cognition and it merely benefits the consumers in the richer states. The World Bank and others have stated that dependance on low-cost exports merely gives rise to low-wage occupations that do non assist in raising life criterions.

With these issues in head, critics have strongly rejected free trade based on comparative advantage. As mentioned by the World Bank, states must seek to hammer new countries of comparative advantage by concentrating on instruction and knowledge-intensive industries like IT. Clearly the intrinsic comparative advantage that the states possess is considered damaging. It is because of this that developing states are encouraged to set up industrial zones by investing in advanced engineering and industry of high value-added goods. The kind of goods that should be produced must be those that have a demand that rises as people ‘s incomes rise ; this manner the manufacturers do non confront the kind of jobs faced by exporters of primary goods.

It is clear that the manner comparative advantage is defined has changed. Whereas it used to be that comparative advantage was considered ‘God-given ‘ but new thought is that it can be created. Furthermore, non all trade forms can be explained by this old theory and alternate theories and policies must besides be considered.

Mentions

Blytt, Erik ( 2002 ) : Can Poverty be a Comparative Advantage? A survey of export schemes based on low labor costs: The instance of Zimbabwe, Thesis submitted in partial fulfilment

of the Cand. Polit. grade in Human Geography, Department of Sociology and Human Geography, University of Oslo.

This clearly implies that if two states have indistinguishable resource bases, none will hold a comparative advantage in any good and hence there would be no justification for trade between them.