II. What kind of policies support a dynamic comparative advantage?
Comparative advantage and trade performance: Policy implications
This chapter establishes the relative importance of different sources of comparative advantage in explaining trade, with particular focus on policy and institutional factors. The policy and institutional areas shown to be important determinants of comparative advantage include physical and human capital accumulation (especially secondary and tertiary education), financial development, the business climate, as well as a number of aspects of labour market institutions. The results suggest that comparative advantage has been — and is likely to be in the future — relatively more important for North-South and South-South trade. Overall, the chapter concludes that when seeking to maintain or develop competitiveness in a certain area, it is best develop an effective broad policy approach.
For close to two centuries the comparative advantage hypothesis has been suggested as one of the principal explanations of international trade and, indeed, as one of the most potent explanations of higher incomes and income growth rates of open economies.2 As such, the concept of comparative advantage had a strong influence on economic policy making in the post-WWII era, most notably the trade liberalisation initiatives under the auspices of the GATT and the WTO, regional integration initiatives as well as unilateral trade reforms, all of which placed emphasis on removing remaining trade barriers and facilitating trade-related structural adjustment, so that countries can benefit from comparative advantage-driven trade. There are controversies surrounding policy implications of the theory of comparative advantage. On the one hand, the theory indicates that an interference with comparative advantage, even if it entails government support to sectors in which a country may have “natural” comparative advantage, can reduce gains from trade or even render them negative (As argued in the Introduction to this volume). On the other hand, as pointed out by Rodrik (2009) even broad policies, not focused on any particular sector (e.g. education or capital market policies), may influence conditions for development of certain activities more than for others. What is then the “natural” comparative advantage? Can governments influence comparative advantage in a fashion that is sustainable and beneficial for the country and its trading partners?3
This chapter makes the first necessary step to answer some of these fundamental questions. It does so by: (i) estimating the extent to which comparative advantage may determine trade flows today as well as how this may have changed over time;
- (ii) establishing the relative importance of different sources of comparative advantage in explaining trade, with particular focus on policy and institutional factors; and
- (iii) drawing policy conclusions.