International Trade: Comparative Advantage and Protectionism

Absolute versus comparative advantage

A country has an absolute advantage in a good when it can produce more of that good from the same resources. It has a comparative advantage when it can produce the good at a lower opportunity cost. Only comparative advantage determines the pattern of trade: a country that is worse at making everything still has a comparative advantage in something, because opportunity costs are ratios and both ratios cannot be higher.

Each country specialises in the good with the lower opportunity cost, world output rises, and both can consume outside their own production possibility curve.

Terms of trade

Trade raises both countries' consumption only if the exchange ratio lies between the two domestic opportunity cost ratios. Outside that range, one country would rather produce the good itself. An index below $100$ means the terms of trade have deteriorated: a given volume of exports now buys fewer imports.

Assumptions and limits of the model

• constant opportunity costs (a straight-line PPC), whereas real costs rise as resources are stretched;
• two countries and two goods, no transport costs, no trade barriers;
• factors of production perfectly mobile within a country but immobile between countries;
• the model says nothing about how the gains are distributed, nor about the sustainability of specialising in one primary commodity.

Instruments of protection

• Tariff — a tax on imports. It raises the domestic price, raises domestic output, cuts consumption and imports, and yields government revenue.
• Quota — a quantitative limit. It raises the domestic price by the same amount as an equivalent tariff and destroys the same welfare, but the price wedge on the imported units becomes quota rent for whoever holds the licence, not revenue for the state.
• Production subsidy — paid to domestic producers. Consumers keep paying the world price, so there is no consumption loss; the cost falls on the budget and there is still a production efficiency loss.
• Administrative barriers — standards, licensing, customs delay. They protect without appearing in any tax schedule, which is why they are hard for the WTO to police.

Arguments for and against protection

For: infant industries, national security, protecting employment during adjustment, preventing dumping, diversifying away from a single primary commodity. Against: higher prices for consumers, protection of inefficiency, retaliation, and the loss of the very interdependence that lets small economies reach scale. The WTO and regional blocs exist to hold the line, but they are enforced only by dispute settlement between sovereign members.