Running head: COMPARATIVE ADVANTAGE
Week 2
Comparative Advantage
Theory of comparative advantage
The concept of comparative advantage is one of most important idea of the economic
Thought and is recognized as central theme in international policy. Nations that produce their
Comparative advantage are maximizing the benefits they receive from trade and consequently their
National welfare. This is same as maximizing their gains from trade. Comparative advantage is often
Confused with absolute advantage, the latter refers to the advantage a nation has if it's absolute
Productivity in a particular product is greater than its trading patterns. Therefore it not necessary to have
An absolute advantage in order to have a comparative advantage. One common argument against
Comparative advantage is that workers in other countries are paid less than the workers at home. The
Explanation of this argument is that developing countries wages are lower because the value of output
From one hour labor is less. Labor productivity is less because workers are generally less skilled, they
Have less capital on job; they have less capital on surrounding economy to support their own job
Productivity (JamesGerger, 2008).
Concept of Comparative Advantage
David Ricardo in 1817 has developed the principle of comparative advantage. He has illustrated this
Concept by using wool in Britain and wine from Portugal. According to This principal each country has a
Comparative advantage in producing commodity in which it has lower opportunity cost (JamesGerger, 2008) .
Mike Moffat in his article on "About .com" states, "To illustrates the concept of comparative
Advantage requires at least two goods and at least two places where each good could be produced with
scarce resources in each place. The example drawn here is from Ehrenberg and Smith (1997), page 136.
Suppose the two goods are food and clothing, and that "the price of food within the United States is
0.50 units of clothing and the price of clothing are 2 units of food. [Suppose also that] the price of food in
China is 1.67 units of clothing and the price of clothing is 0.60 units of food." Then we can say that "the
United States has a comparative advantage in producing food and China has a comparative advantage in producing clothing. It follows that in a trading relationship the U.S. should allocate at least some of its scarce resources to producing food and China should allocate at least some of its scarce resources to producing clothing, because this is the most efficient allocation of the scarce resources and allows the price of food and clothing to be as low as possible" (Moffatt, 2009).
In another example, the principle of comparative advantage has been explained by using hypothetical
Tables given in the example below:
Table A
Comparative Advantage: production before specialization
Wheat unit's cloth units
Australia 30 20
China 10 10
Total output 40 30
In the given example Australia has absolute advantage in production of both wheat and cloth.
So both countries can gain specialization and trade by using the theory of comparative advantage.
Table B
Opportunity costs
Country One unit of wheat one unit of ...
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In another example, the principle of comparative advantage has been explained by using hypothetical
Tables given in the example below:
Table A
Comparative Advantage: production before specialization
Wheat unit's cloth units
Australia 30 20
China 10 10
Total output 40 30
In the given example Australia has absolute advantage in production of both wheat and cloth.
So both countries can gain specialization and trade by using the theory of comparative advantage.
Table B
Opportunity costs
Country One unit of wheat one unit of cloth
Australia 1.5(30/20) units of wheat 0.6 (20/300) units of cloth
China 1(10/10) units of wheat 1 (10/10) units of cloth
Interpretations from table B
a. According to calculation in the given example Australia has to give only 0.66 units
Of cloth to produce an extra unit of wheat, while china would have to give one unit of cloth to produce an
Extra unit of Wheat, Therefore Australia has a comparative advantage in the production of wheat .so it is
More Practical for Australia to specialize in the production of wheat.
b. China has to give up only 1 unit of wheat to produce an extra unit of cloth, while Australia has to give
Up 1.5 units of wheat to produce an extra unit of cloth; therefore china has comparative advantage in
production of cloth. Consequently it is more practical for china to specialize in the production of cloth.
Australia has a comparative advantage in the production of wheat and China cloth. Trade between the
Two countries should be beneficial because of the different opportunity costs for these commodities.
When the two countries specializes in the production of goods and services based on
comparative advantage the total output increases .As both countries are using their resources more
Efficiently, trade will lead to higher standard of living than would be otherwise.
Analysis of the comparative advantage of low labor cost in china:
According to author in his web article "People daily online" China's comparative
Advantage is reported not only in the production (manufacturing) fields but china also has comparative
Advantage of low labor cost. Compared with the labor costs in Europe and North America, the labor cost
Is much lower in China. The factors like comparatively matured industrial technology and reachable
Basic education resources that equip labor with the necessary technologies have converted the low
Labor cost into an advantage (Hemerling, 2004).
As compared to china, in Africa lot of countries has available low labor cost, but that labor cost cannot
Be a comparative advantage, because they are without the comparatively matured industrial technology
And reachable basic education resources (Hemerling, 2004).
