AUS 100 OR 600 1W:6C
Specialise
UK 600 0
AUS 0 600
Now we trade at an exchange rate lying between opportunity costs, so 1W:2C
At 1W:2C we specialise and trade –
Wheat Cars
UK 400 400
AUS 200 200
Comparative Advantage Example –
- UK has absolute advantage in both wheat and cars but has a comparative advantage in cars.
- Australia has no absolute advantage but has a comparative advantage in wheat
Wheat Cars Opp Cost
UK 60 OR 60 1W:1C
AUS 50 OR 10 5W:1C
- so UK will specialise in cars and Australia will specialise in wheat.
Specialisation
UK 0 120
AUS 100 0
Trade
UK 40 100
AUS 60 20
In both examples the UK and Australia are doing much better and end up outside their own production possibility curves, thereby increasing their national output as a result of trade
One of the most important reasons for trade is that countries have different endowments of factors of production, i.e. they are unevenly spread around the world. Factors of production are generally considered immobile, therefore the uneven distribution of factors remains, hence the reason for trade. The Heckscher-Ohlin-Samuelson Model states that the relatively “labour-rich” nations will export the relatively labour-intensive commodities, since the wage rates are relatively lower, thus labour-intensive commodities can be produced cheaper. Similarly they will import the relatively capital-intensive commodities, since capital is relatively more expensive and production of the capital intensive commodity will be more costly. Samuelson also argued that when the international trade, based on the factor endowment, takes place, the prices of the factors would converge and would gradually be equalised in both countries.
Ricardo’s, Smith’s and Samuelson’s models state that there are major welfare gains to made from free trade in international markets with world output rising. I disagree, however, with the statement that all countries gain from free trade. Protectionism has always been widespread indicating that there must therefore be many disadvantages to free trade.
The theories themselves put forward to illustrate the gains from trade have many problems associated with them. In Ricardo’s theory, it isn’t clear how the benefits of trade are distributed. The comparative advantage theory is static and focuses only on the current relative cost structure. Developing countries will continue to produce rice, for example because in the short run they will make more profit. In the long run, however, if they invest in technology and produce industrial goods forfeiting short run profit, developing countries might be able to produce industrial goods cheaper and develop. Output may rise in the short term as a result of trade, but will have little effect on development. There is also a simplistic interpretation of the labour value theory. The value created by spending 1 hour producing cars is not equal to the value created by spending 1 hour producing wheat, so in this case it is not true that everybody equally benefits from this specialisation as the car producers will earn more money than the wheat producers. Like the Ricardian model, the HOS model is also based on a number of very controversial assumptions that are unrealistic to assume in the modern world, for example, it assumes mobility of factors but there will more than likely be immobility’s and countries won’t be able to change their whole wheat production into car production. It also assumes no transport cost so it is quite possible that after transport costs have been added on, the comparative advantage may be lost. The HOS theory also has no evidence to suggest that more trade occurs between low and high income countries and has no evidence for factor price equalisation. Any trade benefits occurred would be disproportionately to rich nations and within poor nations disproportionately to wealthy citizens.
Free trade may not be so beneficial for many other reasons. Monoproduction may occur, resulting in the danger of relying on one product too heavily. If they produce just an agricultural good, supply can be variable, demand and supply are inelastic and therefore incomes can be very volatile. Countries may become interdependent, and if there’s a breakdown in supply in one country it can halt the production of another country’s as well as a country becoming reliant on others for strategically important goods. The balance of payments may become worse as it will increase the spending on imports. Dumping might occur where developed countries sell goods at below their AC to developing countries, in order to get a foothold in a foreign market or to get rid of surplus stock. Trade may also lead to overdevelopment e.g. Tourism, an unequal distribution of income or even a reduced quality of life e.g. Education/ Health in UK.
There are in conclusion, therefore, many arguments for and against trade. It is extremely unrealistic, however, to suggest that “all countries gain from trade” as the theories themselves put forward to back this up have many problems. Trade is not beneficial in many other ways, mainly however, towards developing countries. Trade is, however essential in the modern day and although not all countries gain from trade, there are a lot of gains to be had from trade.
Bibliography
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Todaro, M.P. (2000), Economic Development, (London: Longman), chapter 12
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Venables, A.J. (1996), ‘International Trade’, chapter 13, pp. 426-456, in M. Mackintosh, V. Brown, N. Costello, G. Dawson, G. Thompson and A. Trigg, Economics and Changing Economies, (London: Open University)
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Perkins, Radelet, Snodgrass, Gillis and Roemer (2001), Economics of Development, (New York: W.W. Norton & Company) chapters 16 and 18
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Thirlwall, A.P. (1999), Growth and Development, chapter 16, pp. 419- 459.
