BUSM4689: Theory of Comparative Advantage in International Business

This report provides a comprehensive analysis of the theory of comparative advantage within the context of international business. It begins with an abstract summarizing the dynamic international business environment and the importance of understanding international trade through various theories. The introduction highlights the challenges and complexities of cross-border business operations, emphasizing the influence of factors such as government policies and technological advancements. The core of the report delves into the theory of comparative advantage, explaining its principles based on opportunity and marginal costs, and illustrating it with examples from the electronics industry. The report then traces the origin and historical context of the theory, attributing its formulation to David Ricardo and comparing England and Portugal's trade dynamics. It also discusses the theory's historical relevance in the context of slave trade and barter trade. The report further examines criticisms of the theory, particularly its impact on developing countries. Finally, it compares past and current facts in international business, highlighting the enduring importance of efficiency and opportunity cost. The report concludes by summarizing the key arguments and insights presented.

Running Head: Theory of Comparative Advantage 1
Political Economy of International Business
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Theory of Comparative Advantage 2
Political Economy of International Business
Abstract
The international business environment remains one of the most dynamic arenas due to
the constantly changing factors. There are myriad factors which tend to influence international
trade which may include government influence, economic levels, differences in levels of
technology and the level of infrastructure just to mention but few. This therefore implies that a
proper understanding of the international business environment basing the arguments on its
historical context is a crucial undertaking (Bernhofen and Brown, 2009). As such, various
theories both modern and old, have been put in place in a bid to offer a better understanding of
the dynamics of international business. This paper relies upon review of contextual literature to
draw facts which better describe international business and the influence of the surrounding
factors. Through the analysis of a modern theory of international business, the discussion shall
seek to establish the historical context of the theory as well as an examination of how the
arguments in the theory enable a better understanding of international business in the current
world (Bernhofen and Brown, 2015).

Theory of Comparative Advantage 3
Introduction
Business operations across borders remain one of the most challenging yet interesting
ventures in the globe. The hurdle involved in international trade at times makes it hard especially
for the developing countries to fully achieve their business objectives. For instance, when the
government taxes become high, the extent to which a country can export and import products is
equally affected (Bernhofen, 2015). At the same time, countries which are more technologically
advanced have higher efficiency levels especially due to the use of machinery in production.
This in turn impacts the costs of production and eventually the amount of goods and services that
the nation is able to present for international trade. There are various theories of international
trade including: trade theory, theory of comparative advantage, and mercantilism and porter
diamond theory just to mention but few. It is a fact worth mentioning that each of these theories
offers a vast perspective of the aspect of international trade hence enabling a clear understanding
of the origin of some of the current trends. This paper however picks on one theory which is the
theory of comparative advantage. The analysis of this theory shall be pegged on the electronics
industry by noting how the countries dealing in the production of electronic gadgets and
equipment have been coping in their trade with one another and with other countries. The
discussion shall equally highlight the historical context of the comparative advantage theory, the
aspects which led to its formulation and consideration as well as the nature of criticism which
have been directed at the theory (Bernhofen and Brown, 2016).

Theory of Comparative Advantage 4
Theory of Comparative Advantage
The theory of comparative advantage largely works on the basis of both opportunity and
marginal costs. When a country is able to produce a given product my incurring relatively lower
costs, then the country is said to have a comparative advantage over another. This comparison
becomes more eminent when the other country tends to incur a lot of costs in production. For
instance, China is a one of the leading producers of cars, trucks as well as electronic appliances
which include household goods. The cost of producing these goods in the country is relatively
lower. This is an aspect which could be associated with the relatively high level of technological
development and presence of machinery in the country. On the other hand, Australia equally
produces cars and other electronic appliances. However, Australia incurs a higher cost of
production mainly as a result of the fewer raw materials available for this particular industry. As
a result, Australia may choose to export to china some of the goods which are readily available in
exchange for the raw materials needed for the electronic industry in the country. Given the fact
that Australia is a country that is rich in natural resources, it mainly exports agricultural products
and energy in the form of liquefied gas and coal (Dixit and Norman, 2010). The two countries
can involve in international trade such that China exports the electronics and cars to Australia
due to the fact that the country is comparatively advantaged. In return, Australia exports natural
gas and agricultural products to China. The gain that comes out of this arrangement is then
referred to as a trade gain. The illustration above distinctly defines the theory of comparative
advantage by bringing out the clear picture that there is the presence of a mutual gain between
the two countries in the process of the international business.

