Theoretical Approaches to Economic Growth and Development by Panagiotis E. Petrakis

Author:Panagiotis E. Petrakis
Language: eng
Format: epub
ISBN: 9783030500689
Publisher: Springer International Publishing

10.3 Absolute and Comparative Advantage

The productivity dimension as a source of growth is derived from the Ricardian theory of comparative advantage.2 Ricardo in his work (1817) Principles of Political Economy and Taxation, described a model in which international trade between two countries can be beneficial (for both countries), if each country exports the products in which it has a comparative advantage, which refers to the different labor productivity of each country.

The basic idea behind comparative advantage is that every economy, regardless of how advanced it is in terms of labor productivity compared with other economies, is in a position to exercise a beneficial trade with other economies. The Ricardian model contains a factor of production, work, and is based on the comparative advantage of countries, which determines the international division of labor.

Under this model, international trade leads to growth (increasing global production), as each country specializes in producing the goods in which it has a comparative advantage. Hence, for products of the same quality a country has a comparative advantage, if the relative opportunity cost of producing this product, in terms of production costs (i.e., labor costs), is lower than that of the other country. So, then, if this country produces more and consumes less of this product, given the existence of external demand (since other countries are willing to trade with her), it would achieve the improvement of its production, i.e., development. Finally, the pattern of international trade depends on differences in labor productivity.

The concept of comparative advantage was developed as opposed to the absolute advantage of Smith (1776). According to absolute advantage, international trade takes place when one country exports products in which it has higher labor productivity to another which simply has lower labor productivity, that is, not in comparison to its trading partner. So, in a single world with a production factor that is lagging behind in terms of labor productivity, there should be no external trade.

It should be noted that Ricardo’s theory of comparative advantage has been, from its creation until today, an essential tool of the intellectual toolkit of every economist. Although it has been 200 years since the emergence of this theory, sophisticated models of international trade (Dornbusch, Fischer, & Samuelson, 1977; Eaton & Kortum, 2002) are significantly influenced by the underlying framework of the comparative advantage theory, as it is designed in a very well structured way and the knowledge it imparts is timeless. In more recent works, the Ricardian model extends to the case of many goods (Deardorff, 2007; Dornbusch et al., 1977; Wilson, 1980). In its new version the Ricardian model continues to examine the case of the open economy and the benefits of trade for both countries involved.

Box 10.2 Comparative Advantage (Ricardian Model)

The basic assumptions:

There are two countries, country and one foreign country, , using the vector symbolism Each country produces two goods (usually when explaining the model. The two goods are considered unrelated, e.g., steel and cotton) which we here denote as and . Therefore, we can say

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