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Account for the economic reasons/explanations/assumptions behind the structure of the diagrams in the

article.  Are there any other interpretations for the diagrams?




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SCHOOLS BRIEF
of Africa, or Britain, or wherever, prosper through trade regardless
that it has no comparative ad-
of how inefficient, in absolute
vantage in anything, they are
terms, they may be in their cho
simply confusing absolute ad-
sen speciality.
vantage (for which their claim
At first sight this is an implau
The miracle of trade
may or may not be true) with
sible, not to say miraculous, find-
comparative advantage (for
ing. In economics, it stands
The most popular and most dangerous of all elementary eco-
which it is certainly false).
apart. One distinguished practi
Why does this confusion over
tioner has even called the princi-
nomic fallacies is the claim that an unproductive economy may
be harmed by free trade. This view misunderstands one of the
terms matter? Because the case
ple of comparative advantage the
sublest but most powerful deductions in economic theory: the
for free trade is often thought to
depend on the existence of abso-
only result in economic theory
that is neither trivial nor false.
principle of comparative advantage
lute advantage- and is therefore
That may be a little hard on the
DOP economists of even the . feriority, however impressive, is
thought to collapse whenever ab-
solute advantage is absent. But
rest of economics, but it does sug
smallest pretension claim an . presumably smaller. Conversely,
intimate acquaintance with the
economics (thanks to David Ri-
gest that the principle is worth
Mr Lewis's comparative advan- . cardo in the 19th century, not . derstand it. .
the small effort required to un-
principle of comparative advan-
tage-usually pointing out,
tage is in sprinting, in which his
Adam Smith in the 18th) shows
Speaking of which
wrongly, that it dates back to
margin of superiority is greater.
that gains from trade follow, in
Adam Smith. Understanding
Across. any range of athletic
fact, from comparative advan-
Imagine a global economy com-
events, Mr Clinton would have
why it is wrong to credit Smith " no comparative advantage with
tage: Since comparative advan-
prising two countries, North and
with this crucial idea takes you a
tage is never absent, this gives the
respect to Mr Lewis only in the
theory far broader scope than
South. Each makes two goods,
good way towards understand- . all-but-impossible circumstances.
most popular critics suppose.
bread and wine; each has 100
ing the idea itself. .-.
workers, and no input but labour
Smith was much concerned .
that his margin of inferiority
were' exactly the same in each
: In particular, it shows that is required for production. As-
even countries which are desper-" sume that they are market econo-
with the gains to be made from sport. As long as he is, as it were, . ately bad at making everything
mies but, to begin with, closed to
specialising. Hence his interest
relatively less bad at something, can expect to gain from intema-
foreign trade.
in trade among people and na-. he is bound to have a compara-
tional competition. If countries
To proceed, an assumption
tions: specialisation both re- . tive advantage in that activity.
specialise according to their com-
quires and promotes trade. But
. about technology is required.
North, it seems, could make 100
what Smith said about special-
: Accordingly, when people say
parative advantage, they can
isation was implicitly based on
loaves a day if it devoted all its
the idea of absolute, as opposed
The geometry of geography
manpower to bread, and 100 bot-
to comparative, advantage.
NORTH
SOUTH
les a day if it devoted all its man-
Bread
power to wine, with all interme-
It is mere common sense that
: 2. ...
if one country is very good at"
diate : combinations (50 loaves
making hats, say, and another is
and 50 bottles, say) in propo:-
very good at making shoes, then
tion. is production choices are
". . .. . . ...
total output can be increased by
70
therefore shown by the line,
arranging for the first country to
which is called a production-pos-
concentrate on making hats and
sibility frontier, in chart 1. Ex-
the second .on making shoes.
actly how much of each good it
Then, through trade in both
chooses to produce depends on
Wine
the relative demand in North for
goods, more of each can be con-
sumed in both places.
30
'S.;100
... ..30.
90' Wine
bread and wine. Suppose de-
That is a tale of absolute ad-
mand is such that the economy
vantage, such as Adam Smith
Broad
.9. :
Bread
chooses point A: 70 loaves and
might have told. Each country is
30 bottles.
better than the other at making a
100
South is less efficient at mak-
certain good, and so profits from
ing both goods. At one extreme, it
specialisation and trade. Com-
Slope=1:2
could make 30 loaves a day; at
parative advantage-is different: a
the other, 90 bottles of wine. Sup-
country will have it despite being
pose demand is such that it pro-
30
Slopeali
bad at the activity concerned. In-
. Slope=1:1
duces 20 loaves and 30 bottles-
deed, it can have a comparative
point A in chart 2.
advantage in making a certain
Wine
Slope=1:3
With these facts, the rate at
good even if it is worse at making
100 7.
3.7:. 30. . Lia
so Wine
which bread will be exchanged
that good than any other country.
for wine in each economy is
": This is not economic theory,
known. In North this rate is 100
but a straightforward matter of
Imports.
Bread ..' 1 0
loaves to 100 bottles (that is, 1:1).
definition: a country has a com-
of wine
parative advantage where its
100 0727
In South it is 30 loaves to-90 bot-
tles (1:3). These rates, which are
margin of superiority is greater,
of bread
the relative prices of bread and
or its margin of inferiority small-
wine in the two economies, are
er. Carl Lewis, one imagines, is
xpon
shown by the slopes of the lines
better than Bill Clinton at both
of wine
in charts I and 2.
sprinting and tennis-that is, he
Now suppose that the econo-
has an absolute advantage in
Win
Imports
of bread
mies are allowed to trade with
both. Even so, the president has a
30 50
100
30 40
B-
90 Wine
each other. What happens? Cer-
comparative advantage in ten-
tainly, North is going to offer
nis, in which his margin of in-
South some bread in exchange
1996
THE ECONOMIST JANUARY 27TH 1996
for wine. In North, a loaf sells for
61