Theory of Comparative Advantage 5
Origin and Historical Context of the theory
Despite the fact that the theory has been mention in Adam Smith’s Book “The Wealth of
Nations” the origin of the theory has been largely associated with David Ricardo. According to
Adam Smith, if it is possible to import a product from another country at a rate that is cheaper
than the cost of producing the same good internally, then it would only be prudent to buy it from
outside rather than produce the good internally (Dornbusch and Samuelson, 2010). The
principal of comparative advantage is however believed to have been formulated by Ricardo in
1817 in his book titled “The Principals of Political Economy and Taxation.” In this book, he
distinctly addresses the theory using a comparison between England and Portugal. He gave an
analogy concerning the products produced by the two countries. While each produced both wine
and cloth in almost equal measure, Ricardo noted that the number of hours required in producing
these products differed from one country to another. This difference could be associated with
variations in efficiency as well as the availability of labor. Due to the higher efficiency level in
Portugal, it possesses an absolute advantage in the production of cloth. On the other hand,
England is able to produce the same product but at a lower opportunity cost hence the country is
said to have a comparative advantage. Basing the comparison on the two products, Ricardo
highlighted that Portugal exhibited more efficiency in the production of cloth than wine. At the
same time, England was notably more efficient in the production of wine than cloth. The two
countries taking part in the free market, trading on goods for which they had a comparative
advantage would lead to a general increase in the production of the good and subsequently a gain
by both parties.
In line with the historical context of the theory, it can be established that the period
around its formulation which the very duration in which slave trade was at its best. This leads to

Theory of Comparative Advantage 6
the concept of availability of labor as the slaves were basically used in almost all the procedures
in the industries. They were in the farms preparing the raw materials and also right inside the
machinery which during the time were manually operated. As a result, efficiency in the historical
context of international business was not necessarily based on machinery and technological
know-how but on the availability of labor as provided by the slaves. For instance, both Portugal
and England were active in slave trade (Golub, 2009). The number of hours taken to produce
both cloth and wine was majorly pegged on the number of workers who were available for the
processes at a given time. This therefore implies that an increase in the number of slaves led to
an increase in the number of workers and hence a reduction in the total duration of production.
The other fact which could be highlighted with respect to the history of this theory is the aspect
that during this time, transactions were not purely monetary but barter trade was eminent.
International business therefore involved the direct exchange of good hence a country would
gain more by exporting or supplying good which they would easily or cheaply produce in
exchange for those that they were not efficiently able to produce. It would equally be a point
worth noting that the theory was put forward in a bid to disseminate the theory of absolute
advantage whose proposition never gave a good enough environment for international business.
One bad attribute about absolute advantage is the fact that a country which has it is likely to
exercise excessive control over the international market while giving little room for the
development of other nations. The theory of comparative advantage was therefore instrumental
at giving international business a better perspective by pointing out the possibilities for free and
fair trade accompanied with mutual gains (Krugman and Obstfeld, 2008).
The theory tried to explain the reason behind the increasing good performance in the
international levels for some countries in comparison to the others. The nations were not at all

Theory of Comparative Advantage 7
developed as much but there are aspects which made one nation have a competitive edge over
the other. It is through these edges that international trade was possible. Through this theory, it
has been possible to answer the question as to why certain countries were and have been able to
export certain products while importing others. It is practically impossible to have a country
wield absolute advantage in product exportation majorly due to the dynamic nature of the
corporate international environment. The various comparative advantages that countries have
over each other have kept international trade alive and possible.

Theory of Comparative Advantage 8
Criticism of the theory
According to the theory of Comparative advantage, countries which have a comparative
advantage in a particular area ought to maintain specialization in the same area. For instance, a
country with a comparative advantage in the exportation of agricultural products ought to remain
specialized in the same area while importing high technology devices for which they lack the
same advantage. This principle has attracted criticism from various economic perspectives. As
pointed out by Ha-Joon Chang who is an economist, the principle allows the developed countries
to maintain this edge which usually comes at the expense of the developing countries. In line
with the components of this principle, the economist also argues that the developed countries not
only use interventionist policies but equally apply protective approaches in a bid to stay rich.
These strategies effectively hinder other developing nations from experiencing the same gain.
The fact that applying this principle retains a country at a given status while diminishing the
ability of the other countries to come up in the international levels remains one of the greatest
criticisms of this theory (Maneschi, 2008).

