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These argue instead that while a country may initially be comparatively disadvantaged in a given industry such as Japanese cars in the s , countries should shelter and invest in industries until they become globally competitive.
Further, they argue that comparative advantage, as stated, is a static theory — it does not account for the possibility of advantage changing through investment or economic development, and thus does not provide guidance for long-term economic development.
Much has been written since Ricardo as commerce has evolved and cross-border trade has become more complicated. Today trade policy tends to focus more on " competitive advantage " as opposed to "comparative advantage".
Several arguments have been advanced against using comparative advantage as a justification for advocating free trade, and they have gained an audience among economists.
For example, James Brander and Barbara Spencer demonstrated how, in a strategic setting where a few firms compete for the world market, export subsidies and import restrictions can keep foreign firms from competing with national firms, increasing welfare in the country implementing these so-called strategic trade policies.
However, the overwhelming consensus of the economics profession remains that while these arguments are theoretically valid under certain assumptions, these assumptions do not usually hold and should not be used to guide trade policy.
Galbraith disputes these claims of the benefit of comparative advantage. He states that "free trade has attained the status of a god" and that ".
But this is not generally the case. For manufactured products, increasing returns, learning, and technical change are the rule, not the exception; the cost of production falls with experience.
With increasing returns, the lowest cost will be incurred by the country that starts earliest and moves fastest on any particular line.
Potential competitors have to protect their own industries if they wish them to survive long enough to achieve competitive scale. Galbraith then explains that nations trapped into specializing in agriculture are condemned to perpetual poverty.
Agriculture is dependent on a finite natural resource called land. As the population increases the per capita land resources decreases. Also the average farm size has also been increasing.
If a nation is not allowed to expand into manufacturing and only specialize in agriculture, that nation is condemned to an ever expanding poverty.
The strength of free trade is its weakness. A diverse economy is a healthy economy. A specialized economy is a weak economy.
According to historian Cecil Woodham-Smith , Ireland in the s is an example of the dangers of specialization.
When the union with Great Britain was formed in , Irish textile industries protected by tariffs were exposed to world markets where England had a comparative advantage in technology, experience and scale of operation which devastated the Irish industry.
Ireland was forced to specialize in the export of grain while the displaced Irish labor was forced into subsistence farming and relying on the potato for survival.
When the potato blight occurred the resulting famine killed at least one million Irish in one of the worst famines in European history.
As Woodham-Smith would later comment, "the Irish peasant was told to replace the potato by eating his grain, but Trevelyan once again refused to take any steps to curb the export of food from Ireland.
The classical and neoclassical formulations of comparative advantage theory differ in the tools they use but share the same basis and logic.
Comparative advantage theory says that market forces lead all factors of production to their best use in the economy.
It indicates that international free trade would be beneficial for all participating countries as well as for the world as a whole because they could increase their overall production and consume more by specializing according to their comparative advantages.
Goods would become cheaper and available in larger quantities. Moreover, this specialization would not be the result of chance or political intent, but would be automatic.
However, the theories of free trade and comparative advantage are based on assumptions that are neither theoretically nor empirically valid :.
The international immobility of labour and capital is essential to the theory of comparative advantage. Without this, there would be no reason for international free trade to be regulated by comparative advantages.
Classical and neoclassical economists all assume that labour and capital do not circulate between nations. At the international level, only the goods produced can move freely, with capital and labour trapped in countries.
David Ricardo was aware that the international immobility of labour and capital is an indispensable hypothesis.
He devoted half of his explanation of the theory to it in his book. He even explained that if labour and capital could move internationally, then comparative advantages could not determine international trade.
Ricardo assumed that the reasons for the immobility of the capital would be: Neoclassical economists, for their part, argue that the scale of these movements of workers and capital is negligible.
They developed the theory of price compensation by factor that makes these movements superfluous. In practice, however, workers move in large numbers from one country to another.
Today, labour migration is truly a global phenomenon. And, with the reduction in transport and communication costs, capital has become increasingly mobile and frequently moves from one country to another.
Moreover, the neoclassical assumption that factors are trapped at the national level has no theoretical basis and the assumption of factor price equalisation cannot justify international immobility.
Moreover, there is no evidence that factor prices are equal worldwide. Comparative advantages cannot therefore determine the structure of international trade .
If they are internationally mobile and the most productive use of factors is in another country, then free trade will lead them to migrate to that country.
This will benefit the nation to which they emigrate, but not necessarily the others. An externality is the term used when the price of a product does not reflect its cost or real economic value.
The classic negative externality is environmental degradation, which reduces the value of natural resources without increasing the price of the product that has caused them harm.
If prices are wrong due to positive or negative externalities, free trade will produce sub-optimal results .
For example, goods from a country with lax pollution standards will be too cheap. As a result, its trading partners will import too much.
And the exporting country will export too much, concentrating its economy too much in industries that are not as profitable as they seem, ignoring the damage caused by pollution.
