1) Chain Of Comparative Advantage

Chain of comparative advantage refers to the ranking of goods or countries in the order of their

comparative advantage. With a two country comparative model with many goods, Good can be

ranked by their comparative advantage in a country in terms of relative unit labor requirements

(Ricardian Model). A country will thus export the goods which lie on one end of the chain, in

which it has a comparative advantage and import the goods at the other end, in which the other

country faces a comparative advantage.

The chain of comparative advantage is a generalization of the Ricardian Model into more than

two countries or goods or both (Haberler, 1930). It supposes that there are two countries with

multiple goods, g=1, 2,.., G. Thus numbering the goods in the order of country’s relative labor

requirement we get the equation as given below

a1Aa1B<a2Aa2B<.. <aGAaGB

Thus in the above chain the country A’s export will be on the left of the chain in relation to the

Country B’s export. This is because country B will export the goods in which it has the

comparative advantage over country B.

In a free trade economy there will be a single break in the chain such that the goods on the left of

that break are exported by country A and on those on the right are imported. The results can be

generalized to an infinite number of goods (Donbursch el at., 1977)

In case of many countries, the chain can be made by ranking different countries on the basis of

their relative labor requirements for producing the two goods (Deardorff, 2005). Suppose there

are many countries, c=1, 2, …, C. then the chain of comparative advantage is give as below

a11a21<a12a22<.. .. <a1Ca2C
In this chain all the exporters of goods 1 will be to the left of the exporters of the good 2. In a

free trade economy, the chain will have a single break such that the countries exporting good 1

will be on the least side and those exporting good 2 will be on the right side of the break.

2) Deardorff(1979), in his paper- “Weak Links in the chain of comparative

Advantage” has tried to investigate whether trade in multiple goods can be understood

by ranking the goods in the order of their factor intensities and inferring that exports

must lie higher on this order. Dearorff cities that a similar two factor model was proposed

earlier by Jones (1957) which was invalidated by Bhagwati (1972). Deardorff explains

that under free trade, two countries producing and trading multiple goods, the pattern and

direction of trade must agree with the ranking of goods by factor intensity. Between two

countries the more capital abundant country will export the goods to the other country.

Thus the exports of the country must be more capital intensive than its imports.(Jones,

1957)

Under impediments to trade, that is, when tariffs and transportation cost results into different

process in the two countries, the argument does not remain valid. According to Deardorff the

argument can still stand if direct subsidies do not exist. In that case a good will only be exported

if the price abroad ia at least as high as the domestic price and vice versa.

In the case of intermediate goods and free trade, the maximum net revenue earned and payments

to primary factors like labor and capital can be used to establish the pattern of trade. Deardorff

concludes that the chain of comparative advantage can be used in the case of intermediate goods

as long as the trade between the two countries is free and the prices of primary factors like labor

and capital are not equalized.

Deardorff draws the difference in the case of intermediate goods and impeded trade. When the

trade is not free and there are tariffs on intermediate goods, it results in the rise in price of
intermediate good and also the final good. Thus, the country shifts it production to good 2 which

is less labor intensive, as the country cannot lower the cost of good 1 due to higher intermediate

good prices. Thus chain of comparative advantage will cease to hold.

Deardorff (1979), argues that ranking by any factor must fail in determining the pattern of trade

given that trade tariffs exist. No ranking based on any labor or capital intensities will or even

relative autarky prices will not be able to determine the pattern of trade if there exists

intermediate goods and impeded trade between two countries.

3) The law of comparative advantage is one of the most basic concepts explaining why

countries trade the way they do and how they are benefited from the same. From the

Recardian and Heberler theory it can be concluded that comparative advantage can be

defined in terms of the relative autarky prices, which represents the marginal opportunity

cost. Thus comparative advantage can be used to reallocate resources within the country

to increase the total output.

But the real world is a competitive place and these theories do not find much relevance. Recardian

theory of two countries and goods can be generalized to include multiple goods and multiple

countries. The generalization leads to the chain of comparative advantage that can be obtained by

ranking the relative labor requirement or the relative autarky prices in an order.

