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 will always make countries with absolute advantages better-off.
Table 1b Absolute Advantage (after Specialization and Trade)
This case was lately developed by David Ricardo in 1919 when he introduced his Theory of Comparative Advantage. The theory suggests that it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself. In other words even if one country possesses all absolute advantages it can benefit from specialization and trade. We can show this on our model. Now assume that with the same total amount of resources Spain holds an absolute advantage in both commodities. The production and consumption before specialization can be found in Table 2a.
Table 2a Comparative Advantage (before Specialization and Trade)
Comparative advantage is said to have such country which opportunity cost (OC) of X in terms of Y is less than in other country. Now we can notice that Spain has a comparative advantage only in producing of laptops (and is twice as much efficient in this production) – OC of one laptop is 3/4 ton of potatoes compared to 6/5 in Russia. Nonetheless, Russia has a comparative advantage in potatoes, it can produce one ton of potatoes at an OC of 5/6 of one laptop (whereas in Japan it is 4/3). Based on these facts countries decided to reallocate their resources into industry where their comparative advantage takes place. New higher partial and total production and consumption numbers can be found in Table 2b. Need to be said that specialization based on comparative advantage does not have to necessarily lead to higher production in each of particular goods. What is true though is an increase in the total sum of those products.
Table 2b Comparative Advantage (after Specialization and Trade)
So far our examples connected with theories of absolute and comparative advantages suggest that countries will always be better-of if they engage in trade. However, there is one example where there would be no gain for no country and that is the case where no country possesses comparative advantage (OC of product X in terms of Y are of the same value in every country). Specialization and trade would therefore lead to no benefit. Such example is shown in Table 3.
Table 3 No advantage
Even though the couple of theories mentioned advocates specialization and trade they are simplified by a few assumptions that do not fully reflect the conditions of real economy. Both theories must be qualified by the existence of substantial transport cost, price differences of resources in countries, changes in exchange rates. Also by the strategic importance to some countries of maintaining domestic sources of essential supplies and by existence of many countries and many products and services as well. Besides this, the theories presume free movement of a fixed stock of resources from one production to another and so do not count with increasing or diminishing returns to scale (specialization) when economies (at lower level of production) or diseconomies (at higher level of production) of scale occur. Although these and a few other arguments weaken the theory of absolute and comparative advantage, empirical studies based on that theories, come to a conclusion that even in real economy with many countries and products there is substantial economic gain for trading nations. Generally speaking the trade appears to be beneficial up to the point where the gain from trade is at least of the same value as the total cost of production.
Besides this there are a few more less social rows looking at the impact of trade on particular nations. Some authors of literature call them the myths of trade protectionism. The first and probably the most rooted argument is that trade (import) evokes job losses on the domestic market. The second wrangle, a corollary to this one, is that eventually a domestic industry might collapse, leaving the country dependant on foreign import. This could be devastating if the nation suddenly went to war. Whether the second argument is commonly accepted as reasonable, the first one is rather short-sighted. The unemployment that may occur is only of structural character and in longer period the job losses are more than replaced by the new ones in more efficient sectors of economy. Moreover if government puts trade barriers in order to protect one industry, the industry dependent upon this protected industry, facing declining revenue, will have to either lay off a significant number of workers or go out of business entirely. This is exactly what happened to many U.S. manufacturers when President Bush imposed steel tariffs in 2002. Another problem could be deteriorating environment due to chase for efficiency. However, empirical studies show the opposite can be true. As very poor countries begin to grow, pollution initially could get worse but as they continue to grow and accumulate wealth from trade, they will have both more resources and a greater resolve to keep the environment clean. The influence of globalisation is another factor that could make a country from the cultural point of view worse-off. Then there is an effect of over specialization saying that if a country’s wealth depends on export of limited variety of goods and services abroad, the fall in demand for these products could cause severe problems to domestic economy.
In order to round off the picture we should outline the most important attributes of trade that make countries prosper. Basically, what economic theory has been suggesting for centuries, a country cannot be better-off without economic growth. Based on absolute and comparative advantage this could be achieved since specialization and trade supports employment with consequence of an increase in income, consumption and investments resulting in economic growth through the shift of production possibility frontier outwards. Countries can further benefit from the import of new technology and higher variety of product on the market has always been for public welfare.
In conclusion it is necessary to call the reader’s attention to the fact that despite accord with commonsense, most statements presented here rely on general basis. For a comprehensive judgement many qualifications, conditions and factors should be considered in each of countries which go beyond this paper. Nonetheless, weighting up all the statements above we can come to a general conclusion that, with respect to some special conditions when there is no cost advantage between countries and some strategic and short-term domestic arrangements, countries engaging in international specialization and trade will always be better-off.
BIBLIOGRAPHY
Textbooks:
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Robert Holman, Economics, C.H.Beck, 2002 (Third edition)
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John Sloman, Economics, Prentice Hall, 2003 (Fifth edition)
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Charles W.L. Hill, International Business: Competing in the Global Marketplace, McGraw-Hill/Irwin, 2005 (Fifth edition)
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Paul R. Krugman & Maurice Obsfeld, International Economics: Theory and Policy, Adisson-Wesley/Pearson Education, Inc., 2003 (Sixth International edition)
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Michael Zammit Cutajar & Alison Franks, The Less Developed Countries in World Trade, Overseas Development Institute Ltd., 1967
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David Ricardo, The Principles of Political Economy and Taxation, Homewood, IL: Irwin, 1963 (first published in 1817)
Reports:
- World Trade Organization, World Trade Report 2004 – Exploring the Linkage between the Domestic Policy Environment and International Trade, 2004
Internet Resources:
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(World Trade Organisation, World Trade Report 2005)
World Trade Report 2005, World Trade Organisation, http://www.wto.org/
M.Z.Cutajar & A. Franks, The Less Developed Countries in World Trade, p.11
Eli Heckscher (1879-1952), Swedish economist and economic historian, Bertil Gotthard Ohlin (1899-1979), Swedish economist, politician and a 1977 Nobel Prize Laureate in Economics
Adam Smith (1723-1790), The Wealth of Nations, Scottish political economist and philosopher
Charles W.L. Hill, International Business, pp. 148-149
David Ricardo (1772-1832), Principles of Political Economy, the British economist and Member of Parliament
David Ricardo, The Principles of Political Economy and Taxation, 1967 (first published in 1817)
For explaining of these terms e.g.: John Sloman, Economics, 2005, pp. 126-128
Paul R. Krugman & Maurice Obsfeld, International Economics: Theory and Policy, pp. 31-34
For example: Robert Holman, Economics, pp. 121-127
However it is interesting to note that when tariffs in Australia increased greatly in the period 1974–1984 for textiles and footwear employment in the sector fell by 50 000 for the same period. www.hsc.csu.edu.au/economics.mht
For example: John Sloman, Economics, p. 386