Factors that Cause Differences in Comparative Advantage

The following points highlight the nine main factors that cause differences in comparative advantage. The factors are: 1. Geographic Diversity 2. Tradition 3. Productivity Differences 4. Technology 5. Factor Abundance 6. Human Skills 7. Product Life Cycles 8. Preferences 9. Intra Trade.

Factor # 1. Geographic Diversity:

One key factor is geographic diversity, that is, differences in the climate and natural resources of different regions. For example, Panama exports bananas because it has a tropical climate, the Congo exports copper because it has large deposits of this scarce ore. Kuwait exports oil because the country literally floats on a vast pool of it.

Because geographic diversity is so important a cause of differences in comparative advantage, international trade plays a bigger role in the eco­nomic life of small countries whose resources and climate are homogeneous than in the economic life of large countries that have many geographically diverse regions.

Factor # 2. Tradition:

Sometimes comparative advantage maybe largely the result of acquired skills and tradition. People get used to doing a thing and keep on doing it, generation after generation. For example, the Swiss have a tradition of making watches, the Norwegians of operating a far-flung merchant fleet, and the French — to the delight of gastronomes everywhere — of producing cheeses. Each of these traditions is certainly consistent with the resource endowment of the country in question, but it is not an inevitable outcome of it.

Factor # 3. Productivity Differences:

Comparative advantage is determined by differences in the labour hours requires to produce each good. In Ricardo’s theory, differences in the productivity of labour accounted for comparative advantage. Following Ricardo, economists have argued that productivity differences account for comparative advantage. In fact, Ricardo explained and analysed the idea of productivity-based comparative advantage. Vari­ation in the productivity of labour can explain many observed trade patterns in the world.

Factor # 4. Technology:

While labour productivity differs across countries — and this can help explain why countries produce the goods they do — there are factors other than labour productivity that determine comparative advan­tage. Furthermore, even if labour productivity is all that matters, we would still want to know why some countries have more productive workers than others.

The truth is that technological differences between countries account for differences in labour productivity. The countries with the most advanced technology will have a comparative advantage with regard to those goods that can be produced most efficiently with modern technology.

Factor # 5. Factor Abundance:

Goods differ in terms of the resources, or factors inputs, required for their production. Countries differ in terms of the abundance of different factors of production: land, labour, capital and entrepreneurial ability. So, it is quite obvious that countries would have an advantage in producing those goods that use relatively large amounts of their most abundant factor of production.

Certainly countries with a rela­tively large amount of farmland would have a comparative advantage in agriculture, and countries with a relatively large amount of capital would tend to specialise in the production of manufactured goods.

The idea that comparative advantage is based on the relative abundance of factors of production is known as the Heckscher- Ohlin Theory. In order to improve Ricardo’s theory two Swedish economists Eli Heckscher and Bertil Ohlin (a Nobel Laureate) developed a theory which stressed factor endow­ment as the basis for international trade.

They suggested that countries, such as India, with a huge supply of relatively cheap labour would specialise in labour-intensive products and countries, such as the USA, with abundant capital would specialise in the production of capital-intensive products.

In many cases, factor abundance has served well as an explanation of observed trade patterns. However, there are situations in which Ricardo’s theory of comparative advantage contradicts the predictions of the factor-abundance theory. This is why economists have suggested other explanations of com­parative advantage.

Other Sources of Comparative Advantage:

There are other explanations of the trade pattern in some narrow category of products, viz., human skills, product cycles and preferences.

Factor # 6. Human Skills:

This approach emphasises differences across countries in the availability of skilled and unskilled labour. The basic idea is that countries with a relatively abundant stock of highly-skilled labour will have a comparative advantage in producing goods that require relatively large amount of skilled labour.

Likewise, developing countries would be ex­pected to have a comparative advantage in industries requiring a relatively large amount of unskilled labour. This theory is similar to the factor-abun­dance theory, except that here the analysis rests on two segments (skilled and unskilled) of the labour force.

Factor # 7. Product Life Cycles:

Raymond Vernon explains how comparative advantage in a specific good can shift over time from one country to another. This occurs because goods experience a product life cycle. At the outset, development and testing are required to conceptualise and design the product.

For this reason, production at the initial stage (i.e., when the product is launched) will be undertaken by an innovative firm. Over time, however, a successful product tends to become standardised, in the sense that many manufacturers can produce it.

The mature product may be produced by firms that do little or no research and development. Rather they find it profitable to copy successful products invented and developed by others. As Schumpeter has pointed out, innovators are few and imitators are many.

The product-life-cycle theory is related to international comparative advantage in that a new product will be the first produced and exported by the nation in which it was invented. As the product is exported elsewhere and foreign firms become familiar with it, the technology is copied in other countries by foreign firms seeking to produce a competing version. As the product matures, comparative advantage shifts away from the country of origin, if other countries have lower manufacturing costs for using the now-standardised technology.

The history of colour-television production shows how comparative advantage can shift over the product life cycle. Colour television was invented in the US, and US firms initially produced and exported colour TVs. Over time, as the technology of colour-television manufacturing be­came well-known, countries like Japan and Taiwan came to dominate the business.

Firms in these countries had a comparative advantage over US firms in the manufacture of colour TVs. Once the technology is widely available, countries with cheaper assembly lines, due to lower wages, can compete effectively against the higher-wage nation that developed the technology.

Factor # 8. Preferences:

All the theories of comparative advantage have been based on supply factors. However, the demand side of the market can also explain some of the patterns observed in international trade. Seldom are different producers’ goods exactly identical. Consumers may prefer the goods of one firm to those of another firm.

Domestic firms usually produce goods to satisfy domestic consumers. But since different consumers have different preferences, some consumers will prefer goods produced by foreign firms. International trade allows consumers to expand their consumer opportunities.

Consumers who live in countries with similar levels of development can be expected to have similar consumption patterns. The consumption pat­terns of consumers in countries at much different levels of development are much less similar. This would suggest that firms in industrial countries will find a large market for their goods in other industrial countries than in developing countries.

In reality, industrial countries mostly trade with other industrial coun­tries. This disproves the factor-abundance explanation of comparative ad­vantage which would suggest that countries with the most dissimilar endowments of resources would find trade most beneficial.

Yet rich coun­tries, with large supplies of capital and skilled labour power, trade more actively with other rich countries than they do with poor countries. Firms in industrial countries tend to produce goods that relatively wealthy con­sumers will buy.

The truth is that we do not live in a world based on simple comparative advantage, in which all cloth is identical, regardless of the producer. We live in a world of differentiated products, and consumers want choices between different brands or styles of an almost similar good like Polo T-shirts, or McDonald’s milk-shake.

Factor # 9. Intra Trade:

Consumer preferences also explain intra-industry trade, a circumstance in which a country both exports and imports goods in the same industry. The fact that India exports Maruti cars and imports Toyota cars is not surprising when preferences are taken into account. Supply side theories of comparative advantage fail to explain intra-industry trade. Yet, the real world is characterised by a great deal of such trade.