Theory of Comparative Advantage 9
Comparison of current and past facts
International business in the past is characterized by a number of similar facts. On the
other hand, it is equally worth to note that some of the facts tend to differ due to the changing
structure of the corporate world and international business. The theory relies upon the principles
of efficiency and opportunity cost as a crucial determinant in international business. Despite the
fact that these elements were vital in the past, they are considerably essential even in the current
international trade realms. Based on the example of Portugal and England which is a historical
phenomenon, it can be deduced that that Portugal would export cloth because it had a
comparative advantage in this area. The comparative advantage was caused by the efficiency
levels as well as the low opportunity costs involved. England on the other hand would trade wine
due to the high efficiency levels involved. Similar aspects can be traced to the current trends in
international business as countries still prefer to export or supply goods which they can cheaply
produce while importing those that are expensive to produce locally. For instance, most African
countries have a comparative advantage in agriculture and have been key exporters of
agricultural products especially to the developed countries (Maneschi, 2008). On the other hand,
the high level of infrastructure and technology in the developed countries has given them a
comparative advantage in technological equipment like computers and phones which have been
supplied to the developing countries in Africa. This illustration reveals a similarity in both the
past and current facts. In both the historical and current scenarios, it is clear that countries are
keen on engaging in international business with a good return on investment at a relatively low
cost. The ability to create a balance in the supply and reception of goods based on the principle
of comparative advantage is therefore a major element in the definition of economic capabilities
in countries.

Theory of Comparative Advantage 10
However, there is notable difference in facts while looking at the theory from both the
present and past perspectives. In the past, efficiency was basically based on labor as well as the
availability of raw materials. This is because there was no much use of machinery due to the low
level of technology at the time. The current trend is totally a different picture since the rise in
technology has given efficiency a whole new meaning. Countries in the current world tend to
have comparative advantage due to the availability of technology which encourages the use of
machinery hence increase in efficiency (Nunn, 2008). For instance, developed countries like The
United States and United Kingdom have incorporated technology which has offered them a high
comparative advantage over developing countries. This indicates a difference while looking at
the theory from a historical perspective where efficiency was mainly defined by the number of
workers who were present for a particular process.
These changes have come with a number of implications with reference to the principles
of comparative advantage. The high level of technology in developed countries has placed them
at relatively higher economic levels compared to the countries that are not in this position as yet.
On the other hand, the developing countries with comparative advantage in products which have
a lower value have largely hindered the economic advancement of these countries. This therefore
explains why the developed countries continue to thrive while the developing one keeps
struggling to create a stable economic balance. The value of technological products including
electronics, cars, computers and phones is definitely higher than that of agricultural products. As
a result, it has become hard to create a conducive economic environment for participating
countries despite the fact that the business takes place at the same level. This has led to massive
deficits hence to maintain their economic standards; most developing countries have resorted to
borrowing from their developed counterparts (Maneschi, 2008). This scenario gives international

Theory of Comparative Advantage 11
business based on the theory of comparative advantage a lesser meaning due to the fact that the
gain here is one sided. The original stipulation of the theory indicated a mutual gain by both
countries hence the aspect of a one sided gain indicates a negative economic effect on the
developing countries as a result of the transition from the past to the present world.

Theory of Comparative Advantage 12
Assessment of the Theory’s Analytical Power
The theory of comparative advantage, just like many other theories of international
business gives one a deeper perspective of the dynamics that characterize international trade. The
analysis of the theory reveals a crucial link between the economic status of a country and its
ability to participate in international trade. Gauging by both the historical and current facts, it can
be established that for a country to comfortably engage in the dynamics of international trade, it
must have something to present to the table, this implies the nation ought to be endowed
economically in one way or the other. The endowment may be defined by various elements like
labor, machinery, raw materials and infrastructure just to mention but few. It is however
important to note that the variations in the economic levels of countries are what the comparative
advantage constitutes.
One of the strengths of the theory is its profound explanation of the aspect of trade gains
at international levels. The theory is instrumental in revealing a better understanding of why
some countries tend to thrive in the international business arena more than others. The other
strength of the principle is the fact that it encourages mutual gain between the parties involved in
the trade. However, there are weaknesses which can be associated with this principle. For
instance, the theory fails to explain a specific balance especially in scenarios where the
participating countries are separated by huge margins in their economic levels. Based on the
theory, successful countries may continue registering success in the international business fonts
at the expense of countries with low economic levels (Stern, 2012). There therefore a need to
create policies which encourage almost equal gains for both countries irrespective of their
economic status.

Theory of Comparative Advantage 13
Conclusion
This paper highlighted the aspect of international business based on the theory of
comparative advantage. From the discussion, it has been possible to establish the definition as
well as the origin of the theory. By explaining the various elements of the theory, it emerged that
efficiency and opportunity costs are crucial determinants in international business. Countries
there supply goods which they can efficiently produce at relatively lower costs (Zimring and
Etkes, 2014). Comparing the theory based on historical and current perspectives has also enabled
an understanding of the origin of current economic trends especially in the field of international
business.

Theory of Comparative Advantage 14
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