Problems With Comparative Advantage and Specialisation

Comparative advantage is the ability to produce a good relatively more efficiently than a trading partner. The law of comparative advantage states that overall trade can be increased if all individuals specialise in producing the goods in which they have comparative advantage.

Even if one country has absolute advantage (the ability to produce both goods more efficiently than a trading partner) in the production of two goods over another country, they may still benefit from specialisation, as the opportunity cost of their producing one good could be markedly higher than the opportunity cost of their producing the other good (relative to another country).

The theory of comparative advantage makes several assumptions:

1. Perfect occupational mobility - all factors of production can be switched immediately from the production of one good to the production of another
2. The trading countries only produce two goods
3. Absence of transport costs
4. There are no economies of scale as a result of specialisation
5. There are no externalities in the production or consumption of either good

Of course when put into practice many of these assumptions are not met. For example, factors of production tend not to be perfectly mobile, for example - labour. Workers trained in the production of shoes could not suddenly switch to producing cars because the government decided that it would be more efficient for the country to specialise in car production, they would have to be re-trained. Also many capital goods used in shoe production may not be appropriate for computer production. The assumption that trade only occurs between two countries and with two goods is also never met.

Presence of barriers to trade may also inhibit comparative advantage. If China has a huge comparative over the USA in textile production, but the USA (wishing to protect its own textile industry) has placed a tariff barrier on the import of Chinese textiles, this weakens China's comparative advantage, as do transport costs.

Finally, countries may wish to maintain some degree of autonomy. Many countries would not like to be reliant upon another for agricultural produce production or arms production because this leaves them very vulnerable in the case of war or (when looking at agricultural produce) supply shocks in that country. Similarly specialising entirely in the production of one good leaves the country vulnerable to changes in demand for that good on the world market - diversification can help cover risk.