3 Kinds Of Advantages

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Definition: Comparative advantage is what a country is the best at producing, when compared to other countries, for the lowest opportunity cost. A country has a comparative advantage when it is better than any other country in producing something, AND it doesn't give up as much by producing it.It's more likely to be goods, like jets, luxury automobiles, or cheese, than a service. That's because goods are easier to export.But some countries do have an advantage in services, such as banking and entertainment. (Source: Comparative Advantage, Bureau of Labor Statistics. Comparative Advantage, Financial Times.)For example, oil-producing nations have a comparative advantage in chemicals. That's because the oil provides a cheap source of material for the chemicals when compared to countries without it. As a result, Saudi Arabia, Kuwait, and Mexico are competing with U.S. chemical production firms.Their opportunity cost is low. They don't have to give up much to produce chemicals. That's because a lot of the raw ingredients are produced in the oil distillery process. (Source: "Robust Growth and the Strong Dollar Set Pattern for Import and Export Prices," Bureau of Labor Statistics) What It Means to You: Comparative advantage is what you do best while giving up the least. If you’re a great plumber and a great babysitter, you should become a plumber.You’ll make more money as a plumber and can buy more babysitting services. Even if you are the best babysitter in the world, you’ll be able to buy less plumbing services. That’s because you’ve given up the opportunity of making more money as a plumber. Theory of Comparative AdvantageDavid Ricardo created the theory of comparative advantage.He argued that a country boosts its economic growth the most by focusing on the industry in which it has the largest comparative advantage. For example, England was superior in manufacturing cloth. Portugal was better at making wine. Ricardo correctly predicted that England would stop making wine, and Portugal would stop making cloth. England made more money by trading its high-value cloth for Portugal's high-value wine, and vice versa. Why make inferior wine yourself when you can get a larger quantity of superior wine by selling your cloth?This theory of comparative advantage became the rationale for free trade agreements. Ricardo developed the comparative advantage theory to combat trade restrictions on wheat in England. That's because it was lower cost and higher quality when grown in countries with the right climate and soil conditions. England received more value by exporting products that required skilled labor and machinery. It could receive more wheat in trade than it could grow on its own. The theory of comparative advantage explains why trade protectionism doesn't work in the long run. Political leaders are always under a lot of pressure from their local constituents to preserve jobs by raising tariffs.That temporarily protects local industries from overseas competition. However, it hurts the nation in the long run by allowing the country to waste resources on poor-performing industries. It also forces consumers to pay higher prices to buy lower-quality goods.David Ricardo started out as a successful stockbroker, making $100 million in today's dollars. After reading Adam Smith’s The Wealth of Nations, he became an economist. He was the first person to point out that significant increases in the money supply create inflation. This theory is known as monetarism. He also developed the law of diminishing marginal returns, one of the most important concepts in microeconomics.It states that there comes a point in production where the output isn't worth the additional input in raw materials. (Source: EconLib, David Ricardo)Example United States: America's comparative advantage is its large land mass, bordered by two oceans. It also has lots of fresh water, arable land, and available oil. It has a diverse population with a common language and national laws. For more, see The Power of the U.S. Economy.Those all give U.S. businesses cheap natural resources, protection from land invasion, and a large test market to support innovation of new products and services. As a result, the United States became a global leader in banking, aerospace, defense equipment, and technology. For more, see The 4 Major Things the U.S. Is Good at Producing and How Silicon Valley ls America's Innovative Advantage.Comparative Advantage vs. Absolute AdvantageAbsolute advantage is what a country, business, or individual, does at a lower cost than the competition. That's because it has abundant natural resources, such as oil, farmland or even labor. (Sources: Absolute Advantage, FT.com Lexicon. Comparative Advantage, Library of Economics and Liberty. Comparative Advantage and Absolute Advantage, Shmoop.com. Absolute Advantage in Trade, Study.com. What It Means to You: Absolute advantage is what you do most efficiently. You’re better than everyone else in the neighborhood at plumbing and babysitting. Comparative Advantage vs. Competitive AdvantageCompetitive advantage is what a country, business, or individual does better than its competitors. It can be because 1) it is the low-cost provider, 2) it offers a better product or service, 3) it is technologically superior. (Source:"Free Trade and Protection: Why Do Nations Trade?" HSC Online.)What It Means to You: Competitive advantage is what you do better than your competitors. You have a competitive advantage as a plumber and a babysitter because you do both better than anyone else in the neighborhood. But it’s not necessarily because you do them more efficiently. It may be because you offer better customer service. You bring brownies, so others are willing to pay you more even though you aren’t more efficient. Or, you take pictures and send them to the owners, so they know how the repairs are going, or the children are doing. That is an example of innovation. Competitive AdvantageThe examples you site (Fb and iPhone developer ecosystem) feel more like network effects as competitive advantage, but I think they achieved those network effects because of product choices/features. In