Comparative cost advantage

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The comparative cost advantage (from Latin : comparare = to compare) is a model of foreign trade that goes back to the English economist David Ricardo . At the beginning of the 19th century he developed the concept of comparative advantage. It is an extension or, in part, a correction of the previous theory of the absolute cost advantage (cf. Adam Smith 1776).

Unlike the "old" theory, Ricardo's findings say that international trade can bring cost advantages for a country even if this nation has absolute cost disadvantages in the manufacture of all products, and the other country accordingly has absolute cost advantages. This theoretically justifies that cross-border exchange processes increase the welfare of both trading partners. The comparative cost advantage exists within the framework of economic theory when a country, a region, a company or a person is able to produce a certain good at lower alternative costs ( opportunity costs ) than the competition.

The comparative cost advantage is a simple and fundamental representation of the advantages of free trade for all participating nations.

Core idea

→ In the article Ricardo model , the comparative cost advantage according to the Ricardo model for two countries with two products is clearly shown in an example.

The theory of the comparative cost advantage states that the profitability of trade between two countries does not depend on the absolute production costs, but on the relative costs of the goods produced. In principle, trading between two countries is therefore always advantageous if the two trading partners have different production cost structures. That is, if one country has to forego fewer units of another good for a produced good than the other country (lower opportunity costs ). In this case each country should specialize in the good that it can produce relatively (comparatively) more cheaply. Thus, according to the theory, international trade and the international division of labor are advantageous even for those countries that can produce all goods at a lower cost than abroad. In reality, this can mainly be applied to trade relations between highly and less industrialized countries.

example

The principle of comparative advantage is not only found at the economic level, but can also be applied to everyday life: If you look at two neighbors who both have to do the same work to the same extent, namely mowing the lawn and cutting the hedge, you can determine the following initial situation:

activity Neighbor A Neighbor B
Cut the lawn 6 hours 3 hours.
Cut the hedge 8 hours 2 hours.
Needed time 14 hours 5 hours

Neighbor A takes 6 hours to mow his lawn and 8 hours to cut the hedge; so it takes a total of 14 hours. Neighbor B, on the other hand, takes 3 hours to mow his lawn and only 2 hours to cut his hedge. So he's busy for 5 hours. Neighbor A needs longer than B for all work. So there is no job he is “good” at. It takes four times as long to cut the hedge and twice as long to mow the lawn. So it can mow the lawn relatively well, which means that it can cut hedge even worse than mowing the lawn. If the two neighbors communicate with each other, however, so that neighbor A takes on the work that he can do relatively well, neighbor A only needs 12 hours to mow both lawns and neighbor B only needs 4 hours to cut the two hedges . So there is a time saving for both neighbors. Although neighbor B does better in all occupations, he also has an advantage through the agreement and specialization.

activity Neighbor A Neighbor B
Cut the lawn 12 hours -
Cut the hedge - 4 hours
Time saving 2 hours. 1 H.

Historical classification

The theory of comparative advantage goes back to David Ricardo , a representative of classical political economy . In his main work "On the Principles of Political Economy and Taxation", which appeared in 1817 and was expanded and revised in the third edition in 1821, Ricardo dealt with the advantages of foreign trade, particularly in Chapter 7, "On Foreign Trade". Based on Adam Smith's approach to the international division of labor , which explains the trade of two countries with their absolute differences in production costs , Ricardo expanded his theory to the effect that specialization is advantageous even if a country has higher labor productivity in all sectors .

Ricardo published his theses at a time when the idea of ​​free trade clearly stood in opposition to the thinking then prevailing. Until the 19th century, international trade can be compared more with a war (see trade war ). In Europe, which has hitherto been shaped by mercantilism , the nation states tried to steal economic and trade volumes from each other through the lowest possible imports using tariffs on the one hand and the highest possible exports on the other. A zero-sum game in which the macroeconomic benefit cannot be maximized. It was only through the emergence of economic liberalism based on Adam Smith's works that there was a social rethink here.

The concrete historical background for Ricardo's theory was the lifting of the continental blockade against Great Britain by the Congress of Vienna in 1815, which, however, did not correspond to the interests of the British government in all respects. This was because it intended to limit imports to necessary raw materials and to promote exports to other countries. Therefore, high protective tariffs were introduced to protect the domestic economy from foreign imports (“ protective tariff policy ”). This restricted in particular the importation of agricultural products, such as B. of wheat. This kept the grain price artificially high. This was of particular benefit to the large landowners who had particularly fertile soil and (according to Ricardo) was less used to protect the British economy. Because of the incipient industrialization and the high population growth in England, he considered specializing in agricultural products to be inefficient. With this historical background in mind , Ricardo published his theory of comparative advantage to show that , contrary to the government's opinion, mercantilist trade protectionism does not protect the domestic economy, but only restricts Britain's consumption opportunities that free trade could maximize.

