Back in 2018, I wrote a column about trade and “comparative advantage.”
Let’s delve further into the issue with this video from Kite & Key.
Just like “creative destruction,” people don’t intuitively understand comparative advantage.
In the video, I thought the Michael Jordan example was insightful. He was probably in the top-1 percent of baseball players, but that wasn’t good enough to get to the major leagues. His comparative advantage was in basketball, where he was an all-time elite player.
If you prefer traditional examples, the Matt Ridley video in my 2018 column included the simple example of how Adam and Oz could both be richer (in terms of more leisure time) by specializing and trading.
A practical real-world example is that workers and businesses in the United States have an absolute advantage at producing textiles compared to workers and businesses in Bangladesh.
But textile production over time has shifted to nations such as Bangladesh because American workers and businesses have even greater advantages in higher-value activities.
This difference between absolute advantage and relative advantage is explained (somewhat wonkily) by Gary Galles in a column for the Foundation for Economic Education.
If…B’s workers were half as productive as A’s workers in producing good X, but only one third as productive in producing good Y, B’s workers still aren’t among the apparently fittest, as A’s workers still have an absolute advantage in producing both goods. But now B’s workers have a comparative (or relative) advantage in producing good X relative to A’s workers because they only give up two-thirds as much Y per unit of X they produce compared to A’s workers. When prices are allowed to adjust and trade is not artificially restricted, …both groups of workers can gain by having B’s workers specialize in the production of X (which they are relatively better at), some of which they trade to A in exchange for A’s production of Y (which they are relatively better at). …That is, in essence, what David Ricardo demonstrated with his theory of comparative advantage in 1817. Even if one country’s workers are less productive in making every good than another country’s workers, specialization according to comparative advantage combined with international trade can benefit both countries’ workers.
Lauren Landsburg has a more intuitive explanation in her Econlib column.
…everyone always has a comparative advantage at something. Let’s look at another example. Suppose you and your roommate want to clean the house and cook a magnificent Chicken Kiev dinner for your friends one night. …But what if your roommate is a veritable Martha Stewart, able to cook and clean faster and better than you? How can you earn your keep toward this joint dinner? The answer is to look not at her absolute advantage, but at your opportunity costs. If her ability to cook is much greater than yours but her ability to clean is only a little better than yours, then you will both be better off if she cooks while you clean. That is, if you are the less expensive cleaner, you should clean. Even though she has an absolute advantage at everything, you still each have different comparative advantages. …The upshot is quite extraordinary: Everyone stands to gain from trade. Even those who are disadvantaged at every task still have something valuable to offer.
The bottom line is that society is wealthier when people specialize in what they do best, comparatively speaking.
That’s why it’s good to have a lot of people you can trade with. Not only across town borders and state borders, but also across national borders.
