Comparative Advantage Theory in International Business
With the integration of the global economy and the emergence of local and regional economic cooperation organizations, in the open international market environment, many countries will adopt international trade to carry out international economic activities. Among them, the theory of comparative advantage is the most basic and most important theory in international trade. Since the establishment of the method of comparative advantage, this theory has always been the norm for guiding international trade activities and the cornerstone of international trade theory. In 1817, David Ricardo proposed the theory of comparative advantage, indicating that the basis of international trade is the relative difference in production technology and the resulting relative cost difference. Each country should concentrate on producing and exporting its products with “comparative advantages” and importing products with “comparative disadvantages” based on the principle that “the two benefits are equal, and the two disadvantages are taken lightly.” However, in the face of the new economic situation, the theory of comparative advantage has also been continually challenged by its opponents’ theory and experience. With the unremitting efforts of its followers, the theory of comparative advantage has continuously made new progress, making it maintain its final mainstream position in international trade even today when trade theory emerges.
In the current economic environment, trade theory has reached great development, and how to make good use of comparative advantage theory is particularly important. When analyzing trade between the two countries, you can use comparative advantage to investigate why they trade and the possibility of business. The following five articles comprehensively examine the application of comparative advantage theory in international trade, its advantages and disadvantages, and how to effectively circumvent the shortcomings of comparative advantage theory by splitting into traditional horizontal and vertical types.
The narrative of the five documents uses the following logical structure. First, Natalia Ishchukova and Luboš Smutka (2013) and Yoko Asuyama (2012) analyzed the application of comparative advantage. Yoko Asuyama (2012) first pointed out the comparative advantages and technological dispersion between countries and the length of the industrial chain. There is a direct correlation, and then Natalia Ishchukova and Luboš Smutka (2013) use the Russian example to illustrate the comparative advantage of the active development of agricultural export trade. In the third article, Asier Minondo (2011) pointed out the benefits of comparative advantage, which can increase the level of diversification of national product exports. Later, Pauline Lectard and Eric Rougier (2018) highlighted the shortcomings of comparative advantage and the comparative advantage trap. Finally, in the fifth article, Bernard C. Beaudreau (2011) compares the comparative advantage into the traditional horizontal and vertical types, thus weakening the disadvantage of comparative advantage.
The comparative advantage between countries is directly related to the degree of technological dispersion and the length of the industrial chain. In China and India’s international trade, the degree of technology dispersion and the length of the industrial chain lead to a comparative advantage in different industries. Yoko Asuyama (2012) pointed out that China’s economic development has been driven by manufacturing and export growth, while the Indian economy has been driven by services and export growth, such as software, business process outsourcing and call center services. The main reason for this difference is the comparative advantage caused by productivity between the two countries. Yoko Asuyama (2012) emphasizes that the difference in skill distribution between China and India affect its comparative advantage. In most manufacturing industries, the length of the production chain tends to be longer, while in the agricultural, mining and service industries it is shorter. Although the estimates are only applicable to non-service industries, the results also prove that China, a country with a narrowly dispersed technology and a long production chain, has a comparative advantage in large-scale manufacturing, while India is a country with a large technology dispersion. The offshore service industry with a short production chain has a comparative advantage.
Russia has adopted comparative advantages in the export trade of agricultural products for nearly two decades to enable the active development of agricultural trade. Natalia Ishchukova and Luboš Smutka (2013) introduced the analysis of the specialization and comparative advantage of Russian agricultural exports in the article. These analyses used several indices showing comparative advantages, which were calculated between 1998 and 2010. Natalia Ishchukova and Luboš Smutka (2013) argue that the most important agricultural products in Russia are cereals (mainly wheat and barley) and oilseed and vegetable oils (sunflower oil). Significant changes in comparative advantage are related to strengthening its position in several regional markets. Due to its geographical location and good trade relations, Russia has a more significant comparative advantage in trade relations with the CIS countries and Asian countries. During this period, the comparative advantage of processed products did not increase significantly. Effective trade policies should focus on supporting the export of products with the highest comparative advantage. Concerning the Russian Federation, this specialization enables the state to use foreign trade while maintaining a reasonable proportion of basic food self-sufficiency. After Russia’s accession to the WTO, the government can take subsidies to agricultural enterprises, improve the availability of credit and other measures to increase production capacity, and infrastructure construction in areas with comparative advantages is, therefore, more promising. Besides, the development of production capacity in the country will increase the comparative advantage of processed products with higher added value.
A country with a comparative advantage plays a vital role in the level of diversification of national exports. Asier Minondo (2011) shows in the text those countries that have a comparative advantage in certain commodities that are relatively easy to redistribute and deploy knowledge and assets in other products than those that are less competitive and difficult to redeploy. Countries that have a comparative advantage in the development of commodities with assets have more opportunities to diversify their new products. When the state has more comparative advantages in products, it will have more capital to carry out diversification and innovation of products, which will further enhance the country’s comparative advantage in import and export commodities. Asier Minondo (2011) used the National Diversification Possibility Index as a powerful predictor, using nonparametric and parametric techniques to demonstrate that export diversification may not be an automatic outcome of the development process, while products with comparative advantages are explaining exports. The level of diversification plays a crucial role.
