Critically assess the argument that countries will be better-off if they engage in international specialization and trade.

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Question: Critically assess the argument that countries will be better-off if they engage in international specialization and trade.

One of the most remarkable features of the post-war world economy is liberalisation of international trade. Change in trade policy strategies and the trade policy environment are among the reasons why trade has grown nearly five times faster than world output (as Chart 1 show) and also why global trade growth increased by 9 per cent in 2004, more than twice as fast as output. But is this strategy of specialisation and trade really a good way how to make countries better-off?

Chart 1  Growth of World Exports of Manufactures and GDP, 1950-2003 (1950=100)

        Source: World Trade Organisation

For a country to become richer there is only one way how to achieve it and this is through increase in production of goods and services. In order to do so, it must be able call upon resources of land, capital and productive and entrepreneurial skills. These factors of production and their specific parts, however, differ from country to country not only by their total amount but also their mutual ratios causing different premises toward their efficiency in every segment of economy. This fact was applied as an explanation to the theories written below and known as Heckscher-Ohlin theorem . In other words each country has better (or worse) disposition to produce a particular product cheaply (or more expensive) than another one. And this is the point where two theories concerned with it crop out.

The first of them is The Theory of Absolute Advantage which was first developed by Adam Smith in 1776 when he suggested that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it so the country should never produce goods at home that it can buy at a lower cost from other countries. Let’s have a look at one example of such a case by using two countries/two products model; Russia & Spain producing only potatoes & laptops. Assume that both countries have the same but limited total amount – 6000 units - of resources which can be used to produce either potatoes or laptops. Despite the same amount of resources, they are not of even efficiency. Russia takes more units to produce 1 ton of potatoes and less units to produce 1 laptop compared to Spain. Russian economy is then said to have an absolute advantage in production of potatoes and Spain has the same advantage in production of laptops. These differences can be explained by Heckscher-Ohlin theorem suggested above. Before trade and specialization, as Table 1a suggests, both countries produce and consume each of the commodities.

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Table 1a  Absolute Advantage (before Specialization and Trade)

Then the countries engage in specialization and trade. In reality it means that each country “transfer” their resources into industry where they have an absolute cost advantages and then trade the products between themselves to fulfil their needs. The result is visible in Table 1b. After trading of potatoes and laptops on a one-to-one basis (one ton of potatoes for 1 laptop) both Russia and Spain ends up with higher consumption of each products and total output of these countries increased. Thus, according to Smith, trade is a positive-sum game and ...

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