The theory of comparative advantage was first
put forward by David Ricardo in 1815. This theory
supplanted Adam Smith’s absolute advantage
theory , presented in The Wealth of Nations, which
suggested that if a country can provide a commodity
at a cheaper price then it should be bought instead
of producing it locally. Ricardo’s theory
suggested that international trade was not governed
by absolute advantage in price but by comparative
advantage. Following this principle, a country
can still gain from trading certain goods even
though its trading partners can produce those
goods more cheaply. The comparative advantage
comes if each trading partner has a product that
will bring a better price in another country than
it will at home. If each country specializes in
producing the goods in which it has a comparative
advantage, more goods are produced, and the wealth
of both the buying and the selling nations increases.
Ricardo’s theory has been well accepted
by economists for almost two centuries and has
been the basis for most international trade that
has taken place. This theory, however, is starting
to face criticism and its applicability to the
new economy. Modern economists have started to
question its validity to the newer forms of economic
trades that are starting to take place. Foremost
amongst them is outsourcing, a topic that has
been a cause célèbre in United States
for the past few years. Though outsourcing is
not a new economic concept, it has gained much
popularity due to the rampant movement of jobs
from United States to countries with cheap labor,
primarily in the technology sector. This movement
of jobs to countries like India and China has
left thousands jobless in this country and has
been ensued by public outcry.
Adhering to the classical school of comparative
advantage, most economists have tried to justify
the movement of these jobs by this doctrine. They
believe that this movement is explained by the
doctrine and that anything that is being lost
will be replaced by something better. Though such
arguments may appease the public, they have not
quelled much of the criticism they faced by other
economists who find flaws in their reasoning.
They argue that the theory of competitive advantage
was propounded at a time when capital, labor and
technology could not move offshore. This assumption,
which was fulfilled for two centuries, has come
to be a necessary requirement for the applicability
of the theory of comparative advantage. In recent
times however, the technology has freely moved
overseas. An Indian is as capable at programming
as an American is and thus the technology has
lost geographical boundaries.
These economists argue that unlike before when
the replaced commodities were replaced with other
commodities, this job shift is permanent and that
it will not be replaced. Their argument says that
the reason that is shifting these jobs to cheaper
labor countries is what will also shift jobs that
will replace them. The reason for this shift is
simply cheaper and skilled labor. This is a facet
that applies to all kinds of industries and therefore
they will follow the technology industry overseas.
The moving of jobs overseas will result in a gradual
decline of wages that are paid in this country
and the countries that this capital is moving
to would enjoy an increase in their wages. This
presents a dismal situation for the First World
as their capital is starting to slowly move overseas.
This debate of outsourcing and its economics have
debunked the theory of comparative advantage and
have taken back to the doctrine of absolute advantage.
Since the countries with cheap labor enjoy an
absolute advantage in terms of wages, all the
jobs would eventually move to these countries.
Another theory on international trade and its
economics was propounded by Harvard’s Michael
Porter in the 80’s. The doctrine of competitive
advantage set poised to supplant the doctrine
of comparative advantage in economic analysis
of international competitiveness. This doctrine
identifies the fundamental determinants of competitive
advantage in an industry and how they work together
as a system. Porter’s theory revolved around
his Diamond Model of the competitive advantage
of nations. The traditional comparative advantage
doctrine follows four factors for regions and
countries, namely; land, location, natural resources
and labor. Because these factor endowments can
hardly be influenced, this fits in an inherited
view towards national economic opportunity.
Porter says sustained industrial growth has hardly
ever been built on above mentioned basic inherited
factors. Abundance of such factors may actually
undermine competitive advantage. He introduced
a concept of "clusters," or groups of
interconnected firms, suppliers, related industries,
and institutions that arise in particular locations.
The competitive advantage of nations has been
the outcome of 4 interlinked advanced factors
and activities in and between companies in these
clusters. These can be influenced in a pro-active
way by government. These interlinked advanced
factors for competitive advantage for countries
or regions in Porters Diamond framework are firm
strategy, structure and rivalry, demand conditions,
related supporting industries and factor conditions.
Porter argues that the "key" factors
of production are created, not inherited. Specialized
factors of production are skilled labor, capital
and infrastructure. "Non-key" factors
or general use factors, such as unskilled labor
and raw materials, can be obtained by any company
and, hence, do not generate sustained competitive
advantage. However, specialized factors involve
heavy, sustained investment. They are more difficult
to duplicate. This leads to a competitive advantage,
because if other firms cannot easily duplicate
these factors, they are valuable.
The theory of competitive advantage goes a long
way to explain outsourcing and how it will affect
the First World in the coming years. Using competitive
advantage we can see that cheap labor is a specialized
factor that cannot be obtained by the First World,
hence the jobs in all sectors will keep on flowing
to low-wage countries. And with ease of flow of
technology and knowledge, the absolute advantage
enjoyed by these countries would undermine any
comparative advantage held by the First World.
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