On the positive externalities, if an industry generates technological spinoffs for the rest of the economy, then free trade can let that industry be destroyed by foreign competition because the economy ignores its hidden value.
Some industries generate new technologies, allow improvements in other industries and stimulate technological advances throughout the economy; losing these industries means losing all industries that would have resulted in the future .
Comparative advantage theory deals with the best use of resources and how to put the economy to its best use.
But this implies that the resources used to manufacture one product can be used to produce another object. If they cannot, imports will not push the economy into industries better suited to its comparative advantage and will only destroy existing industries .
Comparative advantage theory allows for a "static" and not a "dynamic" analysis of the economy. That is, it examines the facts at a single point in time and determines the best response to those facts at that point in time, given our productivity in various industries.
It does not indicate how best to transform factors of production into more productive factors in the future .
According to theory, the only advantage of international trade is that goods become cheaper and available in larger quantities. Improving the static efficiency of existing resources would therefore be the only advantage of international trade.
And the neoclassical formulation assumes that the factors of production are given only exogenously. Exogenous changes can come from population growth, industrial policies, the rate of capital accumulation propensity for security and technological inventions, among others.
And this is not affected by what is called "dynamic comparative advantage". In these models, comparative advantages develop and change over time, but this change is not the result of trade itself, but of a change in exogenous factors .
However, the world, and in particular the industrialized countries, are characterized by dynamic gains endogenous to trade, such as technological growth that has led to an increase in the standard of living and wealth of the industrialized world.
In addition, dynamic gains are more important than static gains. The volume of trade may change, but international trade will always be balanced at least after a certain adjustment period.
The balance of trade is essential for theory because the resulting adjustment mechanism is responsible for transforming the comparative advantages of production costs into absolute price advantages.
And this is necessary because it is the absolute price differences that determine the international flow of goods. Since consumers buy a good from the one who sells it cheapest, comparative advantages in terms of production costs must be transformed into absolute price advantages.
In the case of floating exchange rates, it is the exchange rate adjustment mechanism that is responsible for this transformation of comparative advantages into absolute price advantages.
In the case of fixed exchange rates, neoclassical theory suggests that trade is balanced by changes in wage rates .
So if trade were not balanced in itself and if there were no adjustment mechanism, there would be no reason to achieve a comparative advantage.
However, trade imbalances are the norm and balanced trade is in practice only an exception. In addition, financial crises such as the Asian crisis of the s show that balance of payments imbalances are rarely benign and do not self-regulate.
There is no adjustment mechanism in practice. Comparative advantages do not turn into price differences and therefore cannot explain international trade flows .
Thus, theory can very easily recommend a trade policy that gives us the highest possible standard of living in the short term but none in the long term.
This is what happens when a nation runs a trade deficit, which necessarily means that it goes into debt with foreigners or sells its existing assets to them.
Thus, the nation applies a frenzy of consumption in the short term followed by a long-term decline. The assumption that trade will always be balanced is a corollary of the fact that trade is understood as barter.
The definition of international trade as barter trade is the basis for the assumption of balanced trade. Ricardo insists that international trade takes place as if it were purely a barter trade, a presumption that is maintained by subsequent classical and neoclassical economists.
The quantity of money theory, which Ricardo uses, assumes that money is neutral and neglects the velocity of a currency.
Money has only one function in international trade, namely as a means of exchange to facilitate trade . In practice, however, the velocity of circulation is not constant and the quantity of money is not neutral for the real economy.
A capitalist world is not characterized by a barter economy but by a market economy. The main difference in the context of international trade is that sales and purchases no longer necessarily have to coincide.
The seller is not necessarily obliged to buy immediately. Thus, money is not only a means of exchange. It is above all a means of payment and is also used to store value, settle debts and transfer wealth.
Thus, unlike the barter hypothesis of the comparative advantage theory, money is not a commodity like any other.
Rather, it is of practical importance to specifically own money rather than any commodity. And money as a store of value in a world of uncertainty has a significant influence on the motives and decisions of wealth holders and producers .
Ricardo and later classical economists assume that labour tends towards full employment and that capital is always fully used in a liberalized economy, because no capital owner will leave its capital unused but will always seek to make a profit from it.
From a theoretical point of view, comparative advantage theory must assume that labour or capital is used to its full potential and that resources limit production.
There are two reasons for this: In addition, this assumption is necessary for the concept of opportunity costs. If unemployment or underutilized resources exists, there are no opportunity costs, because the production of one good can be increased without reducing the production of another good.
Since comparative advantages are determined by opportunity costs in the neoclassical formulation, these cannot be calculated and this formulation would lose its logical basis .
In this case, a State could even earn more by refraining from participating in international trade and stimulating domestic production, as this would allow it to employ more labour and capital and increase national income.
Moreover, any adjustment mechanism underlying the theory no longer works if unemployment exists . In practice, however, the world is characterised by unemployment.
Unemployment and underemployment of capital and labour are not short-term phenomena, but are common and widespread.
Unemployment and untapped resources are more the rule than the exception. From Wikipedia, the free encyclopedia.
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