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The Law of Comparative Advantages in International Trade

International Trade

According to economists, one concept allows citizens to enjoy today’s high living standards. The concept – comparative advantage – involves trading goods, but does not necessarily rely on cost efficiency. Instead, comparative advantage focuses on which manufacturer produces goods with the least opportunity cost. This occurs when a producer possesses ample natural resources or a superior supply chain. The concept is complex in its simplified form and even more so in practice. Despite this complexity, nations such as the United States enjoy excellent living standards by using comparative advantage in international trade.

Understanding Comparative Advantage

In economic theory, comparative advantage is an enterprise’s ability to produce goods or services with less opportunity cost – or benefits lost by expending resources to produce one good compared to another. [1] The theory suggests that by conducting trade economies benefit from reduced production costs and better goods and services. This principle forms the basis for international trade.

In modern society, comparative advantage items are more likely goods rather than services. However, some nations do possess a comparative advantage in services.

While it seems effective for a nation capable of producing a good in the highest volume and quantity to do so, this is not necessarily the most beneficial practice for the global economy. The world, after all, has a limited supply of resources. By producing comparative advantage goods, nations supply society’s demands and allocate resources in the most efficient way possible.

Many historians credit economist David Ricardo for developing comparative advantage theory. [2] When he devised the theory, his goal was to overcome trade restrictions on England wheat. Throughout time, as forecast by Ricardo, nations have ceased manufacturing goods in favor of trade because of this concept.

Comparative Advantage in the Real World

As an example, some nations possess a comparative advantage in chemicals because they produce oil. [3] Vast natural oil stores allow the nations to acquire and refine oil easily compared to other producers. The opportunity cost for these nations to produce chemicals is low, because the good evolves incidentally during oil distillation. Resultantly, regions such as Mexico, Saudi Arabia and Kuwait are well-known chemical suppliers, which have grown economically by focusing production on a good in which they have a comparative advantage.
While many citizens prefer their own nations to produce and manufacture goods, this ideal is not a long-term solution. Trade restrictions temporarily boost local economies, but those economies waste resources by producing goods inefficiently. Eventually, citizens in self-sustaining economies pay more for inferior goods.

How Global Cooperation Improves Living Standards

The Adam Smith Institute is the third highest ranked domestic policy think tank in the world. [4] A Forbes piece penned by institute fellow Adam Smith opines that despite the increased complexity presented by comparative advantage in real-world application, the concept proves that any trade is better than no trade. This does not diminish the fact that varying trade levels produce different results, but unlike the simplified example presented by Ricardo, comparative advantage in the real world is a subtle endeavor.

When seeking international trade efficiency, states Smith, nations must determine what goods they can produce proficiently before participating in the international market. This is counter intuitive to simply seeking cost saving trade deals first. To this end, major manufacturers must weigh their strengths and weakness to discover what goods they are the most efficient at producing. Finally, Smith explains, consumers will gain more advantages over time.

The Argument for Comparative Advantage

An important aspect of Ricardo’s theory is that because a nation pays lower wages or produces all goods more efficiently does not mean it will not benefit from international trade. [5] If all nations produce goods in which they possess comparative advantages total yield will increase, but resource expenditures will remain constant. This kind of cooperation can foster a trade environment envisioned by economists for some time. All nations would benefit from good surpluses. As a result, the global community will experience a better quality of life and enhanced economic efficiency.

Comparative Advantage in the United States

The United States enjoys a comparative advantage – with its large mass, ocean lined coasts, fresh water reserves and fertile land – as well as an established, authoritative legal system and a diverse population. [3] America also possesses relatively inexpensive natural resources, political security and a healthy research and development market and as a result leads the world in industries such as aerospace, defense and banking.

Although the United States is no longer the world’s largest economy, it is the strongest economic power on the globe. In 2014, the US produced around $17.5 trillion in goods, which was almost 20-percent of an estimated $107.5 trillion in global production. To put this in perspective, most countries have the gross domestic product (GDP) of one state in the United States. As a result, American citizens enjoy one of the highest standards of living in the world.

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Sources:
[1] http://www.investopedia.com/terms/c/comparativeadvantage.asp
[2] https://www.britannica.com/topic/comparative-advantage
[3] https://www.thebalance.com/comparative-advantage-3305915
[4] http://www.forbes.com/sites/timworstall/2015/06/07/inditexs-zara-and-the-power-of-comparative-advantage/#65f7b9856b4a
[5] https://internationaleconpolicy.wordpress.com/2007/10/03/a-lesson-on-comparative-advantage/

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