Comparative Advantage

Under capitalism, different regions have long specialized in the production of different types of goods and services. In Europe during the Industrial Revolution, for example, Britain became a major producer of textiles, ships, and iron; France produced silks and wine; Spain, Portugal, and Greece generated citrus, wine, and olive oil; Germany, by the end of the 19th century, was a major exporter of heavy manufactured goods and chemicals; Czechs sold glass and linens; Scandinavia produced furs and timber; and Iceland exported cod to the growing middle classes. Within the United States, similarly, different places acquired advantages in some goods and not others. The Northeast was dominated by light industry, particularly textiles; the Manufacturing Belt became the center of heavy industry; Appalachia developed a large coal industry to feed the furnaces of the industrial core; the South grew crops such as cotton and tobacco; the Midwest became the agricultural products behemoth of the world; and the Pacific Northwest was incorporated into the national division of labor based on the expanding timber and lumber industry.

When regions or countries specialize in the production and export of some goods or services, they enjoy a comparative advantage. This notion was first introduced by 19th-century economist David Ricardo (1772–1823). Like all classical political economists, he assumed the labor theory of value (i.e., the value of goods reflects the amount of socially necessary labor time that goes into their production) and thus ignored demand. Ricardo concluded that nations will specialize in the production of commodities that they can produce using the least labor compared with other nations.

Ricardo's classic example of this process is demonstrated in Table 1, which illustrates the allocation of labor time in England and Portugal, two longtime trading partners, before and after they specialized. In the first part, which depicts the labor hours per unit of wine or cloth that England and Portugal must each dedicate to the production of one unit of each good, it is evident that Portugal has an absolute advantage in both goods; that is, it can produce both of them with fewer labor hours than can England. If Portugal is more efficient, does it make sense for Portugal to trade? The answer is yes, implying that even the most efficient producer benefits from trade. Ricardo's analysis examined what happens when each country allocates its resources to the good it can produce most efficiently compared with its trading partners, that is, when it acquires a comparative advantage. Thus, in the second part of the table, England produces only cloth (two units at 100 hours each) and Portugal produces only wine (two units at 80 hours each). In the process of specializing (i.e., of producing for a market that consists of both economies together rather than either economy alone), each country frees up some resources that would otherwise have been dedicated to the inefficient production of a good in which it did not have a comparative advantage. England saves 20 labor hours and Portugal saves 10 labor hours; thus, the combined trading system saves 30 labor hours that can be reallocated toward investment (although the original model is static and says nothing about change over time).

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