This paper aims to explain the basis for trade in David Ricardo’s point of view, how the gains from trade generated and compare and contrast his comparative advantage to Adam Smith’s theory of absolute advantage.
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According to an English economist, David Ricardo the basis for trade is to gain more profit as he demonstrate this on his book entitled Principles of Political Economy and Taxation. He promotes free trade or extensions of foreign trade as one of the ways to gain more income while all restrictions to trade will hinder its economic growth like in mercantilist country. High price of tariff taxes imposed to goods and restrictions on policies eliminate exporting products to other countries. Those countries which have free trade agreements will benefit from this system as they economically and effectively allocate their capital and labour. By the means of trade between two countries the amount of labour will be saved. In the globalization period today, influential countries are pressing the developing world to adopt liberalization of trade to support the best way to raise global living standards which is to take full advantage of trade.
Ricardo observed that a country characterized by the most substantial advantages either naturally or artificially in exchanging them for the commodities of other country. ‘Comparative advantage refers to superior features of a country that provide it with unique benefits in global competition typically derived from either natural endowments or deliberate national policies’ (Cavusgil et al 2008, p. 98). In this theory the most important is the comparative efficiency or the ratio between how easily the two countries can manufacture the product. Saudi Arabia is naturally rich in oil as it is known as the world’s leading oil producer and exporter to other country like its fast-growing export to United States of America includes crude oil, fuel oil, liquefied petroleum gases, industrial organic chemicals, and precious metals like gold. Petroleum products with oil and gas represent over 98% of Saudi Arabia’s exports to the U.S. While the artificial export products are textile industrial supplies. In return for such commodities United States of America exporting products to Saudi Arabia are water, wheat, barley, oats, sorghum, corn and fish Saudi’s emerging demand for food and clean water depends on a constant supply of oil revenues from its American trading partner. In addition to that are their artificial import from US are new and used passengers cars, civilian aircraft, industrial engines, drilling and oilfield equipment, generators, electric apparatus, excavating machinery, measuring, testing and control instruments and many other industrial machines.
The predecessor of Ricardo’s theory of Comparative advantage is the theory of Absolute Advantage of Scottish political economist, Adam Smith. Both of them are known in the classical economic theory and Adam Smith has a legendary book which is The Wealth of Nations. Just as Ricardo, he is interested in economic growth through the benefit of trade freely and examined its dependence on international trade. Tariffs and policies are the barriers for trade. They both based their theory on the assumptions that labour is the only one kind of production factor. According to Adam Smith absolute advantage in the production of particular goods or using fewer resources is the only basis for trade (Cavusgil et al 2008, p. 97). The central part of his theory is labour is the source of welfare and the replacement of domestic market with international market will make the partition of labour which will rise productivity through specialisation.
Like in my previous example consider Saudi Arabia and United States is trading partner. Saudi Arabia has an absolute advantage in producing petroleum products and United States has absolute advantage on producing of wheat. Presume labour is the only production used in making both goods. It is clear that Saudi Arabia have abundance of oil to produce petroleum products in which the average worker takes 20 days of labour to produce these products and because of scarcity in water it takes more time to produce which average worker takes 60 days. Compare to its trading partner US which can produce wheat in 30 days and 100 days to produce petroleum products. Saudi Arabia can import wheat from US in exchange of petroleum products (see Appendix A). As a result both countries receive substantial gains from trade since petroleum products and wheat is essential to the advancement of their national living.
China has an absolute advantage in human capital and gives the most economical price of labour but it doesn’t mean it will not engage in trade. Based on Comparative advantage China can export mobile phone and import car from USA since it can save more labour cost rather than producing both (see Appendix B).
Having a comparative advantage is not the same as being the best among the rest of the countries or having an absolute advantage doesn’t automatically have comparative advantage on other country. I consider neither of the two principles is superior to the other. Every country has comparative advantage with different absolute advantages in producing goods or either have an absolute advantage in the production of a good without comprising a comparative advantage. However it doesn’t imply that a country with an absolute advantage in the production of such good should always produce this good rather than import it from other country. Comparative advantage determines whether it pays to produce a good or it is better to import it by measuring what you have forgone or your opportunity cost.
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Comparative Advantage and Absolute advantage is interconnected with each other as they have common interest which is trade for economic growth. In my analysis to David Ricardo’s discernment, I agree with him to value the significance of opportunity cost rather than cost for the reason that it is more practical in a way it gives more value to efficiency of allocating resources and most important is it doesn’t monopolise trading despite it gives chance to small countries to also benefit from trade. Comparative advantage is proportional to the difference between the relative prices in world markets and other relative price that would be successful in domestic markets without trade. If that difference is large, then a country earns a large advantage otherwise if the difference is small, then there is only a small advantage from trade.
Each nation is mutually interdependence with each other as they need to fill up the surplus of other goods specially the natural resources as it vary to the geographical location of the country. In addition to this argument government intervention has a vital role in the balance of trade for the reason that it is characterized by national saving and investment.
Smith and Ricardo’s principle is basically emphasizing the importance of trade in economy. ‘Free Trade could also lead to world peace by substituting commercial relationships among individuals for competitive relationships between countries’ (Richard Cobden).