Concept of Comparative Advantage and How Economies Can Leverage It

Introduction to Comparative Advantage

Being the best at something means that person or an entity has a competitive advantage which requires rigorous innovation and research. To stand out from the crowd of competitors, one has to constantly be on the lookout to make their product or service better, which can be a tiring process, and the probability of failure will be high. David Ricardo theorized an economic model that solves competitive advantage through comparative advantage. It focuses on internal aspects and things that one can control rather than external factors. Having a comparative advantage means possessing the ability to produce goods or services at a lower cost than any other market competitor, which means the producer does not necessarily have to be the best at producing high-quality goods (Landsburg, n.d.).

The concept of comparative advantage also considers opportunity cost when analyzing the advantages. According to Buchanan (1991), “opportunity cost is the anticipated value of ‘that which might be’ if the choice were made differently” (Buchanan, 1991, p. 520). For instance, the opportunity cost of watching TV a day before an exam is performing poorly in the exam. The theory of comparative advantage also suggests that when an entity, individual, or country has comparatively lower opportunity costs than its competitors, it can successfully produce the goods or services and reap the benefits by selling them (Costinot & Donaldson, 2012).

For instance, labor cost is comparatively cheaper in India than in other countries like the US and UK. India has utilized this advantage by outsourcing its labor to other countries in call center industries. Even though India does not have the best English-speaking population, the cost factor allows it to capture the opportunity by establishing a comparative advantage through cheap labor. The opportunity cost of utilizing cheap labor has high youth unemployment in India. If a proper analysis is made, it is better to provide affordable labor opportunities than have unemployed youth, as it can also exacerbate social challenges.

The economist David Ricardo proposed that a country with an absolute advantage with regional trade can never profit exponentially as the consumption is only limited to their own country, limiting their potential to leverage the cost advantage by exporting the goods or services (Ricardo, 1817). Ricardo believes that the theory of comparative advantage benefits all consumers as they can increase their profits by producing more goods with limited costs, which reduces the overall wages and cost of essential goods in the producing nation as it can easily trade with other countries (Ricardo, 1817). When international trade between two nations remains strong, the countries can exchange comparatively advantaged goods and non-comparative advantaged goods. For instance, as India exports its human resources to Silicon Valley companies in the US, it can import non-comparative advantaged goods such as mobile phones from the US quickly. Therefore, the theory of comparative advantage explored in this paper will provide insights to policymakers, individuals, and entities to analyze their opportunity costs.

Economic Problem and Comparative Advantage

The theory of comparative advantage solves the fundamental economic problems, which are, “What to produce? How to produce? For whom to produce? What provisions (if any) are to be made for economic growth” (Pettinger, 2020). The first problem regarding production refers to the goods or services the economy should produce. A country cannot deliver goods that are not available easily in its homeland as they will face many issues. For instance, countries in the Middle East cannot produce agricultural goods due to a lack of agrarian land. Since the middle east economies have petroleum products as primary raw materials, it can create them at a lower cost being its significant comparative advantage. Therefore, the concept of comparative advantage helps economies to analyze what to produce.

The economic problem regarding production methods is a challenge that has grappled economies for many years. With the help of the comparative advantage concept, economies can develop, innovate, and research various production methods, which helps to form an ideal way to produce goods. For instance, countries can analyze the cost of producing rice through traditional agriculture methods and scientific methods adopted by other countries, after which it can follow the most cost-effective model to export goods at a competitive price. Therefore, comparative advantage helps economies understand and adopt the most cost-effective methods to produce and export goods or services.

After what to produce and how to produce, the next economic challenge is whom to produce the goods or services. Economies need to understand the demand generators to meet the supply quickly, and no waste occurs in the supply chain. A country can analyze the goods it is producing and hopes to export by determining whom to produce. For instance, when a country in Asia such as Bangladesh is considering exporting petroleum products to Middle East countries that already can produce goods at a cheaper rate, it can analyze its comparative advantage. Bangladesh is a country that can produce textile at a cheaper rate; therefore, it can focus on producing and exporting those goods to Middle East countries rather than petroleum products.

