If people specialise they are
more productive – if you are like me, you probably could not make a good pair
of shoes, do brain surgery or advise on investing for pensions! We tend to do
what we are best at. Imagine the result
if we did what we are worst at!
Countries are the same – if they
concentrate on what they are best at, they produce more and better goods or
services. As a rule of thumb, countries
that follow a protectionist policy (protecting their industries from foreign
competition) are trying to do what they are worst at, or at least not trying to
do what they could be best at. Most economists
would probably think that protectionism is not exactly a good idea.
Two concepts of “advantage”
Absolute advantage – this means a
country can produce more of almost everything than another, i.e., it is a
wealthy country. The USA can produce
more than Egypt for instance – clearly, the USA has an absolute advantage over
Egypt. It is of no particular interest
as an idea: the rich are just rich!
Comparative advantage – this
means that a country is better at producing something, but not necessarily
everything, than another. For instance,
Sweden is better at making marine engines than the UK, but we are better at
organising financial markets and insurance.
All countries are better at doing a few things more than others.
Comparative advantage is the one
that matters in economics and it is the main reason why countries trade with
each other. We do not simply buy
pineapples from tropical countries because it is too cold to grow them
here. We could in fact grow them under
glass and with heating, but we clearly lack a comparative advantage in the
pineapple producing business. Hawaii on
the other hand has a strong comparative advantage in that area.
The gains from trade If a country
tries to produce everything for itself, it will stay poor. Examples: China under Mao Zedong and Russia
under Stalin both followed such a policy and the people suffered a very low
standard of living as a result. The
message is that trade helps the people in a country to gain wealth! The gains
from trade consist of: Comparative advantage – we do what we are best at and
thus produce more.
We then exchange our surplus with
other countries for something we are less good at. Both the other countries and our country do
better and enjoy higher living standards as a result.
Economies of scale – if we
specialise we can follow a system of mass production, and lower our costs. We can then exchange the surplus with other