Comparative vs. Absolute Advantage in Global Trade

Global trade is a complicated endeavor in which countries attempt to maintain a level playing field but still gain advantages wherever they can. Maintaining the right balance is a lot like a dance. Unfortunately, no type of global trade can be 100% equitable. This is easily understood by examining what is known in global trade as comparative and absolute advantage.

In base terms, advantage in the global trade arena is economic advantage. Companies involved in international trade seek whatever advantages they can get. Likewise, countries develop their trade policies based on the dual principles of maximizing advantage and minimizing disadvantage.

Comparative Advantage

Imagine two countries trying to protect their domestic markets by limiting imports of cheaper goods. The Investopedia website uses the example of Portugal and England in explaining comparative advantage. In their example, Portugal is capable of producing wine cheaply. They cannot do the same with cotton. England’s situation is just the opposite. Cotton is relatively cheap to produce but wine is not.

Both countries could attempt to protect domestic production by limiting imports. Portugal could insist on producing its own cotton at a much higher price while England could still encourage domestic wine production. The principle of comparative advantage discourages them from doing so.

Comparative advantage suggests that both countries could benefit through trade. Practically speaking, Portugal would reduce its cotton production while England would not produce as much wine. They would trade those two products in comparative volumes, thus allowing both countries access to cheaper goods than they could produce domestically. Production of additional volumes for export would only strengthen the two country’s domestic markets.

Absolute Advantage

Absolute advantage exists when manufacturers in a given country can produce a product at a lower absolute cost per unit compared to manufacturers in other countries. They achieve this through greater efficiency and requiring fewer inputs.

Using the previous example, Portugal would have an absolute advantage over England in terms of wine production if the absolute production cost of their wine products were consistently lower than England’s due to greater efficiency and fewer inputs.

It is possible for absolute and comparative advantage to exist simultaneously. What makes absolute advantage problematic is when countries use it to their own benefit without any regard to reciprocation. For example, Portugal could use its absolute advantage to dominate the English wine market without reciprocating by importing English cotton.

Market Balance Through Regulation

Entities like the World Trade Organization (WTO) attempt to moderate both comparative and absolute advantage to maintain a balance. They do so through regulation. Companies like Ohio-based Vigilant Global trade Services exist to help importers and exporters to navigate complex regulatory regimes. It is all part of the delicate dance.

The fact is that international trade is highly competitive. Countries are no different from individual companies in the sense that they look to gain advantages wherever they can find them. Where trade balances do exist, countries want those imbalances to tilt in their favor. That’s why politicians campaigning on international trade issues talk about trade deficits so often.

The thing about comparative and absolute advantages is that they will always exist. No amount of international trade regulations can generate true equity across the board. The best that regulators can hope for is to manage advantages and disadvantages in an effort to prevent extremes.

When managed correctly, comparative advantage benefits all parties equally. When absolute advantage is the priority, comparative advantage is too easily left by the wayside. A prolonged absolute advantage can be utilized to manipulate markets and prices to the extent that one country exercises dominance over another.

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