Comparative advantage also helps nations and economies understand what provisions need to be made to facilitate growth. When a nation wants to produce goods or services, it has to analyze whether it has a comparative advantage. For instance, if India wants to produce and export smartphones, it should consider the cost of raw materials, labor, marketing, logistics, and other costs, making it cheaper to produce the smartphones. When analyzing the costs, if it is seen that a bottleneck such as logistics cost is high, then it can initiate other plans such as the construction of infrastructures to reduce the logistic costs. Therefore, comparative advantage theory helps economies address various economic problems as it acts as a vital tool for analysis.

Leveraging Comparative Advantage

Economists can leverage and implement the concept of comparative advantage at policy and strategy levels to optimize economic growth. According to Treichel (2011), countries can align their policy measures with comparative economic advantage (Treichel, 2011). A study conducted by Treichel (2011) has recommended the Nigerian government, after identifying many industries such as fertilizers, leather, palm oil, and more, to address power issues, smoother access to finance, and reduce tariffs to export products by studying their comparative advantages (Treichel, 2011). Furthermore, the primary hurdle for the growth of Nigerian industries was understood as easy accessibility of cheap imports from China as the local industries had high power costs (Treichel, 2011). Therefore, economists can leverage comparative advantage to understand which products are more likely to sell in other countries when exported.

Economists can address the lack of a particular product in the country with the help of comparative advantage. When a country does not have adequate resources to produce an agricultural good such as wheat, it can import from another country. In exchange for importing wheat, the country can export wine to the other country to properly utilize its labor and capital. To put it into context, if Portugal could produce wine with 80 men and clothes with 90 men, it would be more beneficial for the country to produce and export wine rather than diver the labor to produce clothes (Ricardo, 1817). Similarly, Portugal can import clothes from England even though it takes 100 men to produce the goods because producing wine with lesser men would mean lower cost and higher comparative advantage (Ricardo, 1817). By using the theory of comparative advantage, countries and economists can produce goods that have lower costs to export and gain higher profits.

Furthermore, economists can leverage the concept of comparative advantage to understand the opportunity costs of producing a good. For instance, if Switzerland can produce 1000 tons of Cheese and 500 tons of Cotton using the same labor force, and India can produce 2000 tons of Cheese and 2000 tons of Cotton with the same labor force, then Switzerland has a comparative advantage in Cheese as the opportunity cost for India if they produce Cheese is high. Similarly, the opportunity cost for Switzerland to produce Cotton is high. In such situations, economists can produce economic policies to promote international trade, where Switzerland can import Cotton from India and India can import Cheese from Switzerland.

Application of Comparative Advantage in Modern Economy

The current global trade patterns suggest that the principles of comparative advantage are still relevant and practiced by world economies. Today’s world has economies with highly specialized comparative advantage as the global supply chain has expanded rapidly (Daco & Christopher, 2012). For instance, China has specialized in low-priced consumer goods as it has lower labor costs. Similarly, India outsources to the world’s informational technology industries by utilizing its cheap and young labor. These comparative advantages have allowed countries to develop as it exports in return for foreign currencies. However, the specialization of economies has also increased supply chain risks as a natural disaster, or a global pandemic such as the COVID-19 can disrupt the entire industry (Daco & Christopher, 2012). Similarly, any change in tastes of another country can significantly impact the demand and cause an economic crisis in the exporting nation.

China has emerged as one of the top countries specializing in producing semiconductor chips by utilizing its comparative advantage according to its location with low labor costs compared to other countries (Grimes & Du, 2022). China can utilize its low cost due to its internal factors to stand out in the semiconductor industry. However, the sector has an oligopolistic structure, has high research and development costs, and requires continuous innovation, which the public policymakers must analyze (Grimes & Du, 2022).

The government of South Korea has also leveraged the concept of comparative advantage when developing K-pop and exporting it as a cultural sensation. The government has a substantial advantage over other countries as it already has a trained workforce and internal demand for K-pop content. As the K-pop culture and artists are expanding globally, it is apparent that the government is exporting the culture and reaping the benefits. The expansion of the K-pop culture allows the nation to exercise soft power to increase its global position and profit from selling products related to the culture.