To avoid the trap of comparative advantage, developing countries began to transform their industrial structure, but the effect of reforming against comparative advantage was not significant. It is true that trade according to comparative advantage can increase the welfare of the two countries, but the comparative advantage for developing countries is usually the labor with lower added value. In the long run, it will fall into the trap of comparative advantage. To avoid extreme extremism, developing countries need to transform their comparative advantage by changing the industrial structure and attracting FDI. However, Pauline Lectard and Eric Rougier (2018) said that the inverse comparative advantage through data analysis may not systematically bring about structural changes, because the impact of comparative advantage on production transformation depends mainly on the long-term stock of FDI, and this The degree of specialization of the country’s low value-added components in global value chains (GVCs). Therefore, in the long run, it may be a dangerous strategy to resist foreign direct investment to resist comparative advantage, because it often only brings part of the industrialization of artifacts, manufacturing exports increase and manufacturing value added decreases. From this point of view, the comparative advantage is flawed. Beaudreau and Bernard C (2011) deeply analyze the traditional horizontal comparative advantage from the beginning, so try to re-evaluate the applicability of comparative advantage to current trade from the vertical comparative advantage.
The vertical comparative advantage is more able to provide a theoretical basis for international trade activities than the traditional horizontal comparative advantage. Bernard C. Beaudreau (2011) pointed out that conventional parallel comparative advantages were incorrectly specified from the beginning. The 19th century Britain did not have a parallel comparative advantage in textiles and clothing, but a vertical comparative advantage in processing raw materials or processing imported raw materials in the form of cotton and silk, not to mention wool. Today, from large-scale specialization and exchange, self-sufficient regions or countries are still few – that is, vertical self-sufficiency. Districts and states are now more concerned with vertical comparative advantages, some regarding resources, some in technical knowledge, and so on. Concerning policy, vertical comparative advantage can help the country’s transformation and trade development. Today’s developed countries usually have comparative structural advantages regarding knowledge and capital, while developing countries generally have comparative advantages in natural resources and necessary labor. Therefore, vertical comparative advantage can provide a theoretical basis for current international trade activities.
The five selected papers analyzed the comparative advantage theory using a logical structure. Starting from the theoretical application, the factors related to the application of comparative advantage theory are analyzed, and the application of comparative advantage theory in product export is embodied by examples. Later, two articles describe the advantages and disadvantages of comparative advantage theory. Finally, it is proposed to divide the comparative advantage into a new view of traditional horizontal and vertical, and the vertical comparative advantage can more effectively avoid its shortcomings. Through a logical combing, a comprehensive understanding of the nature of comparative advantage theory and its use in international trade.
Since the birth of comparative advantage theory, comparative advantage theory has always been the most basic principle guiding foreign trade policy. In the face of the new economic environment, followers of comparative advantage theory have studied the static and dynamic sources of comparative advantage, and constantly promoted and improved the theory. The analysis of the source of comparative advantage ranges from the factors affecting the supply side to the static analysis of the factors that affect the demand side to the dynamic analysis of the time factor. Each theory has its applicable aspects and no way to explain it, but this is not the case. Influence its position as a cornerstone in international trade and its guiding role in international trade activities. However, when countries use comparative advantage theory to guide the formulation of foreign trade policies, they should pay attention to their national conditions, pay attention to the integration and application of the comparative advantage theory, pay attention to the development of short-term comparative advantage sources and the cultivation of comparative advantages in the long-term, and follow the comparative advantages. And develop a comparative advantage development strategy. At the same time, governments should also pay more attention to the role of the government in the process of comparative advantage in the development of the economy. In today’s science and technology development and education, the role of the comparative advantage created by the improvement of the government’s own quality will continue to emerge.
- Asuyama, Y. (2012). Skill Distribution and Comparative Advantage: A Comparison of China and India. World Development, 40(5), 956-969.
- Beaudreau, B. C. (2011). Vertical Comparative Advantage. The International Trade Journal, 25(3), 305-348.
- Lectard, P., & Rougier, E. (2018). Can Developing Countries Gain from Defying Comparative Advantage? Distance to Comparative Advantage, Export Diversification and Sophistication, and the Dynamics of Specialization. World Development, 102, 90-110.
- Ishchukova, N., & Smutka, L. (2013). Revealed comparative advantage of Russian agricultural exports. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 61(4), 941-952
- Minondo, A. (2011). Does comparative advantage explain countries’ diversification level? Review of World Economics, 147(3), 507-526.