Domestic Innovation and International Technology Diffusion as Sources of Comparative Advantage Review St Louis Fed

Among those consumers, five percent are willing to pay double the price for a sustainable product over a non-sustainable one. Here are five sources of competitive advantage to leverage for your business strategy. The following example of Comparative Advantage provides an overview of the most popular comparative advantages.

  1. Analyzing the driving forces of productivity is important in understanding the sources of comparative advantage.
  2. We observe that there is a lot of heterogeneity in productivity across countries and industries and that the distribution has shifted over time.
  3. Put simply, an opportunity cost is a potential benefit that someone loses out on when selecting a particular option over another.
  4. Whole Foods stands out in the crowded natural foods market as the first and only certified organic national grocery store in the United States.
  5. Factory B has absolute advantage in both chairs and tables because it can produce more of each in the same amount of time.
  6. It can get more food from its neighbor by trading it for oil than it could produce on its own.

Section 3 quantifies the role of innovation and international technology diffusion. Countries like China and South Korea have made major productivity gains by specializing their economies in certain export-focused industries, where they had a comparative advantage. Nevertheless, they benefit from trade thanks to their comparative advantages and disadvantages. Suppose the attorney produces $175 per hour in legal services and $25 per hour in secretarial duties.

It fully articulates the Heckscher-Ohlin theory of international comparative advantage, in which a country’s factor endowments (land, labor, capital) play a crucial role in determining trade patterns. Using tables, graphs, and econometric data summaries, Learner describes the patterns of trade and the patterns of resource supplies of fifty-nine countries and explains these trade patterns in terms of the abundance of eleven resources. His study should create a standard by which other data analyses will be judged in the future. Similarly, for the average country, the industries that experienced the highest average productivity growth rates are other transport products; chemicals; and computer, electronic, and optical products.

Analyzing the driving forces of productivity is important in understanding the sources of comparative advantage. We analyze, quantitatively, the effect that domestic innovation and the adoption of foreign technologies have on the growth of productivity at the country-industry level. The idea behind this analysis is that countries and industries that invest more resources in innovation can expand the technological frontier and grow (Romer, 1990). However, innovative activity is concentrated in very few, very rich countries. According to OECD data, the United States, South Korea, Japan, and Germany account for the majority of global R&D. Countries farther behind the technology frontier, “followers,” can also grow by adopting technology from the leaders.

Ricardo’s research demonstrated that even if one country can make everything more efficiently than another country, international trade is still beneficial. Labor is the only factor of production, and we assume it to be mobile across industries within a country but immobile across countries. In each country, there is a representative consumer who consumes a non-traded final good and saves.

In these studies, innovation and its international diffusion across countries and industries are the main sources of differences in productivity. Countries and industries differ in both their ability to do research and development (R&D) and their ability to adopt innovations that have been developed elsewhere (i.e., international technology diffusion). Therefore, differences in the rate at which countries and industries innovate and adopt foreign technologies determine differences in relative productivity and comparative advantage.

Open Data – Britain leads the world

Say, for example, the producers of American shoes understand and agree with the free-trade argument but they also know that their narrow interests would be negatively impacted by cheaper foreign shoes. Even if laborers would be most productive by switching from making shoes to making computers, nobody in the shoe industry wants to lose their job or see profits decrease in the short run. In this example, Joe has a comparative advantage, even though Michael Jordan could paint the house faster and better.

In contrast, the industries that experienced the lowest average productivity growth rates are pharmaceutical products; textiles, apparel, and leather; and machinery and equipment n.e.c. (Figure 3). A nation with a comparative advantage makes the trade-off worthwhile. This means the benefits of buying its good or service outweigh the disadvantages. The country may not be the best at producing something, but the good or service has a low opportunity cost for other countries to import. The smaller the country, and the more limited its domestic market, the more incentive it has to look to international trade as a way of gaining the advantages of large-scale production. Thus, Luxembourg or Belgium has much more to gain, relatively, than the United States.

A Test of the Factor Endowments Model of Trade in a Rapidly Industrializing Country: The Case of Korea

Producers of television sets had an incentive to look to other locations, with lower wage rates. In time, the manufacturers established overseas operations in Taiwan, Hong Kong, and elsewhere. Concurrently, the United States turned to new activities, such as the manufacture of supercomputers, the development of computer software, and new applications of satellite technology.

Practical Example: Comparative Advantage

This occurred in the second half of the 20th century when Japan advanced technologically in its automobile production to the point where it could challenge the automobile leadership of North America and Europe. Japan quickly became the world’s foremost producer of automobiles, and, by the early 21st century, Korean automakers were following the Japanese example with the aggressive export of automobiles. For many products, there are advantages in producing on a large scale; costs become lower as more is produced. Thus, for example, automobiles can be made more cheaply in a factory producing 100,000 units than in a small factory producing only 1,000 units. This means that countries have an incentive to specialize in order to reduce costs.

Factor Accumulation and Trade: Dynamic Comparative Advantage with Endogenous Physical and Human Capital

The right-hand side of this expression can be estimated using the observed expenditure shares of domestic product in country and in the United States, as well as the estimated importer fixed effects. Substituting the estimates for relative prices and wages in each country-industry and using the estimated , we can construct the relative productivity based on equation (16). Factory B has absolute advantage in both chairs and tables because it can produce more of each in the same amount of time. However, it has a far greater comparative advantage in tables because it can produce three times the number of tables as Factory A can for the same time cost.

It is important to note that the United States enjoys an absolute advantage in the production of cloth and wine. With one labor hour, a worker can produce either 20 cloths or 20 wines in the United States compared to France’s 5 cloths or 10 wines. The theory of comparative advantage supports free trade and specialization among countries. In other words, no matter how you slice it, comparative advantage, plus international trade, equals higher aggregate output.

One factor in America’s comparative advantages is its vast landmass bordered by two oceans. U.S. businesses benefit from cheap natural resources and protection from a land invasion. Most important, the country has a diverse population with a common language sources of comparative advantage and national laws. The diverse population provides an extensive test market for new products. When used to describe international trade, comparative advantage refers to the products that a country can produce more cheaply or easily than other countries.

Portugal, on the other hand, didn’t have the manufacturing ability to make cheap cloth. Both countries benefited economically by exporting what they could produce most efficiently and importing what they couldn’t produce as easily. Likewise, an agricultural country that focuses only on certain export crops may find itself suffering from soil depletion and destruction of its natural resources, as well as harm to indigenous peoples. Moreover, there are also strategic disadvantages to over-specialization, since that country would find itself dependent on global food prices.

Silicon Valley harnessed the power of diversity to become a leader in innovative thinking. U.S. companies buy this service because it is cheaper than locating the call center in America. Some companies may have customers who experience miscommunications due to language barriers when they’re speaking with representatives at Indian call centers. But the call centers provide the service cheaply enough to make the trade-off worth it for the businesses that hire them. The law of comparative advantage is usually attributed to David Ricardo, who described the theory in “On the Principles of Political Economy and Taxation,” published in 1817. However, the idea of comparative advantage may have originated with Ricardo’s mentor and editor, James Mill, who also wrote on the subject.

Comparative advantage is used to explain why companies, countries, or individuals can benefit from trade. The spread of technology across national boundaries means that comparative advantage can change. The most technologically advanced countries generally have the advantage in making new products, but as time passes other countries may gain the advantage. For example, many television sets were produced in the United States during the 1950s. As time passed, however, and technological change in the television industry became less rapid, there was less advantage in producing sets in the United States.


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