Comparative Advantage Continued

Article excerpt

The concept of comparative advantage, which I began discussing last month, is a straightforward application of opportunity cost and is almost embarrassingly simple. Certainly people have no trouble understanding and recognizing the importance of this concept in their own personal lives. For example, if you were the best brain surgeon in town and also the best at shining shoes, you would not try to be both a brain surgeon and a shoe shiner. Compared to other shoe shiners, you would be at a tremendous disadvantage shining shoes because of the value of your time performing brain surgery.

People are very good at finding and pursuing their comparative advantages. This doesn't mean that people are always good at what they do. We have all seen people working at jobs they can't do well. It could be, of course, that they have made a mistake and will quickly move on to something they do better. But that clumsy waiter who keeps spilling hot soup on his customers may have a comparative advantage at being a waiter. He could be even worse at everything else. So just as you can be really good at something without having a comparative advantage in it, you can have a comparative advantage at something you don't do very well.

While people seem to understand comparative advantage when making personal choices, they often put this understanding on hold when accepting arguments against international trade. For example, last month I explained why the widely accepted argument that countries with low-paid workers will be able to outcompete us in all goods is wrong. I shall now consider a related, and widely accepted, argument against free trade, and explain the fallacy it contains by modifying the example in last month's column.

Being the Best May Not Be Good Enough

A common complaint by domestic producers is that foreign firms that suddenly begin outcompeting them must be selling below cost. They can often support their case by pointing out that the foreign firms were previously uncompetitive and have not improved their efficiency one bit. So how can these firms possibly be competitive now? It may seem strange that firms unable to compete earlier are suddenly able to without becoming more productive. But it is not strange at all. Foreign firms don't have to become more productive to acquire a comparative advantage over domestic firms.

Consider the table on the next page, which contains last month's example (ignore the number in parentheses for now). Americans have a comparative advantage only in car production even though they are absolutely more productive than Brazilians at producing both cars and computers. The opportunity cost of producing 100 cars is 666 computers in the United States and 1,000 computers in Brazil. But the other side of this coin is that Americans have a comparative disadvantage in producing computers, which means Brazilians have a comparative advantage in computer production. While it costs 150 cars to produce 1,000 computers in the United States, it costs only 100 cars in Brazil.

So, as explained last month, both countries are better off when Americans specialize in cars, Brazilians specialize in computers, and they trade with each other. Free trade moves resources into each country's comparative advantage, thereby increasing total output.

But assume that an entrepreneur develops a better way of manufacturing computers in the United States: it now requires only 1.5 units of productive resources to produce 1,000 computers. …