development models - comparative advantage
Introduction
International trade is the exchange of goods and services between countries. Trade improves consumer choice and total welfare.
Different countries have different factor endowments eg climate, skilled labour force, and natural resources vary between nations. Therefore some countries are better placed in the production of certain goods than others.
Economic theory predicts all countries gain if they specialise and trade the goods in which they have a comparative advantage. This is true even if one nation has an absolute advantage over another country.
The Role of International Trade
International trade allows increased specialisation so that higher output allows economies of scale:
- A larger market allows domestic producers greater scope for economies of scale. Without trade the domestic market only allows Q1 output. Access to overseas markets means Q2 output at lowest unit cost
- International competition stimulates competition. Domestic firms strive to become ‘world class’, adapting modern technology, product and process innovations that reduce unit costs.
Absolute advantage occurs when a country or region can create more of a product with the same factor inputs.
Comparative advantage exists when a country has lower opportunity cost in the production of a good or service
Comparative advantage is used to justify free trade and oppose protectionism. Comparative advantage is based on differing opportunity costs reflecting the different factor endowments of the countries involved. The theory assumes free trade, willingness to specialise and factor mobility. Specialisation and trade benefits countries providing at an exchange rate between the respective opportunity cost ratios.
Countries benefit if they specialise in the production of a good or service in which they have a comparative advantage ie a lower internal opportunity cost
Limits of Comparative Advantage in Development Economics
LDC's tend to specialise in products based on intensive labour and/or land. The law of comparative advantage demonstrate their standards of living rise and factor rewards increased given appropriate exchange rates.
However many LDC's remain poor despite extensive specialisation and trade is not operating to even out disparities.
Overspecialisation in the primary sector has made LDC's susceptible to the problems of those industries. Barriers to trade (EU tariffs), unequal bargaining strength, high transport costs, and an inability or unwillingness to specialise have reduced the potential gains from specialisation and trade.
Comparative advantage is a dynamic concept. A country can lose or acquire comparative advantage overtime if there is a change in relative efficiency as measured by opportunity cost ratios.
For example in the immediate aftermath of World War 2 economists advised Japan to specialise in the production of rice. Japan ignored the expert advice. Extensive investment, technical expertise and a skilled labour force saw Japan acquire a comparative advantage in the production of cars and electronics.
Comparative advantage can be gained or improved through:
·
Investment in education and training
·
Investment in infrastructure,
·
Research & development to improve competitiveness ie lower unit costs,
better product design, and reliability
·
Lower inflation rates than competitors
Comparative advantage in the production of lower valued added textiles has shifted away from DC's to LDC economies where unit labour costs are lower. Eg Dr Martens boots are moving production to China with the loss of more than 1,000 UK jobs
International trade requires extensive specialisation. This can have drawbacks including:
- Strategic issues: countries become dependent on imports of essentials from other countries. A dispute in one country can halt production in another
- Foreign producers may engage in dumping ie selling output below average cost as part of a predatory pricing or contribution pricing strategy. Such practices are against WTO rules. The Haitian rice industry was put out of business by dumped overproduction from the US, courtesy of massive subsidies.
- Infant industries argument Sunrise industries may not be able to become established if faced with competitors from foreign companies with lower costs due to greater economies of scale.
- A country may experience the disadvantage of overspecialisation, including diseconomies of scale,
- Vulnerability to sudden changes in demand. All products have a life cycle. Where a country has specialised in a product consumers no longer want, structural unemployment follows.
tutor2u is the leading global publisher of e-learning resources for Economics, Business, Politics, Enterprise, Law, Sociology, Religious Studies and related subjects. Our materials are used by over 3,500 schools and colleges in the UK and in educational institutions in over 85 other countries. tutor2u offers a range of free and subscription-based materials - designed to support teachers and inspire students. The business also runs a popular series of student revision workshops and teacher conferences. tutor2u was named Online Learning Resource of the Year at the prestigious BETT Show - the World's leading educational show.
|
Privacy & terms of Use |
Contact us |
Teacher Newsletters & Subject Blogs |
