Comparative Advantage, continued

Comparative Advantage is one of those concepts that’s far from intuitive, at least for most people.

Don Boudreaux looks at one case I’d been wondering about, whether it’s possible for one side of a trading partnership to have an advantage in everything.

You ask what you are to make of your roommate’s “fear that China will end up with comparative advantage to produce everything.”

You are to make nothing of this fear other than the fact that it reflects your roommate’s misunderstanding of comparative advantage. It’s impossible for any person, entity, region, country, planet, or galaxy to have a comparative advantage – that is, an advantage compared to potential trading partners – at producing everything. To have a comparative advantage at producing X implies a comparative disadvantage at producing Y.

This reality is best seen with an example involving only two people (Ann and Bob) and two goods (fish and bananas). Suppose that the resources necessary for Ann to use to produce one banana are such that, were she instead to use these resources to catch fish, she’d catch two fish. Ann’s cost of producing one banana is, thus, two fish – which implies that Ann’s cost of catching one fish is one-half of a banana.

As for Bob, suppose that the resources necessary for him to produce one banana are such that, were he instead to use these resources to catch fish, he’d catch one fish. Bob’s cost of producing one banana is, thus, one fish – which implies that Bob’s cost of catching one fish is one banana.

Bob has a comparative advantage over Ann at producing bananas and Ann has a comparative advantage over Bob at catching fish. If Ann and Bob both want to consume fish and bananas, they can both gain if Ann specializes in catching fish and Bob specializes in producing bananas, and then trading with each other.

Suppose now that Ann decides that she wants to have a comparative advantage also at producing bananas. She must then lower her cost of producing bananas to less than Bob’s cost of producing bananas – that is, to less than one fish per banana. But if Ann achieves this goal, she loses her comparative advantage at fishing.

If, for example, Ann becomes so good at producing bananas that each banana that she produces now costs her only one-quarter of a fish, Ann’s cost of catching fish rises from its previous level of one-half of a banana per fish to four whole bananas per fish. Because Bob’s cost of catching fish remains at one banana per fish, if Ann succeeds in gaining a comparative advantage over Bob at gathering bananas she necessarily creates for herself a comparative disadvantage at catching fish – meaning that Ann thereby causes the comparative advantage at catching fish to switch from herself to Bob.

People have many baseless fears about free trade. None is more wrongheaded than is the fear that any one subgroup of people – say, the people of one country – can have a comparative advantage at producing everything.

Someday I may want to sit down with this and see if it’s possible to generate “strange loops” where A>B, B>C, and C>A.

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