Analysing International Trade Patterns: Comparative Advantage for the World's Major Economies

Article excerpt

Using disaggregate product data classified by the Harmonized System code, this paper computes the revealed comparative advantage (RCA) for seven major economies that, when combined, contributed more than 80% of global manufacturing exports in 1996-97 and 2006-07. Results show that in the last decade, Canada, the US, and Japan have lost their share of global exports, while China has increased its share three-fold. These losses occurred mainly for low-tech products for the US, but medium and high-tech (MHT) products for Canada and Japan. However, MHT products comprise the highest share of Japanese exports (70%) compared to Canada (which has the lowest share, approximately half of Japan's). Canada is the only economy whose contribution to global MHT exports is lower than that of global total exports. Japan also has the highest share of RCA-based MHT exports of other East Asian countries (OEACs) and the US. China has the highest share of non-RCA-based MHT exports. Finally, the trade patterns for OEACs and Mexico did not change greatly in any dimension in the last decade. However, products with RCA have changed substantially in all economies, with the highest in Mexico.

1. Introduction

Comparative advantage is the single most widely used indicator for measuring a country's international trade performance. A country is considered to have a comparative advantage in the production of certain goods if it has low relative cost in the production of that good compared to other countries. The use of both "relative" and "compared" means that there are two comparisons to be made. Relative cost means the production cost compared to the cost of other goods produced within the same country. The cost ratio is then compared across trading partner countries (Deardorff, 1998). Hence, a country can have a comparative advantage in the production of a good, even if it is not the lowest cost producer. In the latter ease, the country is said to have an absolute advantage (i.e. absolute advantage does not necessarily imply a comparative advantage). The standard trade model implies that an improvement in absolute advantage (i.e. an economy-wide fall in production costs in all sectors) will show up in higher real income for the whole economy, but will have little or no effect on resource allocation or trade patterns.

In business, however, much emphasis is given to competitive advantage, a concept that is closer to absolute advantage than to comparative advantage. (1) According to business literature, a country's standard of living and a firm's profit depend on competitive advantage. On the other hand, economics literature suggests that while it may be desirable to have an absolute advantage in the production of goods, it is the comparative advantage that is vital in explaining trade patterns. There are two theories to explain patterns of trade: comparative advantage and increasing returns to scale.: Comparative advantage occurs due to differences across countries in factor endowment or technology, whereas returns to scale is related to a country's size (returns to scale), market structure (with imperfect competition), and location (with trade costs). Thus, some countries export more in certain industries than others because of endowment-driven or productivity driven comparative advantages. Yet this theory cannot explain intra-industry trade, which results from firm-level horizontal product differentiation combined with increasing returns to scale. A larger country produces more variety and export as costs fall with the level of production.

Despite the different theoretical explanations for why countries engage in trade, in most cases the trade gravitas that arises due to increasing returns to scale also translates into cost differences between two countries. Hence, a country's measure of comparative advantage should reflect its performance vis-a-vis other competitor countries in foreign markets. While several studies have estimated comparative advantage, most have focused only on one country or on a small number of products and industries. …