Comparative Advantage and Globalization


Introduction

Several of the readings in this section refer to globalization. From a sociological perspective, globalization is the development of rules by nations to govern international trade for the purpose of increased efficiency in the production and distribution of goods and services. Rules for trade are developed and enforced by organizations such as the World Trade Organization (WTO), a governing body representing a consortium of 153 nations.

The proposed benefits of globalization are: 1) increases in economic productivity achieved through efficient resource allocation, and 2) greater political stability achieved through economic interdependence. Hence, it is assumed that if nations become economically interdependent, they will be less likely to wage war upon one another or tolerate political instability at home. According to some sources, it was the desire to achieve political stability in post-WWII Europe that most influenced the development of the European Union, the first large-scale cooperative economic arrangement among Western, industrialized nations.

Principle of Comparative Advantage

To understand the economic motivation for globalization, it is important to understand the principle of comparative advantage. This principle, attributed to David Ricardo (1772 - 1823), posits that nations can be most productive through specialization in areas where they have a ratio advantage, relative to other nations, in the production of a good or service.

Consider this often used example. Two nations--England and Portugal--produce two commodities--wheat and wine. The cost per unit in labor hours to produce wheat is 15 hours in England and 10 hours in Portugal. The cost per unit in labor hours to produce wine is 30 hours in England and 15 hours in Portugal. Thus, Portugal has an absolute advantage in labor hours to produce both wheat and wine.

But, Portugal has a relatively better ratio at producing wine and England has a relatively better ratio at producing wheat. That is, the ratio of producing wheat to wine in Portuagal is 2/3 whereas the ratio of producing wheat to wine in England is only 1/2. So, even though Portugal has an absolute advantage at producing both wheat and wine, Portugal has a comparative advantage in the production of wine and England has a comparative advantage in the production of wheat.

How can these comparative advantages be used to improve the total production of wheat and wine?

Suppose England has 270 total labor hours at its disposal and Portugal has 180 hours of labor at its disposal (i.e., "labor hours" encompasses size of labor force and technical capacity). Suppose, before trade, that England produces and consumes 8 units of wheat (at 15 hours/unit = 120 hours) and 5 units of wine (at 30 hours/unit = 150 hours) and Portugal produces and consumes 9 units of wheat (at 10 hours/unit = 90 hours) and 6 units of wine (at 15 hours/unit = 90 hours). The total production of wheat equals 17 units and the total production of wine equals 11 units. Now, suppose England specializes in wheat production and Portugal specializes in wine production. England can produce 18 units of wheat (at 15 hours/unit = 270 hours) and Portugal can produce 12 units of wine (at 15 hours/unit = 180 hours). Note that total production of both wheat and wine have increased by one unit! Through specialization and trade, England and Portugal, taking advantage of their comparative advantage, can increase total production of both wheat and wine.

This principle assumes:

  1. no transport costs,
  2. constant costs and no economies of scale,
  3. just two countries producing these goods,
  4. traded goods are interchangeable,
  5. factors of production are perfectly mobile,
  6. perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally, and
  7. no tariffs or other trade barriers (i.e., perceived restrictions on trade).
Obviously, world trade is considerably more complicated than the exchange of two goods between two countries. But taken to a global scale, in theory the principle of comparative advantage should increase productivity for all. The restrictions implied by the first six assumptions listed above presumably can be overcome with trade volume and relatively standard practices of production, transportation, and monetary exchange. If transportation costs are small relative to the volume of trade, for example, then they will not hinder the benefits of globalization.

The key factor that makes this system work is assumption number 7: no tariffs or other trade barriers. The objective of governing bodies such as the WTO, therefore, is to reduce trade barriers as much as possible to optimize the free flow of goods and services worldwide. Thus, nations, working in groups or as single units, usually informed and pressured by multinational corporations, actively pursue restriction of trade barriers within the WTO.

Concerns About Globalization

Much has been written about the possible negative consequences of globalization. Some of the key concerns are summarized below. Research on the Effects of Globalization

The articles linked below summarize key research findings regarding relationships between globalization and wages, income inequality, and social mobility of nation states. Research indicates that Foreign Direct Investment (FDI) tends to increase wage levels and reduce poverty in both developing and developed nations. For developing countries, FDI tends to increase income inequalities in the short run but decrease income inequalities with greater investment over time. For developed countries, FDI tends to decrease income inequalities. Income inqualities among the richest and poorest nations seems to be decreasing. It can be difficult to determine the extent to which changes in wages, income inquality, and social mobility reflect globalization or technological advancements, which themselves result in part from globalization. The research indicates that, overall, globalization seems to be improving the economies of both the developed and developing nations.