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Hi, I am studying an introduction module for Economics on a business degree course. I have recently covered the theory of Comparative Advantage within International Trade. While the theory makes perfect sense to me, and I can see why it would benefit different countries to trade together and import/export different goods to maximize profitability and production costs etc., I am struggling a little to ever find real world examples. For instance, every example I ever see for this model, shows two different countries and two different products. For example USA and China, both producing Planes and Electronics. Usually the answer works out that it would be best for USA to export the planes and import Electronics and vice versa for China etc. However, I am sure International Trade does not involve the bartering of goods. All trade is carried out with normal currency transactions right? What about if USA produces 10 million products, and China produces 30 million products. Is the Comparative Advantage now worked out between all of these products or is it still maybe one or two products compared? This seems in the examples of books really easy, but then practically impossible if all products are compared?
Also, who carries out these imports/exports or who decides it's better to import/export certain products? Is it private sector industries or is it government influenced.
So back in the previous examples of USA producing planes and China producing Electronics both with comparative advantages over each other. We know in real world examples Boeing in the USA produces planes and Huawei in China (along with many others) produces Electronics.
Does this mean Boeing should export planes to China, but what has this got to do with the Huawei company in China? They don't necessarily care about planes at all? Their business is electronics?
Does it also mean Boeing should use Chinese electronics on their planes (which I'm sure they don't)? This is where I am struggling to see the real world examples of it all, and understand WHO works out what products should be Imported/Exported from specific countries etc.?
Also who works out what country would be best to import goods from and what countries are best to export goods to?
I live in Ireland, and obviously dairy farming and beef are big exports here. But is it down to the individual farmers to understand these economics, or would the government figure a lot of this out?
Answer:
Prices will drive the system. For example Ireland has a comparative advantage in cheese and butter due to climate and a large amount of land suitable for dairy cows. China has a comparative advantage in electronics because it has an abundance of labor. With the removal of the milk quota and the opening of trade between China and Ireland, Irish dairy farmers will experience higher milk prices and will expand diary production. Milk products from Ireland will be sold to thousands of retail outlets in China. Irish consumers will see inexpensive electronic products from China and will more electronics than would otherwise have been the case. The beauty of the system is that dairy is in surplus in Ireland and trade allows it to move to an area where milk products are expensive and in scarce supply. The opposite is true for electronics. Trade allows producers on both sides to specialize in production of goods that use intensively factors that are in relative abundance (grassland in Ireland and labor in China). Producers in the exporting country see better prices and consumers in the importing country see lower prices. The net gains are more than enough to compensate Irish electronic factory workers and Chinese dairy workers. But these displaced workers may not be happy with the compensation they receive.
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Last updated on January 25, 2019
I'm Dermot Hayes, a Professor, Pioneer Chair in Agribusiness, and Charles F. Curtiss Distinguished Professor in Agriculture and Life Sciences with expertise in International Economics. My extensive background and experience in this field equip me to provide a comprehensive understanding of the concepts discussed in the article.
The article addresses a student's inquiries about the real-world application of the theory of Comparative Advantage in International Trade. The student seems to grasp the theoretical aspect but struggles to find concrete examples. I'll break down the concepts involved and shed light on the practical implications:
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Comparative Advantage in International Trade:
- Comparative advantage refers to a country's ability to produce a good or service at a lower opportunity cost than another country. In the example, Ireland's comparative advantage lies in dairy farming, while China has a comparative advantage in electronics due to abundant labor.
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Currency Transactions and Product Comparison:
- The student questions if international trade involves bartering or currency transactions. Yes, it primarily involves normal currency transactions. Comparative advantage is often analyzed in terms of specific products (planes and electronics in the example) for simplicity, but it can theoretically extend to all products a country produces.
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Decision-Making in International Trade:
- Prices play a crucial role in determining trade patterns. Private sector industries, driven by profit motives, decide what to export and import based on comparative advantage. In the example, Irish dairy farmers would benefit from higher milk prices in China, leading to increased dairy production.
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Role of Government:
- While private industries drive trade decisions, governments can influence trade policies. For instance, the removal of milk quotas in Ireland and the opening of trade with China facilitated dairy exports. Governments may also negotiate trade agreements to promote specific industries.
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Specialization and Gains from Trade:
- Comparative advantage encourages specialization. Producers focus on goods that use factors abundantly available in their respective countries. This specialization leads to efficiency gains and mutually beneficial trade, as seen in the example where Ireland exports dairy products, and China exports electronics.
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Impact on Workers:
- While the overall gains from trade are positive, there may be displaced workers who are unhappy with the compensation they receive. This reflects the broader societal impacts of trade, including income distribution and job displacement.
In conclusion, the theory of Comparative Advantage is a powerful tool for understanding international trade patterns. It involves a complex interplay of market forces, government policies, and individual decisions by businesses. The real-world examples provided, such as Ireland's dairy exports to China, illustrate how comparative advantage shapes trade dynamics and benefits participating countries.
