Hi.
In earlier lectures on comparative advantage,
we assumed that different countries had different productivities
in different industries.
Today, what we want to do is just briefly fill that in a little bit
and explain why productivities might differ in different industries,
in different countries. Let's go.
The most obvious differences are those associated with climate, or geography,
or natural resources.
And, indeed, this is how Ricardo first phrased the comparative advantage model,
in terms of wine and cloth,
with Portugal being better at producing wine
and England having a comparative advantage in producing cloth.
So, when we're thinking about agriculture, or mining, or tourism --
then these differences in climate can create differences in comparative advantage.
Bare in mind, however, don't forget, it is comparative advantage.
So, Florida may have an absolute advantage both in producing oranges
and in producing tourism,
but it's comparative advantage may be in producing, let's say, tourism.
So, even if Florida is the best place in the world for growing oranges,
we might see more tourism there and more oranges grown elsewhere,
if Florida has a comparative advantage in tourism.
OK, what else?
Another advantage created by the fact that labor is not internationally mobile --
is that different countries have different proportions of capital to labor
or low skill to high skill labor,
different proportions of the factors of production.
So, some countries, for example, have a lot of low skill labor,
they have a comparative advantage in producing goods
which require a lot of low skill.
Other countries have more high skill labor,
they have a comparative advantage in producing, aircraft, for example,
which requires a lot of high skill.
This, by the way, is the Heckscher-Ohlin model
and a lot has been written about this model.
Increasing returns to scale on the division of labor
is another source of comparative advantage.
And this one is interesting, because --
it's a source of comparative advantage which may be created by trade
rather than existing naturally before trade.
And the focus on models with increasing returns to scale
came about when people realized that countries which are ex-ante quite similar;
they trade quite a bit.
So, the biggest trading partner for the United States is Canada,
which looks a lot like the United States,
don't tell the Canadians that, but it's true.
Developed countries in general tend to trade most with other developed countries.
Theory of comparative advantage says,
“Oh, that's a little bit odd because you want to trade
with countries that are different than you
not with countries that are the same as you.”
So, how does increasing returns explain that, --
the fact that countries which are quite similar trade a lot?
Well, by specializing, countries can increase the productivity.
They become ex-post different,
after they specialize they become different and then they can trade based upon
those increases in productivity.
So, for example, --
in the world we don't need every single country to have it's own automobile plant,
to have it's own set of automobile producers.
It's better to specialize in one, or two,
or half a dozen countries producing automobiles, --
because you get economies of scale.
It becomes cheaper to produce automobiles per unit
the more automobiles are produced.
So, by specializing, one country produces automobiles,
another country produces aircraft,
another country produces computerized chips.
By specializing, countries can take advantage of economies of scale,
they then become more productive in one good or a set of goods,
and they trade for the other goods that they want.
So, it's still comparative advantage, but it's comparative advantage created afterwards, --
in order to take advantage of increasing returns.
And, in these models, what you can show
is that you get lower costs and greater variety.
Paul Krugman won a Nobel prize, in part, for his work on these models
and later, I'll point you towards his Nobel prize lecture.
What else?
When we think about increasing returns to scale,
we typically think about a big dam,
or we think about a huge auto plant
which is able to take advantage of robots the bigger it gets,
or giant agricultural farms and so forth.
But, it's important to realize that increasing returns to scale
could also refer to the division of knowledge,
that is, as people specialize, they become more knowledgeable about an area --
and that is what increases their productivity.
So, think about physicians.
We don't simply have generic physicians.
We have heart surgeons, we have brain surgeons,
we have podiatrists, specialists in the feet,
we have specialists in the ear, nose, and throat,
we have cancer specialists, diabetes specialists.
So, by dividing knowledge among many different brains,
we get a vast increase in productivity.
So, the examples I've given are more about interpersonal division of knowledge,
increasing returns to scale and trade,
but this also happens across countries as well.
Different countries or different regions within a country
specialize in different areas.
Hollywood, for example, Silicon Valley.
Dalton, Georgia is the world's leading producer of carpets
because you have a lot of specialized knowledge in that region.
That's what makes them productive, the specialization of knowledge,
not so much that they have giant factories, but they have smart people,
people who know a lot.
Institutions can also generate comparative advantage.
So, for example, some countries have more labor market flexibility
than do other countries.
Countries with a lot of flexibility,
so where they can take workers from one area of the economy
and move them quickly into another area of the economy.
They tend to specialize more in high value products,
but for which there is a lot of variability, a lot of variability in demand, for example.
Another example is finance.
Some countries have better banking structures.
If you're going to need a lot of finance,
then you're going to want to be in a country like the United States
where you can easily raise a lot of capital.
It gives a big comparative advantage to the United States in production
which requires huge amounts of capital.
Contract enforcement.
In some countries, it's very difficult to enforce contracts.
So, they're going to specialize in production
which doesn't require a big division of labor,
a big division of knowledge,
which can be done all within one family or within one firm,
smaller firm or where you require less contracts.
If you require a greater division of labor over more firms,
over more parts of the country, over more people,
you're going to want to be in a country which has better contract enforcement.
So, for all of these reasons,
these are all sources of comparative advantage.
So, here are some further resources --
on Ricardo's theory of comparative advantage, on factor proportions.
Here's Paul Krugman's Nobel prize lecture, which is quite accessible and I recommend it.
You'll also see it in our list of lectures.
OK, thanks very much.