Examine and critically assess the extent to which the theory of comparative advantage can explain how scarce resources are produced, consumed and allocated in the global economy.
Concept of Comparative Advantage
Scarce resources are any kinds of resources which are much lesser in the environment and the economy than its desired level of use. Land and the labour are the two resources in the literature of economics and both these resources are scarce or limited as well. Apart from that, natural resources of the country are also other scarce resources which contribute to the production processes. However, due to the limited stock of these resources on earth, the management of the production units needs to make sure they are used as accurately as possible so that each of the resources produce the maximum value for the economy increasing the overall production. The aim of this paper is to examine and understand how the theories of comparative advantage explain the use of scarce resources in the economy.
Comparative advantage is the benefit enjoyed by a country in terms of producing a specialised good or services as the opportunity cost for that product is lower compared to other countries. Comparative advantages also guide the countries to specialise in a single production so that the scarce resources are properly used. Bahar, Hausmann, and Hidalgo (2014) commented that the specialising in production as guided by the comparative advantage leads to overall maximisation in the production level of the world as a whole. There is an exemplary theory regarding the comparative advantage and trade which was put forward by economist David Ricardo. Specialising in the production of the good which provides comparative advantage also requires allocation of the scarce resources which leads to higher production and consumption eventually.
Using all the resources in two different production processes, country A and country B produces 30 cars, 6 trucks, and 35 cars, 21 trucks respectively. Seeing this example, it may seem that in both the production the country B excels and hence it should produce both the products. However, each of the countries has a comparative advantage over others for the production of the specific product. This example shows that the country B should specialise in the production of the truck while the country A should concentrate on the production of cars as per the comparative advantage they have. Under this theory, the country will allocate all the resources of the country to the production of the goods in which they have a comparative advantage. The resources, according to the theory are immobile and hence cannot travel to the other countries for the production of the goods in which they have their skills. The skills of the existing resources of the country need to be transformed and allocated for the production of the single product. The opportunity cost or the comparative advantages of producing a specific good is also constant as this theory is a static theory. Then the products of the two countries will be traded as per their relative prices which will also depend on the opportunity cost of the producing that good in the respective economy. Cai and Stoyanov (2016) pointed out that, the gains from trade, in this case, exists due to the fact that the relative prices of the products, under this theory is between the opportunity cost of producing that product by the two countries. Therefore, using the same amount of resources, the country together will be able to produce more of the two types of the product resulting in positive gains from trade for both the countries.
Allocation of Scarce Resources in Production
Figure 1: The production and consumption of the trade
(Source: Dwyer, 2015)
Figure 2: the production and the consumption after the trade
(Source: Camagni, 2017)
Consequently, the use of the scarce productive resources will be accurate and hence the overall production from the perspective of the world will be high. Manova et al. (2015) pointed out that, distribution or the allocation of the resources through this process also will increase the overall value of factors as well. However, this theory does not consider different types of cost associated with the production process which could have impacted the current allocation and the production of the resources as per the comparative Ricardian advantage model. Apart from the labour cost, there is no cost such as the machineries, transportation and many more which have been shown through the model and therefore this theory is not accurate in terms of explaining the production and the allocation of the resources. Again, although this theory guides the countries to specialise in a single product, it does not assume that there is diminishing marginal returns to scale for the factors of production. The consideration of this assumption would have changed the PPF of the both countries. In the case of consideration of the diminishing marginal returns, the PPF of the countries would have become bowed out and hence the finding, as suggested by the theory would have been different. Costinot and Rodríguez-Clare (2014) highlighted that, in the real world, there is perfect mobility of the factors and the transportation cost as well which is completely ignored by the theory. Therefore, for the specialisation in the real world this theory does not work well. Salike and Lu (2015) pointed out that the opportunity cost as assumed in the theory is constant which in general is not. Therefore, specialisation in the production of one good in order to maximise the overall global production does not hold true in case of the real world. The theory in this case depicted a straight line PPF for both the countries due to the fact that the theory did not consider the diminishing returns to the factors of production which explains the real world phenomena more closely than a constant return in case of the use of labours.