Deardorff (1979) brought forward the point that the law of comparative advantage will hold given

the two countries have a free trade market. This implies that the cost of production is the same in

both the countries. Deardorff (1979) argues that any ranking based factor will not be able to

determine the trade between two or more countries if there are impediments to trade and

intermediate products. The presence of these barriers to trade will affect the law of comparative
advantages beyond the level such that a country might end up importing a good that it should

export. The exports of a country should be much more capital intensive than its imports. But the

presence of intermediate products and impediments to trade can change the comparative

advantage. Tariffs on the intermediate produces will lead to rise in prices of an already capital

intensive intermediate. The country will then not go forward with its capital investments in the

end product and rather choose to export another good, which may not have the relative

comparative advantage and import the good with a comparative advantage.

4) The works of Deardorff(1979, 1994) laid the general validity of the law of

comparative advantage. It is difficult to test the law of comparative advantage due to the

following reasons:

a) Lack of information

It is difficult to test the law of comparative advantage as there is very less data available

on the autarky price information required for the comparative advantage example. The

information on relative labor requirement is also difficult to obtain given the difference in

prices and tariffs in two countries.

b) Assumption of balanced trade: The model examined and validated by Deardorff

(1979,1994) assumes balance trade between two countries. In the real world balanced

trade is a difficult proposition to observe. Most countries are net importers or exporters

and hence it is difficult to test the comparative advantage law on them.

c) Assumption of free international trade: The model concludes that the law of comparative

advantage will hold for free economy without any impediments for trade. But, in the real
 world it is difficult to find such a situation. The real world is marked by competition.

There are many countries and goods. There is presence of impediments of trade and

intermediate goods.

3a)

The trade intensity index is the ratio of two export/ import statistic. It shows the relative share of

exports from a region to that of the world. The index does not contain a size bias and hence can

be used across all regions for any period of time. The example shows the import and the export

trade intensity Index for the country Australia. The three other countries chosen as trading

partner are China, United States of America and Japan.

The Import – export figures have been taken over a period of 7 years 2001-2007 from the UN

Yearbook of International Trade (2005, 2007) for the purpose.

The Import Trade Intensity Index is given by the illustration given below:

TIIij= MijMi / XjXw-Xi

Where

Mij is country i's import to country 'j'

Mi is the total import of the country 'i' to the world

Xj is the total export of country 'j' to the world

Xi is country i's total export

Xw is total world export

Appendix 1: Imports by Australia (in US$ million)

2001 2002 2003 2004 2005 2006 2007

World 60675 69241 84492 105244 118922 132651 155657
United
States 11132 12744 13562 15309 16554 18610 20003
Japan 7892 8571 10583 12258 13059 13019 14941
China 5334 6998 9299 13180 16295 19214 24054
Appendix 2: Exports by Australia (in US$ million)

2001 2002 2003 2004 2005 2006 2007

World 63330 65008 70246 97232 105752 123323 139122
United States 6164 6311 6155 7020 7069 7595 8304
Japan 12244 12069 12808 16302 21588 24414 26379
China 3921 4559 5915 8056 12230 15392 19547
Appendix 3: Total Exports (in US$ million)

2001 2002 2003 2004 2005 2006 2007

629595 653253 760973 929035 1057150 1214332 1399984
World 4 2 0 9 0 7 4
118007 120228 130509 152526
US 4 4 2 8 1732321 1918997 2017121
Japan 349300 337609 383452 455254 515866 579064 622243
China 243553 295170 412760 561229 659953 791461 955956
Appendix 4: Import Trade Intensity Index
 2001 2002 2003 2004 2005 2006 2007
United States 1.52 1.68 1.64 1.60 1.58 1.60 1.51
Japan 1.95 1.88 1.96 1.85 1.89 1.80 1.83
China 2.00 1.97 1.86 1.90 1.84 1.77 1.73
The Export Trade Intensity Index is given by the illustration given below:

TIIij= MijMi / XjXw-Xi

Where

Mij is country i's export to country 'j'

Mi is the total export of the country 'i' to the world

Xj is the total import of country 'j' to the world

Xi is country i's total import

Xw is total world import

Appendix 5: Export Trade Intensity Index

2001 2002 2003 2004 2005 2006 2007

United States 0.51 0.52 0.51 0.43 0.40 0.39 0.41
Japan 3.45 3.55 3.58 3.38 4.14 4.11 4.22
China 1.58 1.54 1.54 1.36 1.83 1.89 2.03

b) The trade intensity figures obtained from the data tells us about the trade intensity of

Australia with three countries, supposedly the largest trading partners of Australia over the given

period of time (2001-2007). Australia has witness rise in imports and exports over the given

period.