IMG-2033.jpg

just one bottle of wine;
across the border, it fetches
It's all comparative
.-balance the flows of goods,
three. Once trade is possi-
each economy trades along
ble, consumers in the
Exchange
Bread
Breed
kits (shifting) consumption
North will no longer be
imported (
Wine "
produced. consumed exported (+)
produced consumed exp
frontier to point C. There,
happy: at these prices, they
Before trade
equilibrium is achieved at a
can improve their position
North
1:1
70
price of 1:2, with both econ-
70
30
through trade
South
omies consuming more of
60
both goods than before.
Consumers in the South
World
. none
190
90
will be happy to go along.
For greater clarity, the
They will be keen to sell
After trade
numbers in charts 5 and 6
North
some wine. At home, a bot-
1:2
100
are also set out in the table.
le sells for one-third of a
South
The highlighted numbers
loaf; in the North, the same .
World
1:2
100
100
90
are what really matter. Be-
bottle sells for a full loaf.
Gains from trade
cause of trade, North con-
Here then is the auto-
North
+30
.30
+20
sumes five more loaves and
South
20 more bottles of wine
matic connection between
than before. Unproductive
comparative . advantage
World
+10
+10
OCT
Loaves of bread for bortles of wine
South consumes five more.
and trade. In North, bread
loaves. and ten more bottles
is cheap in relation to wine;
in South, bread is dear in rela- .A. At such points, North would
tion to wine. That difference-..
None of this depends on the
of wine. There you have it:
the gains from trade.
the difference between the slopes
consume more of both goods,
particular price set in the market.
of the lines in chants 1 and 2-
and therefore be unambiguously . That will be determined by the
Free, and fair trade
Those suspecting sleight of hand
gives North its comparative ad-
better off than it was at; A.
pattern of trade in bread and
wine. . The price. will settle at
may still find it confusing that
vantage in bread, and South its
If. North chose to produce at
any point on its production-pos-
whatever level is needed to bal-
South can sell wine in compe-
comparative advantage in wine.
The same difference creates the
sibility. frontier other than B, : ance North's exports (South's im- - tition with North, even though
opportunity for trades that will
opportunities to do better by . ports) of bread with North's im-
North makes wine more effi-
making more bread and;- less
: ports (South's exports) of wine.
ciently. The answer to this puz-
make both sides better off. .
wine (thus shifting the consump-.
tion . frontier. 'upwards) would
. .We know that this value will lie , zle, embedded: in the foregoing
Between the lines
between 1:1 and 1:3. For illustra-
analysis, is wages.
How does this process work itself
again be left-unexploited. In this . tive purposes, suppose the price
out? Once the pattern of trade be-
simple model of a market econ-:
does turn out to be 1:2, as. in
: Recall: that, after trade,
South's 100 workers make 90 bot-
omy, that cannot happen, North charts 3 and 4. Then charts 5 and . thes of wine a day. So their daily
tween North and South has set-
does as well as it can, and spe- . 6 show a possible outcome.....
wage must be nine-tenths of a
tled down, we can be sure of one
cialises entirely in bread: By ex-Each economy moves from its - bottle. (By assumption, there are
thing: the relative price of bread
actly the same reasoning, South
initial production at A. to com-.- no other factors of production:
and wine will be the same in
workers receive all output as
both countries. Otherwise, the
specialises entirely in wine, at
plete specialisation at B. From
point B in chart 4.
there, with prices changing to .
-wages.). North's, workers make
pattern of trade will shift again as
