Friday, May 09, 2008


The debunking of comparative advantage

Conventional wisdom says that comparative advantage is a good thing. And that one must stick to it as it is the only enduring economic doctrine. What is comparative advantage ? Simply put it means that nations can benefit by mutual trade. And that a nation must stick on to a commodity which requires it minimum sacrifices relative to producing other commodities. Mind you that it is not related to absolute advantage. The principle of comparative advantage shows that even if a country has no absolute advantage in any product (ie. it is not the most efficient producer for any good), the disadvantaged country can still benefit from specializing in and exporting the product(s) for which it has the lowest opportunity cost of production. Essentially it means that the less advantaged country should only specialise in things in which it is only a little worse off than the bountiful country. This arrangement will maximise output and through trade both countries will be richer.

Now while this is all rational, it is perhaps self-destructive in the long run. In the pursuit of comparative advantage, a country might only produce which has the minimum opportunity cost. Suppose for a given country the most competitive products are primary products (agricultural/nature's bounty). Now acting rationally the country should continue to produce the same. The other sectors may be startegic and might propel the counties on the path of riches in the long run. So sticking to primary sectors is easier - but then industrialisation will never occur. A country may be stuck in exporing raw products without processing them which lead to substantial value-add and moving up the chain. HOwever, moving into other sectors is inevitably attendent with some pain. Moving to other sectors requires moving out of the comfort zone of what is easy. But it has to be done as other sectors might be more strategic - heavy industry, armaments and all sorts of sectors which give a country much more 'power' than agriculture. Not moving beyond the 'rational choice' of competitive advantage may lead a country of efficient farmers and nothing else. So - Comparative advantage is a good theory when one is referring to a static, peaceful and a just world. It aint gonna happen and hence countries need to move beyond comparative advantage.

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