addition to product, execution, design, brand, operations/logistics, flexibility/adaptability can lead to competitive advantage. I would say Facebook's competitive advantage is not the users, but the fact that they execute better than anyone else in the space and have leaders with a deep understanding of the customer who are comfortable defining "social" for the rest of us. Apple has been built to deliver on the vision of a genius and to begin with his design aesthetic and build an operation to support the delivery of this aesthetic. The iOS ecosystem is an embodiment of this process, but it lives in all Apple products and services from laptops to retail.Coca-Cola sells carbonated sugar water yet they have built one of the most valuable and recognizable brands in the world. CEMEX sells cement and yet their focus on operational excellence and mastery of distributed manufacturing facilities, raw material transport and currency arbitrage has made them the dominant player in the space.The Oregon Ducks football team play FAST. This innovation changes the game and requires the entire organization to operate differently from play calling communication to practices to coaching approach. The advantage on the field is speed, but the real advantage is the flexibility of the staff and the players to fully embrace this new style before it had generated a national championship caliber team. In business, everyone talks about their competitive advantage. What do we do best? How do we leverage on that to be profitable? How do we improve and innovate to get ahead and stay ahead of the competition? There’s absolutely nothing wrong with this approach, as it’s proven to be successful and an indispensable part of a vibrant market system.But economists also talk about comparative advantage, which while it sounds similar is really quite different. Anyone looking around the real world will notice some striking anomalies when looking at different countries.How can businesses which appear at first glance to be uncompetitive – whether through higher costs or inferior products – survive competition? More puzzlingly, why is it that industries in some countries thrive, despite being less productive and efficient than the same industry in another country? And more puzzlingly still, why do countries trade similar products with each other? For example, Germany has a far more efficient and cost effective auto industry, yet the Germans export autos and auto parts to France and Italy, yet at the same time imports cars and parts from those very same countries.The answer to that lies in comparative advantage. With the more usual competitive advantage, the aim is to beat the competition, gain market share, and grab the lion’s share of profits. Whoever manages to do this, management gets bonuses, shareholders gets dividends, investors see their share price go up, workers see their wages increase, and everyone’s happy – except for those who’ve lost out to the winner.Comparative advantage on the other hand takes into account two things – different productivity levels, and scarce resources of land, labour and capital. It’s probably best illustrated with an example. Let’s take an industry – for example steel making – and assume there’s two countries. Country A is hyper efficient, with a high technological level and can make steel at $X per tonne. Country B is less efficient, with low productivity and a lower level of technological advancement. It can only make steel at $2X per tonne – about half as productive as Country A. From a competitive standpoint it’s no contest – Country A would beat Country B hands down and dominate the steel industry.But now assume that we have another industry – say software development – which both countries can pursue. In Country A, software development costs $Y but in Country B they can only produce it at $4Y because of the lower skill level of its workforce, an even worse case than in steel making.If we believe in competitive advantage, Country B is in a hopeless situation – they simply can’t compete with Country A at any level, or in any industry. But taking the principle of comparative advantage, there’s a way for both countries to actually benefit.Because Country A is so much better at software development than it is at steel making, it can maximise the return on its use of resources by concentrating on software development at the expense of steel making. Country B on the other hand can utilise what it resources it has to make steel where it has a “comparative advantage”. The countries then can trade their production of the respective goods – both countries benefit as they’ve utilized their scarce resources to maximum benefit, despite Country B being relatively less efficient and less productive at everything.So here we have the basis for globalization and trade – and the reason why developing countries such as China and Indonesia continue to attract FDI, and particularly labour intensive FDI. It’s not just because of low wages – low wages are a sign of low productivity – but because the labour in the countries that chose to invest here and in other developing countries such as Malaysia, are so much better at doing something else more valuable.Countries like China continue to attract FDI, and particularly labour intensive FDI. because of both low wages and labour that are equally adept at doing valuable activities.Theoretically, comparative advantage implies gains from trade, even if embarking on a particular industry doesn’t appear to make any sense from a competitive standpoint. Malaysia’s national auto industry can be taken as an example of this kind of effort, even if the result often leaves much to be desired. The principle was sound, even if the execution was less than ideal.Comparative advantage also means we as Malaysians shouldn’t be afraid to embark on new industries, even if other countries appear to be so much better placed competitively. It would be nice to be on the more productive side of the trade equation (though that too has costs, as US manufacturing firms and American blue collar labour have discovered), but that’s not a necessary condition for reaping the benefits from trade.

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