Monday, July 16

Economists find evidence for famous hypothesis of ‘comparative advantage’

Proving old Ricardo’s concept of “comparative advantage” is interesting.

I quote:

David Ricardo’s concept of “comparative advantage” is one of the most famous and venerable ideas in economics. Dating to 1817, Ricardo’s proposal is that countries will specialize in making the goods they can produce most efficiently — their areas of comparative advantage — and trade for goods they make less well, rather than making all kinds of products for themselves.
As a thought example, Ricardo proposed, consider cloth and wine production in England and Portugal. If English manufacturers are relatively better at making cloth than wine, and Portugal can produce wine more cheaply than England can, the two countries will specialize: England will concentrate on making cloth, Portugal will focus on making wine, and they will trade for the products they do not produce domestically.

So how did they do it?

To arrive at this conclusion, Costinot and Donaldson identified a data source that let them quantify nations’ potential productivity: The Food and Agriculture Organization (FAO), an arm of the United Nations, analyzes farming conditions globally, estimating potential agricultural productivity based on factors such as soil type, climate and water availability.
Costinot and Donaldson looked at the numbers from an FAO model of yields of 17 crops on 1.6 million plots of land in 55 countries to examine whether countries specialize in the way Ricardo believed. That is, if a country’s terrain allows it to grow wheat more productively than grapes, comparative advantage suggests that specialization will occur. So Costinot and Donaldson compared the predicted output of crops in each of the 55 countries (based on the FAO data and on prevailing prices) with the actual output of those crops.
The numbers show that Ricardo was right — to an extent, anyway. Costinot and Donaldson analyzed the results so that if the real world worked just as Ricardo supposed, the correlation between productivity and output would be 1.000. Instead, the logarithmic correlation they found was 0.212, with a margin for error of 0.057.

Cool, eh? I will be using this in my own business anyway. Pretty neato…I work in the business of financing international trade, so this will help me identify where we can concentrate matters Smile

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