Ricardo\'s Comparative Advantage Theory

Ricardo's Theory Of Competitive Advantage

Ricardo's Competitive Advantage Theory in international trade is as valid today as when it was first proclaimed. Ricardo's theory holds that every country should engage in free trade, just as Adam Smith alleged that all individuals should engage in free and fair trade. Smith stated that all human beings specialize, produce goods or service in excess of what they need, and thus can barter or exchange for monetary value for those goods in a national marketplace. (Smith, 1776) Ricardo agreed with this is also applicable in the international marketplace. (Ricardo, 1817)

The principle of comparative advantage for nations may seem "clearly counter-intuitive. Many results from the formal model may seem contrary to simple logic." (Suranovic, 2003) However, Ricardo's commodity exchange example demonstrated numerically that if England specialized in producing one of the two goods, and if Portugal produced the other, then total world output of both goods could rise, thus benefiting both nations, as if an appropriate terms of trade the amount of one good traded for another were then chosen in a fair means of exchange, "both countries could end up with more of both goods after specialization and free trade then they each had before trade." (Suranovic, 2003)

Michael Porter's Competitive Advantage Theory substantiates Ricardo's theory as well, which stresses that specialization is one way for businesses to maximize different aspects of their value chain to gain a competitive advantage in a marketplace. Areas of differentiation can be in terms of a nation's or a firm's product, distribution, sales, marketing, service, and image. By assuming all nations engage in free trade, a nation is thus free to specialize in the products it produces best. The quality of products produced by different nation in a differentiated marketplace is thus beneficial to international consumers, laborers, and the marketplace as a whole.

In the real world of the 21st century, where substantial differentiation is possible in the diverse world, and the real world factors for the 21st century make nations even closer and more knowledgeable about one another through travel, the commodity exchange example delineated between England and Portugal becomes even more beneficial.

However, it should be noted that Ricardo's assumptions in his free trade example assumes a parity between all nations. But, "one striking result in a free market even when one country is technologically superior to the other in both industries, one of these industries would go out of business when opening to free trade. Thus, technological superiority is not enough to guarantee continued production of a good in free trade. A country must have a comparative advantage in production of a good, rather than an absolute advantage, to guarantee continued production in free trade." In other words, the product must offer extra value and extra levels of differentiation, to succeed in the modern marketplace, according to Porter and Ricardo's combined analysis. "From the perspective of a less developed country, the developed countries' superior technology need not imply that LDC industries cannot compete in international markets." (Suranovic, 2003)

What if a comparative advantage product is not needed or wanted by other countries, however? "The usual way of stating the Ricardian model results is to say that countries will specialize in their comparative advantage good and trade them to the other country such that everyone in both countries benefit. Stated this way it is easy to imagine how it would not hold true in the complex real world." (Suranovic, 2003)