This post involves a fictional company called Acme Motors. Acme manufactures automotive engines in Mexico and ships them to Detroit for inclusion in their automobiles.
Comparative advantage is the “advantage a nation has by being able to produce products or services more efficiently and at lower cost than a competitor nation” (ENERGEX, n.d.). Without comparative advantage, there would be no reason for international trade. Although this concept is fairly simplistic, the measurement of comparative advantage is no easy matter. Countries and multinational corporations go to great lengths to develop a comparative advantage, or enhance one if it already exists.
All countries are naturally seeking a comparative advantage in trade. The U.S. subsidizes the short run costs of production for tobacco farmers in foreign countries for this reason. Since the U.S. has an abundance, or advantage, in capital, it makes sense to move that capital to capital-scarce countries. In the case of foreign tobacco farmers, they have a labor-rich economy that can benefit from an infusion of capital. The tobacco farmers will see an immediate profit from these investments. The ability to gain immediate access to the means of production, and the guaranteed demand in the U.S., means the tobacco farmers will make money from the beginning. The long-range benefits are slightly decreased since the tobacco farmers will be expected to repay any loans they received, but the result is still beneficial (Sawyer & Sprinkle, 2006).
The flow of capital from trade will influence the cost of labor and goods until equilibrium is reached. The influx of capital into the tobacco growing industry of a foreign country will cause farmers to shift their production to tobacco in search of higher rates of return. The U.S. will continue to shift capital into the foreign country until the rates of return for their investment decrease to a level near that of investing in production domestically. In the foreign country, the cost of tobacco will naturally drop as more of the product becomes available. Conversely, the cost of domestic food items will increase as less is produced. Eventually, the cost of domestic food items will reach a level at which there is no advantage to the farmer in switching from food to tobacco (Sawyer & Sprinkle, 2006).
The international market for food and tobacco will also be affected by the direct investments of the U.S. in foreign tobacco production. The increased availability of tobacco on the market will cause the price for tobacco to drop everywhere, including the U.S. This will be followed by an increase in food prices, as less is available. Similar to the case of price movement in the foreign country, prices will fluctuate until equilibrium is reached (Sawyer & Sprinkle, 2006).
Acme Motors specializes in making Quattro engines at its plant in Nuevo Laredo, Tamaulipas. Rather than produce the entire automobile at this facility, Acme exports the engines to other facilities for inclusion in automobiles. Acme Motors enjoys the comparative advantage of inexpensive labor in Mexico. By specializing in one product at this facility, Acme can ensure the highest rate of return on their investment in the facility. Developing countries often lose highly skilled laborers and professionals to immigration as these individuals seek higher wages in developed countries. Although an automotive engine is a complicated piece of machinery, it is not nearly as technical as the automobile in its entirety. By keeping the production of the Nuevo Laredo facility relatively simple, Acme guarantees a quality product at an inexpensive labor cost (Sawyer & Sprinkle, 2006).
Acme Motors has determined that the best course of action is to assemble engines in Mexico and then ship them to Detroit for final assembly. This international shipping would seem to be a huge cost over assembling the entire automobile in Mexico or Detroit. As previously mentioned, automobile assembly is a highly technical process requiring skilled labor. That labor is readily available in the U.S., albeit at a higher wage. These higher wages mean that foreign laborers have likely immigrated to the U.S. Acme Motors has determined that the cost savings of using cheaper Mexican laborer to assemble the engines outweighs the cost of shipping the engines from Mexico to Detroit (Sawyer & Sprinkle, 2006).
This sort of international trade has a positive impact on consumers. As multinational corporations seek comparative advantages in production, the cost of producing their goods decreases and production increases. This results in an increased supply of the good and lower prices for the consumer. Unfortunately, the flow of capital out of the home country means a tighter economy. As production is shipped over borders, workers in the home country must different jobs. If workers are not easily assimilated into new or different industries, unemployment will rise and there will be less money available for consumers to purchase the cheaper goods (Sawyer & Sprinkle, 2006).
ENERGEX. (n.d.). Glossary. Retrieved September 5, 2008.
Sawyer, W. C., & Sprinkle, R. L. (2006). International economics, 2nd ed. Upper Saddle River, New Jersey: Pearson Prentice Hall.