Pat Buchanan is currently campaigning to become the Republican representative in the next U.S. Presidential election. He is credited with striking a chord amongst the main stream, blue collar sector of the country. This is because he has based his economic platform on common myths about free trade and how it is the cause of the economic problems in the U.S. His theme is that layoffs and the closing of American plants are the result of foreign companies and countries taking advantage of easy access into
U.S. markets which, in his opinion, is not being reciprocated abroad. This is how he accounts for the current trade deficit that the U.S. is running with countries like ...view middle of the document...
We decide who enters here and who does not."
The basis of international trade is that their are gains to be had from partaking in it. This was proven by David Ricardo, an economist in the early 19th century, who introduced the concept of comparative advantage. His theory stated that a country's "absolute advantage (overall productivity differences between countries) should be reflected in differences in income, whereas comparative advantage (variations in productivity differences by sector) will determine the pattern of international trade."
A common misconception about free trade is that it is based on absolute advantage.
Comparative advantage always is applicable when applied to international trade so it stands to reason that there will always be gains from trade. The existence of low wages in a country is not by itself a reason for the U.S. to fear trading with them. For one thing, wages generally reflect the productivity levels of workers. If low wages meant low costs then world trade would be dominated by Th!ird World countries and the U.S. would never export. The fact is that differences in technology cause labor productivity variances between countries which affects unit labor costs. A firm will tend to hire
more workers until the value of the product that the last worker produces is equal to the cost of that worker. In the less developed countries low productivity, as a result of low levels of technology, is reflected in wages. The significant measure to determine which sectors a country has a comparative advantage is not wages, but unit labor costs.
A country can have a comparative advantage in a sector even if it is more inefficient than any other country. This is because comparative advantage is based not on who is the best, but rather on where a country's "margin of superiority is greater, or its margin
of inferiority smaller". As long as a poor country specializes in sectors where it is the least inefficient compared to a rich country then it will gain from trade.
The Ricardian Model, based on differences in labor productivity, is best explained using a simple situation based on the following assumptions: two countries, one called Wealthy, the other Poor; two goods, jeans and sneakers; and labor is the only factor of production. Both countries have 40 hours of labor available but Wealthy has more advanced technology which gives it an absolute advantage in the production of both goods. These countries will benefit from trade because pre-trade relative prices
differ. For this example assume that sneakers and jeans are traded in world equilibrium on a 1 for 1 basis and that there are constant returns to scale.
Amount of labor JEANS SNEAKERS JEANS/SNEAKERS WEALTHY hours required to 1 2 1/2
POOR produce one unit 5 2.5 2
In analyzing the production possibility frontiers of each country it becomes apparent that Wealthy can produce only 1/2 a pair of sneakers in an hour. However, in that same hour, they could...