Because Google Adsense deemed this website to have too little content for ads, I'll be posting my top 25 undergraduate papers. This was a paper for the economics of the European Union class. It may seem a little dry to those who are not economics freaks, but it was an A grade paper so it must have something good about it.
January 24th, 2019
One of the most significant developments in economics throughout history is the idea of comparative advantage. This simple mathematical proof has changed the entire landscape of how countries approach goods and services. The idea is that states should spend their energy doing what they’re best at and exporting that to everyone else, even if another country is better at doing that particular thing. It stands to reason that everyone benefits from that strategy of efficiency.
This concept is a justification for a world of free trade and diminishing tariffs; tariff being synonymous for a tax on imports. Traditionally, countries had high tariffs as they maintained the general notion that domestic workers and industries should take priority. Tariffs were used as a measure to keep a country’s imports down to a minimum. The idea being that domestic citizens will want to buy domestic goods and services if they are cheaper after the applied tariffs. However, tariffs have globally diminished to the point where a map of countries with the highest amount of tariffs appears more like a map of weak economies and, potentially, a map of the most undesirable places to live.(1) Not only has the World Trade Organization taken this theorem to heart when designing ideal conditions for international trade, but another globally-present entity has as well. That entity is the project of continental governance known as the European Union. Before going into detail about why countries have comparative advantages, the EU’s approach to comparative advantage, or comparing it with other governing bodies, it is essential to showcase the history of and mathematics behind comparative advantage.
The archetype behind comparative advantage was an individual by the name of David Ricardo, a British political economist who wrote the classical theory in 1817. His contemporaries were individuals such as Adam Smith and James Mill. Ricardo came up with the concept of comparative advantage as a means of explanation as to why international trade takes place. His example consisted of a world economy comprised of England and Portugal where cloth and wine are the only two goods. It takes England one hundred hours of work to produce one unit of cloth and a hundred and twenty hours of work to produce one unit of wine. In comparison, it takes Portugal ninety hours of work to produce one unit of cloth and eighty hours of work to produce one unit of wine(2) In this example, it would take two hundred and twenty hours of work for England to produce one unit of each and for Portugal, it would take one hundred and seventy hours of work to produce one unit of each. However, if England spent the same resources producing only cloth and Portugal the same resources producing only wine, England would produce 2.2 units of cloth and Portugal would produce 2.215 units of wine. Hence, this is why a system of free trade produces more for everyone than a system with no trade. Over two hundred years ago, Ricardo used two European nations in his example. Today, Europe is one of the prime examples of taking advantage of trade. The European Union is comprised of a large sum of tiny countries. Therefore it stands to reason that each tiny country should be focusing on exporting what it is best at producing to the other members of their single market.
Ricardo’s model fails to analyze in any detail what determines the comparative advantage of a country. The Heckscher-Ohlin theorem tries to explain the pattern of comparative advantage between countries. That is, why it costs less for them to produce something. Susan Nello’s explanation of the Heckscher-Ohlin theorem, from the book, The European Union: Economics, Policies and History, is as follows - “a country will export the commodity whose production is intensive of the factor in which the country is relatively abundant.” Nello explains that it works well to account for trade between countries with different endowments of factors of production such as land, labour or capital. She mentions that it explains trade flow between industrialized nations and developing nations quite well. The example that is given involves a developing country producing low skilled items, such as clothing, and a developed nation producing high skilled items, such as computers. Applying this to the EU context, because of its abundance of high education, the European Union would be the nation with high skilled labour, and developing countries elsewhere in the world would be nations with cheap and low skilled labour.(3)
In theory, that is the means of how international trade around and in the European Union should function. But has it worked? Has the European Union been successful in advancing comparative advantages? An article from the World Economic Forum in 2015 by Palin Janse explains why the European Union has become a better trader than the United-States, hence why it has advanced its comparative advantages further. It reads: “It [The EU] is the world’s largest trader of manufactured goods and services, whose large internal market accommodates 65% of its overall trade, given low labour costs and a well-educated common market workforce.”(4) Janse also claims that the European Union is the first in inbound and outbound international investments as well as a top trading partner for 80 countries compared to less than half of that for the US. Perhaps the most interesting part relating to the Heckscher-Ohlin theorem is that the article claims that (excluding fuels) the EU imports more from developing countries and continents, such as Africa, than Canada, China, Japan and the U.S. — combined. It shouldn’t come as a surprise from a technocratic governing project such as the European Union, that strong trade has taken place - even to the point where it has overtaken an economic powerhouse such as the United-States in that area.
Comparative advantage has been a game changer in the world of economics. First explained a couple of centuries ago by David Ricardo, it is now seen as a model of justification for embarking on a world of free trade because that world of free trade will have a greater abundance of goods than one without. The Heckscher-Ohlin theorem goes more in-depth in explaining why comparative advantage exists. That model suggests that developing nations should focus all of their resources on low-skilled production, while already developed countries should focus all of their resources on high-skilled production. This approach seems to ring true in the European Union, considering its most frequent destination of exports is the United-States and its highest amount of imports come from China.(5) Not only that, but the European Union is first in inbound and outbound international investments and a top trading partner for 80 countries which is significantly larger than the U.S. Hopefully moving forward economists will be able to see an increase in larger economic blocks that create greater abundance with free trade.
McCarthy, Niall. "Where Tariffs Are Highest And Lowest Around The World [Infographic]." Forbes. March 23, 2018. Accessed January 24, 2019. https://www.forbes.com/sites/niallmccarthy/2018/03/23/where-global-tariffs-are-highest-and-lowest-infographic/#3c2934767f26.
Ricardo, David. On the Principles of Political Economy and Taxation. 1817.
Nello, Susan Senior. The European Union: Economics, Policies and History. London: McGraw-Hill Higher Education, 2012.
Janse, Kalin Anev. "Is Europe Outperforming the US?" World Economic Forum. October 30, 2015. Accessed January 24, 2019. https://www.weforum.org/agenda/2015/10/is-europe-outperforming-the-us/.
World Integrated Trade Solution. World Bank Data. Trade Summary for European Union 2017.
1 - McCarthy, Niall. "Where Tariffs Are Highest And Lowest Around The World [Infographic]." Forbes.
2 - Ricardo, David. On the Principles of Political Economy and Taxation. 1817.
3 - Nello, Susan Senior. The European Union: Economics, Policies and History. Page 79. London: McGraw-Hill Higher Education, 2012.
4 - Janse, Kalin Anev. "Is Europe Outperforming the US?" World Economic Forum. October 30, 2015.
5 - World Integrated Trade Solution. World Bank Data. Trade Summary for European Union 2017.