Comparative and Absolute Advantage

Comparative and Absolute Advantage

A nation with a comparative or an absolute advantage to produce a specific good or service benefits from the enhancement of the total output and an increase in the standard of living. Distribution of resources varies greatly from one nation to another. International trade provides for countries the landscape to specialize in and raise productivity for delivering goods and services that they can either produce cheaply, most efficiently or both. Ultimately, according to a joint report submitted at the G-20 Summit in 2010, “the benefits of trade generally outweigh the cost associated with the reallocation of labour and capital to more efficient uses” (Anonymous, 2010, p. 5).

Economic Growth / Comparative and Absolute Advantage

Within this report, we are analyzing the economic growth and comparative and absolute advantages for four countries: The United States (U.S.), China, Saudi Arabia, and the Democratic Republic of Congo (DRC).

Economic Growth

Economic growth is defined as “an increase in the capacity of an economy to produce goods and services, compared from one period of time to another” (Investopedia, 2016). Economic growth is measured by gross domestic product (GDP), which is the value of goods and services produced over a course of time. The more the products manufactured and sold, the higher the GDP, the better the health of the country’s economy.

Comparative Advantage

Comparative advantage can be explained as the ability of a party to produce a particular good or service at an opportunity cost lower than its competition. The idea behind comparative advantage is to make use of what can be produced at the lowest cost to generate growth and profit.

Absolute Advantage

“Absolute advantage is the ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service” (Investopedia, 2016). For absolute advantage, the focus is on what the group is the best at producing the most efficiently.

How They Fit Together

Within international trade, the first step in making a profit is comparing a country’s absolute and comparative advantage for different products. The goal for each country is to see where the items they produce fit within the realm of international trade regarding export and import. There will be products that a particular country can produce at a low cost. There will be products that a given country can produce the most efficiently. At times, one product will meet both standards. By accurately determining the different advantages for various products, countries can create strategies that have to do with what to export and what to import, and creating trade and exchange relationships with other nations, in a way that will produce the most profit and economic growth for that country over time.

Economic, Cultural, and Political Developments

When examining any country, one will find that there is an individual uniqueness to every aspect of it. A combination of many factors plays a significant role in setting one country apart from another. Three of the more apparent factors include the economic, political, and cultural developments of a country. As each country evolves over time, it is important that the developments made are those who help improve the overall state of the nation’s well-being. Likewise, it is important for other countries to be aware of the developments and evolution of the countries with whom they conduct business.

United States (U.S.)

The U.S. boasts much of its economic growth through technological advances. At present, the U.S. is the most technologically dominant economy (Central Intelligence Agency, 2016). In part, this is due to the flexibility that private firms have regarding employee relations and product development. The U.S. is the second largest exporter in the world and continues to grow. However, there are some struggles with barriers to conducting business with other countries while they are finding it easier to import to the U.S.Because the U.S. is one of the largest economies, the political policy can have a significant effect on imports, exports, and trade relations with other countries. The U.S. has been an active participant with the World Trade Organization and continues to help develop standards and regulations in global trading. As new administrations are brought in, continued political development gives way to continued economic and trade development. The current issue with U.S. political policy is that at present, there is an increase of import versus export (Active USA Center, 2016). The challenge that the political system has in dealing with international trade is that of increasing the levels of output and export to compensate for the growing rate of import.Culturally, the U.S. is continuing to develop and evolve. Historically coined as “a melting pot”, the U.S. continues to grow through immigration. As the culture continues to become more diverse in various capacities (religion, demographic, country of origin) it can be a challenge for citizens to come together as a country and one nation. Many major cities are still racially divided, and the vastness of culture and how each group relates to one another has an effect on everything else, from politics to economic development at a local, state and federal level. As the challenge grows, there needs to be the consideration as to how this will play a role in international relations, trade, and economic development.

China

China has seen an incredible rise over the last six years. China’s GDP increased from a modest 2.7 trillion in 2006 to 10.3 trillion in 2014 (World Bank China, 2016). The low-cost manufacturing base has fueled this growth. China’s political development has been over thousands of years, but most central powers in a united China have been more authoritarian. China has a long history of warring factions that have always required a strong central power to unite them. The country consists of a core of people with the Han ethnicity, with peripheral groups pulled in at different points in history.

Saudi Arabia

Saudi Arabia ranks fifteenth in the export economy and twenty-sixth in the complex economy (Simoes, 2016). This oil-rich country’s main export is crude petroleum, which represented 75.8% of their export. The government has high control over much of the economic development; however, recently, there is a push for more private sector development to employ Saudi nationals. This type of initiative includes oil as well as telecommunications, health care, and even tourism (Central Intelligence Agency, 2016). Since 1970, Saudi Arabia has a history of implementing five-year plans for economic development, with one currently taking place (2015-2019). The focus of these programs is diversification and job creation. However, the country has a tendency not to fully implement its devised plans (Sfakianakis, 2014).

Politically, Saudi Arabia is run as an absolute monarchy. Political reform has been significant in the Middle East as change has been motivated by the desire to develop relationships to boost the country’s economy. These efforts were demonstrated by Saudi Arabia’s joining the World Trade Organization in 2005. In recent years, there has been an attempt to make the government’s actions more open to the public and allow for improvements that encourage political participation, promote economic growth, increase foreign investment and expand employment opportunities (Information Office of the Royal Embassy of Saudi Arabia in Washington, DC, 2016).

Cultural development has been a priority for Saudi Arabia. The country is continuously involved in efforts to improve educational opportunities and medical resources for its people. Religion has also been an important part of the Saudi people, and they have worked to implement their values and traditions into the modern day. Even today, Saudi people all over the world hold on to and blend their heritage with that of the society they live. According to Cole, (2016), “Adherence to Islamic values and maintenance of social stability, in the context of rapid economic change, have been consistent goals of Saudi Arabia’s development plans. Religion and society combine to foster significant social control.” The country’s cultural emphasis plays a vital role in how the country functions and grows on a local and international level.