In addition to Ricardo, shortly before or at the same time with his publications, the economists Robert Torrens and Heinrich von Storch also recognized the importance of the comparative cost advantage.

The comparative advantage in economic models

The Ricardo model

The Ricardo model is also called the one-factor model (or in short: 2 × 2 × 1 for 2 countries, 2 goods and 1 production factor). It explains how trade between two economies came about. In both economies there is only one production factor, namely human labor (measured in hours worked), and only two goods are produced. Since both economies only have a predetermined number of working hours available and these have to be distributed over the production of the two goods, a unit of good 1 can only be produced at the expense of, for example, 2 units of good 2. Opportunity costs arise that differ in the countries and thus lead to a comparative advantage in the manufacture of one good. It is advantageous for both economies if they specialize in the production of the good in which they have a comparative advantage, export it and import the other good. By exploiting the comparative advantage, there is trade between the two economies.

In order to make the model a little more realistic, it is expanded to include the production and trading of several goods. We continue to consider two economies that have only one factor of production (human labor) but now produce numerous goods. The principle of the one-factor model can, however, be adopted. The two countries produce and export the goods that they have the lowest opportunity cost and thus a comparative advantage to manufacture, and import the goods with the highest opportunity cost.

The Heckscher-Ohlin model

The Heckscher-Ohlin model considers two economies that each produce two goods and each have two production factors at their disposal (in short: 2 × 2 × 2). The comparative advantage results not only from the different labor productivity of the two countries, but is also influenced by the different resources of the national economies. A comparative advantage can therefore result from the fact that one country has a high deposit of gold, but the other country has a high oil deposit.

The Leontief model

In addition to the Heckscher-Ohlin theorem, the Leontief paradox deals with the reasons for international trade in the uptake and the direction of movement and is one of the most important explanations for this - on the one hand, because it is in great contradiction to the Heckscher-Ohlin theorem, and on the other hand, because it is the first analysis to be based on an input-output table developed by Leontief himself. After its publication in 1947, there followed numerous intense debates about the reasons and contradictions between the two theorems. For this reason, the name "Paradox" arose, which resulted in numerous further developments of the models of the factor proportion theory.

Economies of scale

Two countries also operate foreign trade with each other to scale to use ( "economies of scale"). In most cases, economies of scale increase with increasing production volumes; one therefore does not assume constant returns to scale. This means that doubling the factor input more than doubles the production volume . In this case, larger companies usually have an advantage over smaller ones; therefore this model assumes that there is monopoly competition between producers . Since both countries produce different goods (“differentiated products”), trade between them is possible.

Barriers of Comparative Advantage

The comparative advantages of a country are hindered or limited by so-called trade barriers . These trade barriers can lead to a country not using an existing comparative advantage and instead producing the respective good itself. It should be noted that there are some goods and many services that are impossible to transport or trade, e.g. B. a doctor or hairdresser visit. Each country has to ensure that such services are offered. Economics call goods that can be traded internationally, therefore also tradable goods.

The trade barriers are often divided into two types.

Tariff trade barriers

  • Protective and anti-dumping duties are imposed to protect domestic production from cheap foreign production. The domestic import tariff increases the price of cheap goods imported from abroad. This makes the domestically manufactured products relatively cheap in comparison, and they can win back a cost advantage, since tariffs generally make the imported good more expensive.

In recent years, many tariffs have been replaced by non-tariff trade barriers.

Non-tariff barriers to trade

  • Quantitative trade restrictions and the requirements for the imported goods.
  • These include government measures that directly influence the flow of goods (e.g. registration formalities for imports, technical quality requirements for products) and those measures that have an impact on the flow of goods without trade policy motives (e.g. environmental product standards). Technical trade barriers are of great importance here. These are state measures that impose requirements on the import, marketing and manufacture of goods. The technical standards can restrict trade if they are inconsistent in different countries. As a result, manufacturers, importers and exporters are forced to determine the applicable requirements for the individual markets and to adapt their goods to the various requirements. In addition, a certification must be obtained through conformity and approval procedures, which proves the compliance of the product with the technical standards in the importing country. Without such a certification, the product is usually not marketable in the importing country.
  • Furthermore, the domestic industry is protected by specific subsidies and import quotas (quantitative import restrictions). A country uses import quotas to determine which product and in what quantity may be imported into the respective country. These are implemented by the state and are not under the control of the GATT or the WTO .
  • Self-restraint agreement , also understood as a voluntary export restriction , is a special form of quotas (e.g. quantity or value restrictions, even setting a minimum price for export goods) that is best used to eliminate foreign competitive pressure. Here, a foreign producer more or less voluntarily restricts its export to another country, mostly under pressure from that country.
  • In the monetary area, the devaluation of the domestic currency ( exchange rate protectionism ) due to differences in the currency system is also important.
  • In addition, the differences in culture, living environment and law have an impact on the comparative advantages of an economy.