The trade intensity data over the given period shows the trade relations and activity in bilateral

trades between Australia and the other three countries – United States, China and Japan over the

given period of time. Appendix 4 shows the relative trade intensity index of the imports of

Australia.
Japan leads the other two countries in the Import Intensity Index in the year 2007. It has

gradually displaced china from the top position in Australian imports. This figure shows

increasing dominance and intensity of Japanese imports in Australia over the given period.

Though the trade intensity index has fallen for all the three countries, in the case of china the

import intensity index has dropped by 13% since 2001 from 2.0 to 1.73. The import intensity

with USA has more or less remained stable over the period of time.

The trade intensities for all the three countries have declined. This shows that the share of all the

three countries in the Australia’s imports has declined in relation to the imports from other

countries over the given period of time.

The export intensity figure shows the share of bilateral trade of Australia with the other countries

in relation to the share in world trade. Japan again has the highest export intensity index in 2007.

It has been the largest trading partner of Australia since 2001. The export intensity index for of

Australia has risen with Japan from 3.45 to 4.22 during the period 2001-2007. But the greatest

rise in percentage terms has been in the case of China. China has gained prominence in

Australian exports markets. Is share has increased faster than the other two countries. (See

Appendix 5)

Reference

Deardorff, A. V. (2005), How Robust is Comparative Advantage

Deardorff, A. V. (2004), Recardian Comparative Advantage with Intermediate Inputs

Deardorff, A. V. (1979), Weak links in the Chain of Comparative Advantage

Haberler (1936), The theory of International Trade with its applications to Commercial Policy

Jones, R. W. (1956, Factor proportions and the Heckscher--0hlin theorem

The Direction of Trade statistics and the UN yearbook of Trade Statistics, IMF Publication
2009

International Trade Statistics Yearbook Volume I - Trade by Country retrieved from

http://comtrade.un.org/pb/CountryPagesNew.aspx?y=2009

Appendix 1: Imports by Australia (in US$ million)

2001 2002 2003 2004 2005 2006 2007

World 60675 69241 84492 105244 118922 132651 155657
United
States 11132 12744 13562 15309 16554 18610 20003
Japan 7892 8571 10583 12258 13059 13019 14941
China 5334 6998 9299 13180 16295 19214 24054

Appendix 2: Exports by Australia (in US$ million)

2001 2002 2003 2004 2005 2006 2007

World 63330 65008 70246 97232 105752 123323 139122
United States 6164 6311 6155 7020 7069 7595 8304
Japan 12244 12069 12808 16302 21588 24414 26379
China 3921 4559 5915 8056 12230 15392 19547
Appendix 3: Total Exports (in US$ million)

2001 2002 2003 2004 2005 2006 2007

629595 653253 760973 929035 1057150 1214332 1399984
World 4 2 0 9 0 7 4
118007 120228 130509 152526
US 4 4 2 8 1732321 1918997 2017121
Japan 349300 337609 383452 455254 515866 579064 622243
China 243553 295170 412760 561229 659953 791461 955956
Appendix 4: Import Trade Intensity Index
 2001 2002 2003 2004 2005 2006 2007
United States 1.52 1.68 1.64 1.60 1.58 1.60 1.51
Japan 1.95 1.88 1.96 1.85 1.89 1.80 1.83
China 2.00 1.97 1.86 1.90 1.84 1.77 1.73

Appendix 5: Export Trade Intensity Index

2001 2002 2003 2004 2005 2006 2007

United States 0.51 0.52 0.51 0.43 0.40 0.39 0.41
Japan 3.45 3.55 3.58 3.38 4.14 4.11 4.22
China 1.58 1.54 1.54 1.36 1.83 1.89 2.03