The theory of comparative advantage is an economic hypothesis regarding the specific trade revenue for people, organizations, or countries that cause variances in their success and technological advancement (Costinot & Donaldson, 2012). David Ricardo is the one who advanced the classical theory of comparative advantage to describe why some nations get involved in global exchange despite their workers being able to produce goods more efficiently. There are also other views and opinions perpetuated by other economists who have tried to generalize Ricardos point of view on the subject to stem an idea of comparative advantage in a broader perspective. This essay will compare and contrast Adam Smith theory as described by the Schumacher article with that described by Palley.
According to Adam Smith, in economics, the principle of absolute advantage which relates to comparative advantage refers to the ability of an entity to make more goods or products or services regarding quantity than its rivals. This is thought to be possible by utilizing the same amount of resources as the rivals (Costinot & Donaldson, 2012). Adam initially described the concept of absolute comparative advantage under the framework of international trade with labor being the only input available. With total comparative advantage determined through a basic comparison of labor productiveness between entities, there is a possibility that an entity could have no absolute comparative advantage in any aspect. According to that point of view, then no trade will occur in such a situation.
The primary idea behind Adam Smiths concept of absolute advantage countered mercantilist notions. Smith argued that it was not possible that all countries become prosperous and successful at the same time through the ideology of mercantilism. He suggested that all nations could attain simultaneous prosperity if they adhered to free trade and specialized in agreement with absolute advantage (Costinot, 2009). Smith also suggested that the wealth of different countries depends on the goods and services that are accessible to the market and not the gold reserves in storage. While there exist probable gains from trade with absolute advantage, there is the possibility that the revenue may not be equally beneficial.
According to Palley, the classical theory of comparative advantage has acted as a guideline to global trade policymaking for many years. The policy when integrated with technical innovations has reduced the costs of transportation and communications. It has also opened various countries to global economic prospects. Somaya (2014) states that this ideology however beneficial has rendered the classical theory by Adam Smith old-fashioned and irrelevant in the contemporary world especially when perceived from the paradoxical point of view. This has, as a result, rendered the countries applying the theory economically vulnerable since the trade policy used is based on outdated ideas. Palley suggests the use of the economic reasoning of manufacturers moving from one country to another with the incentive of lower costs. According to Somaya (2014), this logic also factors in elements such as undervalued exchange rates, low taxes, subsidies, and cheap labor, unlike the Smith theory which only considers labor as the only input. Globalization made the argument by Palley reality but in so doing also made capital mobility rather than the cooperative advantage as the Adam Smith theory proposed to become the new driver of trade in the global economy.
Unlike the theory supported by Smith, Palleys view of comparative advantage has several elements that differ from the original theory. The idea by Palley is that the directives of the theory can be valuable to the trading activities and general business environment of various nations in the world (Costinot, 2009). The modern theory supported by Palley suggest the idea of simultaneous prosperity for multiple countries even without a free trade as the primary defining factor. There is also no possibility of absolute comparative advantage nonexistence as in the case of the original theory by Smith that states that a country could experience such a situation (Costinot, 2009). The modern approach also considers that gold reserves can be a measure of wealth amassed by a nation which contrasts with the idea of wealth standards described by the original theory by Smith. However, unlike Smiths classical theory, the modern approach is not qualified to anchor the barge, and at times it could even be counter-productive (Somaya, 2014). The primary issue is that corporations that conduct big businesses are mobile across the world. This makes it possible for the various governments to subsidize research and development expenditure with the resultant innovations ending up in offshore manufacturing stations (Somaya, 2014). Moreover, the competitiveness policy described in the modern theory effortlessly reprobates to a nondevelopment rivalry. For example, in the case of the United States reducing its corporation taxes, there might be a prompt to other nations to try and match the action to stay competitive. In so doing, there will be no substantial gain for the US accompanied by income inequality widening due to tax burden being shifted to wages.
From the essay, it is evident that the contemporary comparative theories were founded on the classical theory of Adam Smith. However, there are differences that are existent in Thomas Palleys description of comparative advantage that disagree with the ideas perpetuated by Smiths theory. It can be considered that although both theories are useful and have some usefulness, the Smith theory is no longer applicable in the modern business world. It has some outdated concepts unlike the theory supported by Palley that has adjusted and factored in various elements such as policies that guide different countries in the contemporary business world.
Costinot, A. (2009). An Elementary Theory of Comparative Advantage. doi:10.3386/w14645
Costinot, A., & Donaldson, D. (2012). Ricardo's Theory of Comparative Advantage: Old Idea, New Evidence. doi:10.3386/w17969
Somaya, D. (2014). comparative advantage absolute advantage. The Palgrave Encyclopedia of Strategic Management. doi:10.1057/9781137294678.0107
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