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Specialisation and trade

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Specialisation is when we concentrate on a product or task. Specialisation happens at all levels:

  • The specialization of tasks within extended families in many of the world’s poorest countries
  • Within businesses and organizations
  • In a country – Bangladesh is a major producer and exporter of textiles; Norway is a leading oil exporter. And Ghana is one of the biggest producers of cocoa in the world.
  • In a region of a country – for many years the West Midlands has been a centre for motor car assembly, there has been huge investment in recent years in the Mini plant at Oxford

What are the possible gains from specialization?

By concentrating on what people and businesses do best rather than relying on self sufficiency:

  • Higher output: Total production of goods and services is raised and quality can be improved
  • Variety; Consumers have access to a greater variety of higher quality products
  • A bigger market: Specialisation and global trade increase the size of the market offering opportunities for economies of scale
  • Competition and lower prices: Increased competition acts as an incentive to minimise costs, keep prices down and therefore maintains low inflation

The Division of Labour

The division of labour occurs where production is broken down into many separate tasks. Division of labour raises output per person as people become proficient through constant repetition of a task – “learning by doing”. This gain in productivity helps to lower cost per unit and ought to lead to lower prices for consumers.

Division of labour

Limitations of division of labour

Labour in China
Workers hand-assembling kettles and irons in a factory in China

  1. Unrewarding, repetitive work that requires little skill lowers motivation and hits productivity. Workers begin to take less pride in their work and quality suffers. We often see dissatisfied workers becoming less punctual at work and the rate of absenteeism increases.
  1. Many people may choose to move to less boring jobs creating a problem of high worker turnover for businesses. In 2010, the overall employee turnover rate for the UK was 13.5% per year, nearly one worker in seven changes jobs each year. The highest labour turnover is found in retailing, hotels, catering and leisure, call centres and among other lower paid private sector services groups
  1. Some workers receive little training and may not be able to find alternative jobs if they find themselves out of work - they may then suffer structural unemployment.
  1. Another disadvantage is that mass-produced standardized goods tend to lack variety for consumers

Comparative advantage and the gains from specialisation and trade

First introduced by David Ricardo in 1817, comparative advantage exists when a country has a ‘margin of superiority’ in the supply of a product i.e. the cost of production is lower.

Countries will usually specialise in and export products, which use intensively the factors inputs, which they are most abundantly endowed. For example the Canadian economy which is rich in low cost land is able to exploit this by specializing in agricultural production. The dynamic Asian economies including

China has focused their resources in exporting low-cost manufactured goods which take advantage of much lower labour costs. This is now changing as China looks to move from a middle-income country by specializing in industries that use higher levels of knowledge and technology.

In highly developed countries, the comparative advantage is shifting towards specializing in producing and then exporting high-value and high-technology manufactured goods and high-knowledge services.

The PPF and the effects of specialisation

PPF and the effects of specialisation

Two countries are producing two products (X and Y). With a given amount of resources:

 

Output of X

Output of Y

Country A

180

90

Country B

200

150

In this example, country B has an absolute advantage in both products. Absolute advantage occurs when a country or region can create more of a product with the same factor inputs. But Country A has a comparative advantage in the production of good X. It is 9/10ths as efficient at producing good X but it is only 3/5ths as efficient at producing good Y.

Comparative advantage exists when a country has lower opportunity cost, i.e., it gives up less of one product to obtain more of another product. In our example above, for country A, every extra unit of good Y produced involves an opportunity cost of 2 unit of good X. For country B, an additional unit of good Y involves a sacrifice of only 4.3 units of good X.

There are gains to be had from country A specializing in the supply of good X and country B allocating more of their resources into the production of good Y.

Another example of comparative advantage

Consider two countries producing two products – digital cameras and vacuum cleaners.

Pre-specialisation

Digital Cameras

Vacuum Cleaners

UK

600

600

United States

2400

1000

Total

3000

1600

Were the UK to shift more resources into higher output of vacuum cleaners, the opportunity cost of each cleaner is one digital television. For the United States the same decision has an opportunity cost of 2.4 digital cameras. Therefore, the UK has a comparative advantage in vacuum cleaners.

If the UK chose to reallocate resources to digital cameras the opportunity cost of one extra camera is still one vacuum cleaner. But for the United States the opportunity cost is only 5/12ths of a vacuum cleaner. Thus the United States has a comparative advantage in producing digital cameras.

 

Digital Cameras

Vacuum Cleaners

UK

0 (-600)

1200 (+600)

United States

3360 (+960)

600 (-400)

Total

3000
3360

1600
1800

  • The UK specializes totally in producing vacuum cleaners – doubling its output to 1200.
  • The United States partly specializes in digital cameras increasing output by 960 having given up 400 units of vacuum cleaners.
  • Output of both products has increased - representing a gain in economic welfare.

For mutually beneficial trade to take place, the two nations have to agree an acceptable rate of exchange of one product for another. There are gains from trade between the two countries. If the two countries trade at a rate of exchange of 2 digital cameras for one vacuum cleaner, the post-trade position will be as follows:

  • The UK exports 420 vacuum cleaners to the USA and receives 840 digital cameras
  • The USA exports 840 digital cameras and imports 420 vacuum cleaners

 

Digital Cameras

Vacuum Cleaners

UK

840

780

United States

2520

1020

Total

3360

1800

Compared with the pre-specialisation output levels, consumers in both countries now have an increased supply of both goods to choose from.

We have seen in this chapter how specialisation and trade based on the idea of comparative advantage can lead to an improvement in welfare.





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