Practice Essay: Examine the role of comparative advantage in determining what a country produces for international exchange.

Comparative advantage is the specialisation of a country in one product – the product in which there is the lowest opportunity cost of production. Opportunity cost is the cost of the next best alternative forgone. If we consider a country that only produces two goods (hypothetically), the more they produce of one, the less they can produce of another (see diagram). This is called the countries production possibility frontier and shows the output of an economy when it is using all of its resources.

As you can see from the diagram to the left, by forgoing the production of 50 guns, 10 more units of butter can be produced.  Because of this, countries may choose to specialize in the production of one good or service and trade with another country to receive the other. So if country A has a lower opportunity cost in producing guns and country B has a lower opportunity cost in producing butter, the two can then use all their resources in the production of one and trade with each other.

Of course, in reality, countries tend to produce more then two products, and there are many reasons why countries may not choose to specialize entirely in the production of  products in which they have comparative advantage. Firstly, they may wish maintain a degree of autonomy. The production of only one good leaves a country very dependent on other countries for their goods. If the UK was completely reliant on Country A for supply of agricultural produce, and the two countries then went to war, the UK would not be able to sustain its population and would be vulnerable. Likewise many countries choose to produce their own weapons despite not having comparative advantage, as they don’t want to be left defenceless in the event of war. An example of subsidising the agricultural industry is the common agricultural policy. The EU is a monetary union which practices free trade internally and imposes external tariffs. The EU subsidises its farmers so that they can be guaranteed a minimum price and imposes tariffs and quotas on produce from many other countries. This practice is anti competitive but without it the EU would not be able to maintain a vital industry. The extent to which the countries may want to protect an industry depends on the degree to which the population could live without it – e.g. people have inelastic demand for food and can’t live without it, however the government probably wouldn’t mind only importing (not exporting) something less vital, like ribbon.

Secondly, the rules of comparative advantage break down when product differentiation is considered. With goods such as light bulbs, there’s very little differentiation between the products regardless of where they’re produced. However in other goods, e.g. cars, branding is also an important factor to consider when looking at the international competitiveness of goods. Germany may not have comparative advantage over, say, Japan in the production of cars, but many importers may prefer the quality and design of German cars over Japanese cars. In fact it could be the money and resources used in making the cars in Germany better quality that makes them have a higher opportunity cost then those in Japan. Maybe in this case comparative advantage is less relevant to what the country produces. In terms of quality, some countries have less stringent legislation then others, and so other countries would not want to trade with them regardless of comparative advantage, due to the sub standard goods they produce. This leads to countries blocking the import of goods from these countries (a form of protectionism).

Lastly the government in a democratic country such as the UK, can’t force people to work in the industry in which the country has comparative advantage. Labour is not perfectly mobile and people may be trained in other areas. The government could perhaps provide means of support for those industries however it all depends on the responsiveness of labourers to this. Also people may not be located in the right area to work in these industries e.g. mining can only take place in certain areas. It is hard to shift labour to the necessary areas as people are unable or unwilling to move.

In conclusion, although comparative advantage may maximise a country’s efficiency in producing the good in which they have comparative advantage, it may also leave it vulnerable, and may be impractical for governments to impose on their labour forces so they tend to also look at other factors when considering what to produce for international exchange.