Theory of Comparative Advantage: Do Transportation Costs Matter?

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Theory of Comparative Advantage Do
Transportation Costs Matter?

• Written by Cukrowski, Jacek and Fischer, Manfred

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Background

• Used the Ricardian model of comparative
  advantage, which relied on differences in labor
  productivity.
• This model had two key contributions
• The pattern of trade is determined by differences
  in relative costs with each country exporting the
  good in which it has a relative labor
  productivity advantage in.
• Voluntary trade cannot be welfare reducing for
  any of the parties involved.

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Modified Ricardian Model

• Assumptions
• There are three countries producing two goods, z
  and w, with only one factor of production, labor.
• The technology of each country is described by
  the productivity of labor in each industry, which
  is expressed by the number of hours required to
  produce one unit of each good.
• All three countries have identical tastes.

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Assumptions Cont

• Taking transportation costs into account, for
  each unit of a good shipped, only a fraction of
  it arrives.
• Country A has a comparative advantage in
  producing z relative to the other two countries
  considered.
• If free trade is allowed, Country A specializes
  in production of good z and Countries B and C
  specializes in production of good w.

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International Trade Between Countries
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Assume that Countries B and C are Identical in
Every Respect

• Proposition 1 The presence of increasing
  returns to transportation may cause trade between
  identical economies in a three-country world and
  increase bilateral welfare.

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• This is because of the decline in transportation
  costs due to larger traded volumes between
  countries, which can be seen by Country A
  shipping larger quantities of good z and Country
  C shipping larger quantities of good w.

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• It is important to note that indirect trade
  prevails only in the area where economies of
  scale from transportation exceed the increased
  distance cost required for shipment between
  Countries A and C.

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Assume that Countries B and C Differ in
Productivities

• Proposition 2 In a one-factor world with three
  countries and two traded goods, increasing
  returns in transportation coupled with
  appropriate distances between trading partners
  may reverse Ricardian trade pattern predictions
  in so far that free trade does not reflect
  bilateral comparative advantages between pairs of
  countries.

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• Assume that Country B has a comparative advantage
  in producing good w and Country C in producing
  good z. Assume also that country A is much more
  productive in z than all other countries and much
  less in w.
• Therefore, Country A would specialize in the
  production of good z, and Countries B and C would
  specialize in the production of good w.

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• Also assume that Country B is located closer to
  Country A, so that it can serve as an
  intermediary for Countries A and C.
• Therefore, Country B imports good z from Country
  A and exports it to Country C.

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• This pattern of trade between Countries B and C
  is just opposite to one which follows from the
  Law of Comparative Advantage, which would have
  Country B exporting good w and Country C
  exporting good z.

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Conclusion

• It is widely recognized that differences in
  technology or factor endowments create a basis
  for trade. What Cukrowski and Fischer wanted to
  point out was that trade between two countries
  may also result from economies of scale in
  transportation.

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Any Questions???