Case analysis: The Story of Foreign Trade and Exchange
One of the most powerful and straightforward economic concepts is “comparative advantage.” As important and simple as this concept is, however, it seldom seems to inform public discussions of international trade. Almost everyone “knows” that we can’t compete with countries that have cheap labor—if we have free trade with such countries either wages will be driven down or many workers will lose their jobs. As Will Rogers once observed, “It’s not what people don’t know that is the problem, it is what they do know that’s not true.” Understanding comparative advantage has the same effect on concerns about free trade as water had on the Wicked Witch of the West. Free trade with other countries (regardless of how much or little their workers are paid) doesn’t increase unemployment or lower wages. Indeed, one of the best ways of increasing the wages of U.S. workers is by allowing them to compete with workers (even very low paid workers) in other countries through free trade. Absolute Versus Comparative Advantage. The most straightforward case for free trade is that countries have different absolute advantages in producing goods. For example, because of differences in soil and climate, the United States is better at producing wheat than Brazil, and Brazil is better at producing coffee than the United States. Obviously both countries are better off when Americans produce wheat and exchange a portion of it for some of the coffee that Brazilians produce. But does this mean that a country with an absolute advantage in the production of a good should always produce that good rather than import it? No, as the English economist David Ricardo first explained in the early 1800s. A country can have an absolute advantage in the production of a good without having a comparative advantage. Comparative advantage is what determines whether it pays to produce a good or import it. I assumed that there are only two goods, cars...
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