100 loaves, so they each earn one
buyers and sellers engage in fur-
Reality calling
loaf a day; at the after-trade price,
ther cross-border. ."arbitrage" be-
that is equivalent to two bottles
tween the two goods. : .
of wine. In other words, wages in
Where- will -the price settle?
IN THE real world, the power of comparative advantage seems
South are less than half of wages
This cannot be deduced from the
I weaker than the simple model of trade-implies. For instance,
in North. .
existing assumptions: it depends
... .That difference is enough to
on the pattern of demand in
countries specialise less than you would expect. There is lots of
North and South. All we know is
"intra-industry" trade-France sells cars to Germany and vice
offset South's low productivity in
versa. And competition from foreign suppliers does sometimes
wine, making it a "competitive"
that the free-trade price will lie
lower wages in the importing countries.
supplier. But the difference is not
between the initial prices in
More complicated versions of the model account for these
enough to offset South's low pro-
North and South.
duetivity in bread. This is just an-
Given only this, however, it is
apparent anomalies. Moving from two goods and countries to
other way of saying that North
possible to say exactly what and
many greatly complicates the maths, but otherwise changes lit-
how much North and South will
tle. A bigger point is that in the real world labour is not the only
has . comparative advantage in
factor of production: it works with capital (and maybe other fac-
bread, and South in wine.
produce. At any price even frac-
.Unequal wages may be an ef-
tionally above 1:1, North will spe
ors too). As a result, diminishing returns (extra inputs yield ever
ficient basis for trade, but are
cialise entirely in the production
smaller additions to output) must be taken seriously. It follows
of bread. That is because by mak-
that the production-possibility frontier is not in general a
they a just one? It is often argued
: that such trade is unfair on
ing only bread, and trading some
straight line, but a curve bending outwards in the middle. This
in tum implies that complete specialisation is unlikely. As the
North, because its suppliers are
of it for wine, it can achieve its
highest possible consumption of
consumption frontier moves upwards (see charts 3 and 4), the
being .. undercut by Southern
sweatshop labour. The same
both goods. This is shown in
country shifts production in accordance with comparative ad-
chart. 3. .
vantage-but gently, not abruptly to point B.
.logic, slightly twisted, yields the
At a price of 1:2, say, North
The other big change is that, with two or more factors to re-
opposite complaint: trade is un-
ward, the distribution of income matters. As trade shifts re-.
fair on South, because its workers
produces at point B, and can
are being exploited.
then, in effect, trade along its
sources, this distribution is likely to alter. If an industry that uses
. The best answer to both argu-
new price line to any of a range
lots of labour shrinks and one that uses lots of capital grows,
of points. This new price line is a
payments to labour will fall relative to payments to capital-per-
ments is simply to point out that,
consumption-possibility (as op-
haps enough to lower real wages. But remember that in each
"fair" or not, trade raises in-
posed to production-possibility)
country trade will still raise incomes in the aggregate, making it
comes in both countries. Victims
frontier. It includes many points
possible for losers to be compensated, with net gains all round.
of .injustice and exploitation
that are above and to the right of
should always be so lucky.
62
THE ECONOMIST JANUARY 27TH 1996

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