Theory of Comparative Advantage and its Relation to World Trade
International trade has become inevitable for many nations because of the comparative advantage each country has over the others in the production of some products. Most countries are now engaging in the production of products with more comparative advantage and absolute advantage, and importing those with less comparative advantage and no absolute advantage (Barfield, 2001). This paper discusses the theory of comparative advantage, and its relation to world trade. It will also explain the arguments for and against world trade.
According to the law of comparative advantage, a nation should concentrate on producing and exporting commodities that have a smaller absolute disadvantage, and import other commodities that have a larger absolute disadvantage. According to the comparative advantage law, all nations that trade with each other, with each of them producing only what they have a smaller absolute disadvantage in, should benefit mutually from the trade; therefore, nations should not shy away from specializing in the production of one product (Barfield, 2001).
Before the nineteenth century, the comparative advantage theory was not used in trade among nations, mercantilism was the only economic philosophy used. Mercantilism restricted imports and encouraged nations to increase their exports. Adam Smith countered the mercantilist economic philosophy with that of absolute advantage. His argument was that nations trading among each other cannot become rich simultaneously because as one nation exports, the other imports (Suranovic, 2009). According to Smith, nations can only gain simultaneously when the trade is not restricted, and specialization is only on absolute advantage.
However, Smith’s concept did not consider the fact that there is a possibility that a nation can lack absolute advantage. This might be because the allocation of resources is static, a problem that made David Ricardo become concerned. Ricardo thought of comparative advantage, a concept that according to him is determined by the productivity ratios of labor. He says that the value of a product is determined by labor, a factor that controls all other factors of production. Ricardo was supported by Richard Cobden, who believed that when free trade is based on comparative advantage, it fosters world peace; according to Cobden, commercial relationships among nations can lead to competitive relationships between states (Suranovic, 2009).
The WTO is among the trade agreement that is based on the principle of comparative advantage. Earlier, it was referred to as GATT, and its goal was to reduce tariffs among member states, and prohibit protective trade measures put by most nations. In 1995, the WTO replaced GATT, but the principles were based on those of the GATT (Suranovic, 2009). However, its creation focused on solving issues that were not sufficiently covered by GATT. The WTO later came up with its own principles, which include promoting fair competition among nations, promoting freer trade, encouraging economic reforms and development, and promoting trade without discrimination (Suranovic, 2009).
Countries that engage in world trade hope to achieve more revenues through the increased sales of their products, and improve their relations with other nations. However, there are accusations of world trade contributing to the deterioration of the local environments. Most trade agreements do not allow barriers put by nations to safeguard the environment. For instance, a nation’s act on clean energy can be declared illegal by WTO if it restricts business activities of foreign firms, and this can greatly affect the local environment (Stephen & Edward, 2000).
When a country engages in the world trade, it also risks things like national sovereignty and democracy. This is because the laws made by such a nation have to conform to the rules set by the WTO. For instance, laws to protect new and upcoming domestic industries are prohibited. The democracy of a nation is affected because that the laws of international trade that a nation is forced to forced to follow are made by other people from the developed nation; for developing countries, they need only to follow the laws without question, or complaint (Stephen & Edward, 2000).
Comparative advantage between countries may come naturally, and sometimes because of the history of the development of a country. However, regardless of its cause, it leads to trade among countries. This trade might be a blessing to a nation, especially developing nations in terms of revenue and good relations with other nations, or a curse in terms of contribution to the deterioration of the environment and loss of sovereignty and democracy. Therefore, each nation that wants to engage in world trade should know its gains and losses before it consents, and signs the agreement