The Democratic Republic of Congo (DRC)

The DRC is considered a low-income country by the World Bank, but it has seen a doubling of GDP between 2006 and 2014 (World Bank DRC, 2016). Most of the country’s GDP has been fueled by mineral extraction. The DRC is a republic with a president. While the president has enjoyed western support in recent years, his last election was highly controversial (“DRC Profile,” 2016), and most of DRC history has been ruled by dictators. The cultural development, over the last 50 years, has come to a near standstill because of the civil war over minerals and has claimed millions of lives (“DRC Profile,” 2016).

Economic Growth

There are several reasons the economic growth of the four countries varies so markedly.

The U.S. has a GDP growth rate of 2.4%. Currently, the U.S. is recovering from the economic recession in the previous decade. Its growth has commenced. China is an emerging economy and has a growth rate of 6.9%. Its growth rate is influenced by trade. China depends on the global market for the products it manufacturers. It keeps the value of its currency low so that its exports are attractive in world markets, and imports are costly back home. Over the past 30 years, China has emerged as the world’s fastest growing economy with average growth rates of 10%.

Saudi Arabia’s GDP growth rate has declined to 3.5% according to 2014 figures. This decrease has happened because of decline in global oil prices. From this perspective, trade is directly responsible for the decline of the Saudi Arabian economy. International commerce influences Saudi Arabian economic strength because it is an oil-based economy. It possesses 18% of the world’s proven petroleum reserves and is the largest exporter in the world of oil. The GDP growth rate of the DRC is 6.2%, but the GDP per capita is $400. The GDP growth rate of the DRC is for entirely different reasons than that in the other countries. DRC has subsistence hunting and subsistence agriculture. The industry is petroleum extraction and support. DRC is a developing country, and its weak economic growth reflects in its low per capita income.

Economic Lifecycle

The economy of the U.S. is a developed economy. It has advanced technological infrastructure relative to other less industrialized countries. The country has a high level of economic growth and economic security. The per capita income of U.S. is $55,904 according to 2015 figures. China is a developing country. In the economic life-cycle, it has shown high economic growth during the last 30 years. It also has a lower human development index about other nations.

The economy of Saudi Arabia is also a developed economy but is an oil-rich country. The per capita GDP of Saudi Arabia is $51,804 which is close to the per capita GDP of the U.S.; however, Saudi Arabia is an oil rich country, and its economic wealth is based on its oil resources. Regarding the economic life cycle, the DRC is a developing country with a fair economic growth rate. For economic growth to take place in the nation, a substantial capital investment is required to move to a more productive state. It requires the input of capital to break free from economic shackles related to the lower productivity stage.

Each country has their particular natural, human and capital resources which contribute to productions of goods and services that could provide advantages in the international arena.

Absolute and Comparative Advantage Products

Saudi Arabia has an absolute advantage in the production of crude petroleum over many other countries across the world. Saudi Arabia has that advantage because of their ability to be a swing producer of oil, based on their natural reserves. Being a swing producer gives the Saudi government capacity to increase or decrease oil production as a way to stabilize oil prices (Husain, 2006). Along with crude petroleum as a top export to countries such as China and the U.S., the Saudi government also exports refined petroleum for use in its most important form of gasoline.

Saudi Arabia exports refined petroleum to many countries, as well as, the U.S. and China. The U.S. has a comparative advantage in exporting refined petroleum because the productive output in a given year is at $103 billion dollars compared to the $19 billion dollars the Saudi government earns for exports from the same product (The Observatory of Economic Complexity, n.d.). The ability to produce refined petroleum at lower cost results in the availability of gasoline for use in transportation vehicles. The U.S. exports more cars per year than most countries because 95% of consumers live outside their shores. To only sell cars domestically would mean that U.S. companies are limiting their reach to only a small percentage of potential customers. The U.S. does not have an absolute advantage in the production and export of cars because other countries such as China, Japan, Germany, and South Korea also produce and export vehicles all over the world (Worldometers, 2016).

The DRC produces and exports around $693 million dollars a year to countries such as China. While this is a tidy sum for the nation whose economy has declined in years due to internal conflict, the main export for the DRC has been refined copper as the country is known for its rich mineral deposits. However, as stated before, due to the internal conflicts of the country that includes poor infrastructure and government corruption, the DRC cannot have an absolute or comparative advantage in the products it exports until there is a restructured government that provides a more open and stable economic plan (Africa News Service, 2004).

With China’s entry into the World Trade Organization in 2001, the country has taken a competitive advantage in the export of goods such as computers and broadcasting equipment to countries all over the world. It is well known that China can generate efficient labor-intensive products (McConnell, Brue, & Flynn, 2015, p. 840). The income generated for China from the export of computers is on the average $209 billion a year. Also, revenues generated for the export of broadcasting equipment averages $157 billion a year and is also growing. The advantage China has is the availability of workers that are available to manufacture goods. There are roughly 1.3 billion inhabitants in China with 804 million people in its current workforce (Central Intelligence Agency, 2015). State-led growth and the sophistication in manufacturing procedures also helps China grow its advantage in manufacturing computers and broadcast equipment (Loong-Yu, 2007, para. 4).

Conclusion

Each nation is unique, and the distribution of resources among them is not equal. Specialization and international trade enable countries to access goods and services produced all over the world at the best prices. International trade further aids a country’s economy by allowing it produce more efficiently, have a greater output, and increase the standard of living. The world economy allocates resources more efficiently when each country capitalizes on the comparative advantage of trading goods that are produced at the lower domestic cost and with higher productivity.

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