High transport costs can be a barrier to trade. The transport costs do not change the existence of a comparative advantage, but if they overcompensate for the cost advantage, the production of the respective good in your own country is cheaper than the import.

Critical consideration

The comparative cost advantage can only lead to an international division of labor and welfare gains if free trade is granted. International regulations such as those of the WTO ( World Trade Organization ), TRIPS and GATS ( General Agreement on Trade in Services ) attempt to dismantle certain trade barriers. In 1980, for example, subsidies were banned by the GATT regulations, but the subsidy practice still exists.

In political discussions it is always pointed out that the local economy, especially jobs, must be protected from “ cheap goods ” and the associated low wages abroad (see also exploitation ).

Arguments for free trade from a political and economic point of view

Arguments against free trade from a political-economic point of view

  • However, the comparative advantage (free trade) can also be a disadvantage for economically weaker countries. If, for example, a large country (from an economic point of view) introduces a tariff ( import duty ) for a certain good, the world market price of this good will drop sharply and the home country can purchase the goods cheaper than in the previous free trade situation. The terms-of-trade effect can thus increase domestic welfare . In the case of a small country whose demand has no influence on the world market, the world market price of the imported goods remains constant after the tariff collection. This consideration is based on the theory of the optimal tariff.
  • Ricardo's finding of relative advantages improves Smith, who suggested that absolute cost advantages determine foreign trade. Historically, exchanging English cotton cloth for Portuguese wine - Ricardo's example - was a colonial relationship as England protected Portugal from being conquered by Spain. British guns also helped Latin American landowners get rid of Spanish rule and freely import and export to and from England. Adam Smith and others observed that enlarged markets make industrial products cheaper as they deepen the division of labor. The landowners thus won over the falling prices of industrial products and the growing English demand for their raw materials. But the falling prices of English industrial products also ruined traditional industry worldwide and made England the workshop of the world. This gave the unions - legalized since 1867 - a bargaining power that agricultural workers can never match. The prices of the exported industrial goods now included the high wages of the industrial workers, while the imported raw materials often only covered subsistence wages. The earlier dynamic change in the exchange prices of raw materials for industrial products was turned on its head and underdevelopment developed.

Samuelson's appreciation of the comparative cost advantage theory

Stanisław Ulam , mathematician and co-inventor of the hydrogen bomb , used to tease Samuelson : “'Tell me a statement in the social sciences that is both true and non-trivial'. That was the test I [Samuelson] never passed. But now, some thirty years later ... I can think of an appropriate answer: Ricardo's theory of comparative cost advantages. ... There is no need to tell a mathematician that it is logically true; that it is non-trivial, testify to the thousands of important and significant people who were never able to understand or believe this doctrine for themselves after it was explained to them. "

literature

Individual evidence

  1. ^ J. Schumann: English classical foreign trade teachings, their reception and further development of the German classical economics of the 17th century. In: H. Scherf (Ed.): Studies on the development of economic theory VI. German economics of the 19th century. Duncker & Humblot, Berlin 1988, pp. 29-64.
  2. ^ P. Krugman, M. Obstfeld: Internationale Wirtschaft. 8th edition, Munich a. a. 2009, p. 59.
  3. ^ P. Krugman, M. Obstfeld: Internationale Wirtschaft. 8th edition, Munich a. a. 2009, p. 75.
  4. ^ P. Krugman, M. Obstfeld: Internationale Wirtschaft. 8th edition, Munich a. a. 2009, p. 90.
  5. ↑ Werner Hoyer, W. Eibner: Microeconomic Theory . 4th revised, ext. Edition. UVK, Konstanz 2011, ISBN 978-3-8252-8418-3 , p. 212 .
  6. ^ P. Krugman, M. Obstfeld: Internationale Wirtschaft. 7th edition, Munich a. a. 2006, p. 172.
  7. ↑ Horst Siebert: Foreign trade. 7th edition, chapter 10.
  8. ↑ Dieck Heuer: International Economic Relations. 3rd edition, p. 460.
  9. ↑ Horst Siebert: Foreign trade. 7th edition pp. 189-190, 195.
  10. ↑ Dieck Heuer: International Economic Relations. 3rd edition, pp. 472-474.
  11. ^ Gernot Sieg: Economics. 2nd edition, Oldenbourg Verlag, Munich, pp. 384-386.
  12. ↑ Klaus Rose, Karlhans Sauernheimer: Theory of foreign trade. 14th edition, Verlag Vahlen, 2006, pp. 600–630.
  13. ^ David Ricardo: Principles. Chapter VII: On Foreign Trade.
  14. ↑ Celso Furtado: Formação Econômica do Brasil. RJ, Fundo de Cultura, 1959.
  15. ^ Adam Smith: "... that the Division of Labor is limited by the Extent of the Market." In: Wealth of Nations. Book 1, Chap. III.
  16. ^ The Collected Scientific Papers of Paul A. Samuelson. Volume 3, p. 683, MIT Press, 1966.