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Comparative Advantage and Trade

Criticisms of Trade and Comparative Advantage

Unequal trading power can lead to abuse by more powerful nations. Comparative advantage often overlooks certain costs and can lead to structural unemployment, in which potential employees do not have the required skills and thus remain unemployed. Comparative advantage can change over time.

Trade involves complex negotiations. Because trade closely involves political power, it is not often equally advantageous, and some nations or alliances that have more power can use this to their advantage. Powerful nations can establish trade blocs that harm countries with smaller economies; that is, they form groups that agree to trade with each other for the maximum benefit of those involved and with severe penalty for those not involved. Terms of free trade are defined by nongovernmental bodies (for example, the World Trade Organization) and governments that have the most power, at times neglecting the needs of smaller economies. Many countries that focus on producing one good cannot enact protectionism; that is, avoiding trade and focusing on localized production. Some countries have a comparative advantage in agricultural goods, which puts them at a disadvantage when trading for more expensive manufactured goods, such as trading bananas for computers. Trade theory would indicate that the banana-producing country should follow its specialty and not industrialize, which would put it at a great long-term disadvantage. If the country never industrializes, it remains dependent on other countries for manufactured goods.

There are several common criticisms against the principle of comparative advantage. Comparative advantage may inflate the benefits of specialization and overlook external costs, such as transport costs and air and sea pollution. An transaction cost is a cost, such as shipping, that a transaction imposes that is not part of the transaction itself. Comparative advantage theory presumes an atmosphere of perfect competition, where all corporations are selling the same product at the same price, which almost never occurs. Comparative advantage can create structural unemployment (where potential employees do not have the skills needed and thus remain unemployed); when one product is chosen over another, the workers who produced the product that is no longer chosen will be unemployed, and while some workers may be able to move from one industry to another, others will not.

Simple comparative advantage theory does not account for exchange rates (rate differentials at which currencies are valued) or relative prices of goods and services. For example, if the price of clocks increases relative to doorframes, the benefit of increasing the output of clocks increases. Comparative advantage can change over time as resources run out or as countries develop new advantages. Comparative advantage also does not consider many nations' goal to strive for a minimum level of self-sustaining food security, which motivates them to maintain a minimum level of food production, even if in strict economic terms they "should" specialize only in nonfood products. The idea behind comparative advantage is based on an overly simplistic two-country, two-product model, but in reality, trade is far more complex, involving more players, goods, and services. Global producers repeatedly applying economies of scale and using new technology can produce goods inexpensively and export a tremendous variety of massive surpluses.