What is comparative advantage?

The economist David Ricardo developed the idea of ​​comparative advantage in the early 1800s, and ideas from the theory are still relevant in explaining how countries trade today.

Based on an analysis by the US Congress, Ricardo argued that specialization and trade are mutually beneficial even if a country is more efficient than its trading partners today. Produce all goods: a country has an absolute advantage if it produces a given good at a lower cost than another country.

But Ricardo argued that because resources, particularly labor, are (assumed) immobile across countries, a comparison of the absolute cost of producing a good in each country is less relevant in determining whether specialization and trade should occur.

Instead, what matters is the opportunity cost: how much production of good Y must be given up to produce one more unit of good X.

Comparative advantage

If the opportunity costs of producing the two goods differ in each country, then each has such an advantage over the other’s goods.

Ricardo predicted that a country can gain from trade by specializing in goods that it can produce relatively well (and in which it has a comparative advantage) and then exchanging them for goods that it produces relatively less well (and in which it has a comparative disadvantage).

Later economic theories have expanded and qualified the theory of comparative advantage.

Economists continue to examine the extent to which comparative advantage explains increasingly complex trade patterns in the 21st century with the emergence of global value chains, where different stages of production of a single good take place in multiple countries, and with the rise of trade in services and digital technology, and cross-border flows of data and technology.