South Korea has grown over the years with the help of its manufacturing sector and established itself as one of the strongest global economies by utilizing its local workforce. As the growing local companies expanded to international markets, its local productivity plummeted. The country has also experienced a shrinking working-age population which is pivotal for sustaining the manufacturing sector. Therefore, the country’s diversification towards a booming tourism and service sector by exporting K-pop establishes a comparative advantage over other countries (Mckinsey Global Institute, 2013). Nations can leverage the concept of comparative advantage and learn a lesson from South Korea, as K-pop contributed almost $10 billion to the country’s economy (Sajnach, 2021). Therefore, countries can leverage their comparative advantage like South Korea has done to boost its tourism and service sector through the global expansion of K-pop.

One of the best examples of the relevancy of comparative advantage in the modern economy is former US President Donald Trump’s attempt to bring back manufacturing jobs in the US (Elegant, 2020). As 80 percent of companies having manufacturing units in China enjoy a handsome profit, Trump’s attempt to bring them back to the US was met with pessimism since the wage costs are higher in the US compared to China (Elegant, 2020). Since China has carefully utilized its comparative advantage of cheap labor, it has maintained its stance as manufacturing capital in the world. Therefore, comparative advantage is still relevant in today’s modern economy.

Evolution in Comparative Advantage

Comparative advantage is not a static concept, and it can change over time as the world economy develops. It was developed under the assumption that countries operated under perfect competition; it ignored the tariffs, transportation costs, and the fixed nature of labor markets. However, factors such as frictions in the global flow of investment, knowledge transmission, technological differences among trading states, and monopolistic competition market structure have changed the comparative advantage concept in today’s modern economy (de Ferranti, Lederman, & Maloney, 2002).

The traditional share of raw materials obtained from natural resources does not determine a country’s destiny as current-day trade patterns include knowledge, information, and communication transfer which are intangible and do not require high-cost infrastructure (de Ferranti, Lederman, & Maloney, 2002). Some countries achieved economic growth by tapping into their abundant natural resources by maintaining a comparative advantage over the years. While, some faster-growing nations utilized their natural resources and compiled knowledge, making their comparative advantage an intangible asset (de Ferranti, Lederman, & Maloney, 2002). Therefore, in the 21st century, knowledge has evolved as a comparative advantage compared to traditional tangible resources.

The traditional comparative advantage model has some limitations, which makes it suitable for today’s multi-commodity trading style of nations. As the model only considered two nations producing two different commodities, its development was necessary to be adopted in today’s world. It is vital to go beyond the old factors of production, considering the only cost of wages and demand (Tian, 2008). Therefore, the traditional assumptions of comparative advantage have evolved to consider technological differences between nations in factors of opportunity cost.

Conclusion

This paper explored the concept of comparative advantage developed by the economist David Ricardo in 1817. The concept of comparative advantage suggests that countries should produce and export goods or services with the lowest opportunity cost than their competitor as the lowest cost possible. This model helps countries smoothen international trade as one country can easily exchange its goods or services

. As competitive advantage is challenging work and resources, the theory of comparative advantage can help nations and entities profit from their resources.

Ricardo’s concept helps solve fundamental economic problems regarding the things to produce, production methods, target market, and facilitating economic growth through provisions such as infrastructure development. A country should produce goods readily available at low costs and focus on such export goods with a high demand to avoid waste and losses. Economists and policymakers can take advantage of the comparative advantage concept for economic growth as it helps analyze products or services to be exported. Similarly, they can decide which goods to produce which give the highest return and maximize productivity with the help of the comparative advantage concept. Therefore, countries like China, South Korea, and India have utilized the comparative advantage concept to grow their economy by exporting various goods and services.

As the world economies have developed over the years through the utilization of natural resources, some countries have grown faster by accumulating knowledge and developing it as their comparative advantage. The comparative advantage has developed over the years to include the development of trade patterns considering the exchange of intangible assets. Similarly, the traditional model only considered assumptions of trading between two nations and two commodities, which has been replaced by multi-nation and multi-commodity to accommodate today’s modern economy.

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