Furthermore, the theory states that, under the trade system as per the comparative advantage, all the labours of the world will be employed for the production. According to the principle of the theory, all the labours of the country needs to be devoted to the production of that one product which provides the comparative advantage to the country compared to the other countries. This can also be challenged as the full employment under this system is not possible. This is due to the fact that, in the real world, it is not possible for the workers to transfer their skills from one to another in a short period of time; neither can they go to the other countries for the production of the good in which they have the skills. Therefore the specialisation as guided by the comparative advantage leads to short-term unemployment in the economy. However, Glaser (2017) in this regard has pointed out that this is a short-term phenomenon and will get lower in the long term. In addition to that, the theory also fails to explain the rise in the value of the products being specialised by these countries. That means the relative prices of the products and the exchange rate among the countries also have not been considered which could have affected the allocation of the scarce resources in the context of production in the economy. The theory discusses the trade among the two countries in real terms which allows less complexity and error. However, the increase in the prices of one good relative to the other can increase the benefit of the production of that country leading to a different allocation of the resources through the market operation.
Gains from Trade and Production and Consumption Before and After Trade
The theory of comparative advantage is a static theory which assumes that the advantages of the countries are not changeable. Again in the real world, the advantages of the country are not the same especially in the long run. Cai and Stoyanov (2016) pointed out that the advantages of the countries reduce with time especially in case of the scarce resources which are nonrenewable. For example, the amount of natural gas which provides the country with the comparative advantage, in reality, gets reduced thereby reducing the gains from trade of that country. Therefore, the allocation of the resources, for these countries never stays the same as provided by the theory. Again, countries can also come up with a new product which may give the country comparative advantages in new product, over the other countries of the world. For example, Vietnam, from nothing in the year 1985, became one of the largest coffee producers in the world by 2014. Hence the resource allocation stability concept as shown by the theory does not hold true for the real world. The theory, in this case, has also ignored the innovation of the countries which may give more products of comparative advantage to the countries. Many of the countries of the world strive for the food security of the country and hence do not depend fully on the food production of the other country. According to the theory, the country specialising in the nonfood production depends on the food production of the other country completely. This, in the real world, is not true and hence the theory, here, fails to explain the production and the allocation of the resources. In the real world example, a country always allocates a sizable number of resources for the production of the food despite being a producer of nonfood items.
The theory stated by the David Ricardo also assumes that there are only two countries and two products in the world for the simplification of the study. According to the principle of comparative theory, there are only two countries producing only two products. The resource allocation, production and the consumption of the resources have been as per the assumption of the model. However, in reality, this assumption does not comply with the real world which has a huge number of countries and wide ranges of products. Kim and Kim (2015) pointed out that, the allocation of the resources under the real-world circumstances are much more complex than it is shown in the theory. In the context of a single good production as shown by this theory has also attracted criticism from the side of economist such as Paul Krugman who stated that, due to the economies of scale the producers like China can supply the surplus to the global economy thereby meeting the dynamic and the wide ranges of demand of the customers of the market. This has allowed many of the countries of the world to produce more than one goods in the country. Therefore the comparative advantage theory stated by David Ricardo does not draw the full picture of the resource consumption and the allocation of the real world global economy.
Criticisms and Limitations of the Theory
Therefore, the discussion sheds light on the effectiveness of the comparative advantage theory posited by David Ricardo. According to the study of the paper, the theory has shown on paper how the specialisation as per the comparative advantages of the country can be pursued in order increase the global product through the international trade. According to the study of the paper, the theory has failed to explain the real-life production, consumption and the allocation of the scarce resources of the global economy. This has also been discussed that the gap between the assumption of the comparative advantage theory and the real world phenomena has resulted in the incapacities of the theory to depict the original situation in the real world. In the real world, the factors of the production which in this case is the labours only can travel to other parts of the world influencing the allocation and the consumption of the resources. However, the assumption of the theory states that the factors of the production are immobile and the associated costs of production such as the transportation cost have also been ignored. These have resulted in the low level of explanatory power of the comparative advantage theory when it comes to the case of the real world production, consumption and the allocation of the global resources. The extent of the explanation is very much limited to the conceptual framework and hence the contemporary trade activities of the global economies are completely different from the one depicted in the theory posited by David Ricardo.
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