From this explanation, it could be interpreted that low labor cost also provides information that low labor
Cost can only deliver basic or non advanced process for manufacturer industry but also for service
Industry. China is good example for manufacturer industry and service industry. In the south province of
China, like Guangdong has lot manufacturing factories, employing a great number of workers. Most of
The products from these industries like, garments, shoes, bags and toys are exported. The reason for
This Comparative advantage is mature industry technology and labor with sufficient education (Hemerling, 2004).
India is another good example of service industry .Most of companies has set their calling centers in
India to deliver the customers inquiry services but their advisory offices is in USA.The reason for this is
The local labor is more and better western educated in India. Both countries have the largest benefit
From comparative advantage is from great number of employment opportunities. By the dynamic view
On the world, it could be interpreted that when the other developing countries will make the basic
Education and industrialization available, a competition of comparative advantage will be on show and
The current comparative advantage will be the future disadvantage .Therefore china and other
Countries like India need to reform their comparative advantage.
According to "WTO "Accession analysis eastern region countries to be comparatively advantaged in
Physical and human capital, while central and western regions remain comparatively advantaged in
Natural resources and labor. This market oriented reform has motivated the regional economic
Development to follow comparative advantage in each region through adjusting its industrial structure (zhai, 2009).
The objective of the reform and opening-up is to lend a sustained impetus to long-run economic growth
By exerting comparative advantages of regions. In order to benefit from the accession of WTO, China
Needs to continue adjusting its industrial structure and developing markets of products and factors (zhai, 2009).
Teme L walmsley in article, " Assessing the impact of china`s WTO accession on investments", states
That According to the ETA classification system, of the 1631 SITC manufactured commodities where
China enjoys comparative advantage in the world market, 660 commodities are unskilled labor intensive
(ULI), 600 are technology intensive, 334 commodities are human capital intensive and 94 are natural
Resource Intensive. The maximum advantage for China in 2003 lies in the category of ULI manufactured
Goods. In Comparison with 2000, the number of technology intensive commodities registers an increase
While that in the category of ULI falls in 2003 (Walmsly, 2006).
Interpretation of the Absoluteness of Technological Advantages in china:
The comparative advantages in china are not only helping the local enterprises to survive and develop
Attracting the overseas top companies, especially manufacturing companies, to move their production
Base into china to leverage the local comparative advantages to increase its margins. Although the
Machinery and heavy industry is not very advanced in chins as the world class level, but it is of good
Base. Therefore several big industries like Volve, Komastu, Dowsan, Kobelo and Caterpillar have
targeted China`s machinery industries as their low cost centers to generate high margin. In other words
China is only its low processing center without core technology, research and development.
The comparative advantages in China des not only help the local enterprises to survive and develop but
Also attract the overseas top companies, especially the manufacturers, to move its production base into
China to leverage the local comparative advantages to increase its margin. Although the machinery
Industry or heavy industry in China is not as advanced as the world class level, it is of good base.
Because of the low cost, several global crocodiles of machinery industry: Volve, Komatsu, Dowsan,
Kobelco, and Caterpillar, have targeted China's machinery industries as their low cost center to generate
High margin. In other words, China is only its low-end processing center without core technology -
Research and Development.
In contrast to this, Huawei Technologies Co., Ltd ("Huawei") not only leverages the comparative
Advantages of low labor cost but also introduces global advanced technology to improve its own
Research and development strength.
Conclusion:
Comparative advantages in China deliver only a limited growth. With the development of the other
Developing countries, the comparative advantages that China currently holds are possible to be
Disadvantages against the new low cost countries. Comparative advantage of low labor cost is the
Bridge for China domestic enterprises to enter the global market to compete against the rivals. But it is
Not a long-run advantage to win. Instead, with research and development investment, and the
Innovation of technologies, the Chinese enterprises are possible to sustain its development initiated
From low labor cost and speed up over into the global first tier companies.
Reference:
Gerber, James (2008). International economics (4th Ed.). : Pearson Education Inc.
(Ch, 3 pages 57).
People` Daily Online. (2004). china`s advantage in low labor cost. Retrieved from Sep 7, 2004 ... A website by the People's Daily newspaper; Chichi's advantage in low labor costar, business, world, science, education, sports news.
Google scholar search. (2009). The Implication s of Accession to WTO on China`s economy. Retrieved from F Zhai, S Li - Third Annual Conference on Global Economic Analysis, ..., 2000 - monash.edu.au... the impact of China's WTO accession ... Obviously, to analysis the external trade behavior
and the ... industry in column 13 reflect China's comparative advantage. ...
Pacific economic review. (2006). Assessing the impact of china `s WTO accession on investements. Retrieved from
Comparative Advantage
Comparative Advantage 1
