Economic Benefits of International Trade: Absolute & Comparative Advantage

Economic Reasons for Trade

One usual chapter in any economy manual explains the benefits of trade. We know that trade between two countries is beneficial when one of them produces a product more efficiently, or when the destination country cannot produce it at all. For example, Equatorial Guinea can sell bananas to Finland, and Finland can sell reindeer meat to Equatorial Guinea. While it might be possible to grow bananas in Finland using greenhouses with adequate insulation, it doesn't make sense because it will always be cheaper to get them from Guinea, even considering the cost of transport. The same logic applies in reverse to reindeer meat.

There is also no doubt that international trade can provide Spain with oil, which in turn can offer the world something that is available only here, such as tourism services related to the Alhambra in Granada. In these two examples, we have what is known as an absolute advantage over other countries in the production and supply of certain goods and services: it is cheaper (or can only be done this way, as with the Alhambra) to buy from a foreign supplier than to manufacture it at home.

But since David Ricardo, we know it is not necessary to have an absolute advantage for trade to be justified. It also makes sense even if the advantage is relative. And what is meant by comparative advantage?

The best way to explain this is by using examples, and we will start with a classic that does not relate to international trade, but rather to production in general as a source of wealth. Suppose a prestigious lawyer, in his younger years, excelled at typing, thanks to which he reached 2,000 keystrokes per minute (and without a single error, no less). He has hired an administrative assistant to transcribe his notes on the computer. Since his assistant's speed is only 1,200 keystrokes, it seems that the lawyer is more productive in both tasks: creating the content of the report and typing it. Therefore, according to the principle of absolute advantage, he should do both, because he would use less time than the administrative assistant.

We all know that ultimately things are not like this (and not because the administrative assistant actually types faster), for the simple reason that an hour devoted to producing reports is better (more valuable) than an hour devoted to typing. If the attorney devoted time to typing, he would not be devoting that time to studying and thinking about the report, which is where he generates more value.

One of the fathers of classical economics, along with Adam Smith and John Stuart Mill, was the English economist David Ricardo (1772-1823). And, by the way, he was somewhat sexist according to our current thinking.