THE FALSE PREMISE OF INTERNATIONAL TRADE: Trade Based on "Comparative Advantage" Loaded with Problems

By Nickerson, Mike | CCPA Monitor, October 2005 | Go to article overview

THE FALSE PREMISE OF INTERNATIONAL TRADE: Trade Based on "Comparative Advantage" Loaded with Problems


Nickerson, Mike, CCPA Monitor


"Any new law or regulation of commerce which comes from this order [those who live by profit] ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men whose interests is never exactly the same with that of the public, and who accordingly have upon many occasions, both deceived and oppressed it."

-Adam Smith, The Wealth of Nations

It has always been clear that trade is advantageous when two countries have an absolute advantage in the production of different goods. That is, when they produce particular goods more easily than other nations. We could grow bananas in Canada, for example, by building greenhouses and pumping heat and light into them. Honduras could perhaps, with a lot of effort, grow enough wheat for its needs. But, since the Canadian prairies are so much better suited for growing wheat and the jungles of Honduras for bananas, it makes sense for us to specialize where our absolute advantages lie, and to trade with each other.

Trading for the benefits inherent in "comparative advantage" is a different matter. Comparative advantage is often cited as a primary reason for encouraging international trade. The principle was first explained by David Ricardo in 1817. Comparative advantage identifies the mutual benefit to be realized from trade, even if one nation has an absolute advantage in both goods that might be traded. An example, adapted from Ricardo, explains that Portugal has an absolute advantage over England in producing both wine and cloth. Comparatively, however, Portugal produces wine more efficiently than it produces cloth. Although neither product can be produced as efficiently in England as in Portugal, England, within its borders, produces cloth more efficiently than it produces wine.

Because England can produce twice as much cloth, with a given effort, than it can wine, if it moves the effort used to produce one unit of wine into the production of cloth, it will get two additional units of cloth. Portugal, on the other hand, can produce 1.5 units of wine with the amount of work that it takes to produce a single unit of cloth. In this example, each country gives up one unit of production, but ends up with a greater volume of the product for which it has the comparative advantage. Each country can then trade for the production units forgone, and the trading community will be better off by one unit of cloth and a half unit of wine.

England

1 unit effort = 2 units cloth

1 unit effort = 1 unit wine

Portugal

1 unit effort = 1 unit cloth

1 unit effort = 1.5 units wine

Total production for both countries

3 units cloth and 2.5 units wine

If one unit of effort in each country is moved from the less advantageous product to the one for which it has the comparative advantage, the results would be:

England

2 units effort = 4 units cloth

Portugal

2 units effort = 3 units wine

This is a net increase between the trading partners of 1 unit of cloth and a half-unit of wine.

(Note: Because its climate and other circumstances give Portugal an absolute advantage in both cloth and wine, the unit of effort in Portugal is less than the unit of effort in England.)

When David Ricardo explained the principle of comparative advantage, he pointed out that it does not work within the boundaries of a single country. …

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THE FALSE PREMISE OF INTERNATIONAL TRADE: Trade Based on "Comparative Advantage" Loaded with Problems
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