Extra Credit (Spring 2008)

Economically Speaking

Globalization: The trade-offs of free trade

Photo of a cargo shipWe live in a world where country borders no longer limit what goods people buy or which firms produce them. American cars may be made in Mexico, German washing machines made in America, or Japanese MP3 players made in China. And this development even applies to some services. Calls to a U.S. company's customer service department could be answered in India.

Gaining a comparative advantage
Is all this globalization a good thing? The answer may depend on one's perspective. Economic theory states that economies and their citizens are better off when trade is relatively unrestricted by tariffs and regulations because free trade promotes comparative advantage. For trade to be beneficial, a country does not have to have an absolute advantage in producing goods and services—producing them using the least amount of resources—but only a comparative advantage.

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One country gains a comparative advantage if it can specialize in producing a good or providing a service at a lower opportunity cost than other countries—that is, if it has to give up less labor and resources producing other goods and services in order to produce the specialized goods or services.

And the winners are . . .
This specialization has several benefits. Lower production costs help keep prices down, allowing American consumers, for example, to buy $30 DVD players and reasonably priced fruit in the winter. These lower prices generally increase households' purchasing power. Also, in some countries, such as the United States, specialized industries tend to offer higher wages. So many Americans have higher incomes and still enjoy the benefits of buying cheaper, foreign-produced goods.

Somebody always loses
But there are some trade-offs when countries specialize. For instance, companies that produce goods that can be made less expensively in a foreign country usually may choose to outsource production or may be replaced by foreign companies that produce that good. Areas of a country that have a high concentration of industries without a comparative advantage will feel the economic pinch more than other areas, and individuals who work in those industries may lose their jobs.

A balancing act
Some economists argue that net gainers should compensate those with net job losses. Compensation might include job retraining, unemployment benefits, relocation assistance, job placement assistance, or other safety net options such as housing, food, or health care assistance. Even with the gainers paying to help the losers, the net gain could still be positive.

Despite the negative trade-offs, the overall effects of specialization and comparative advantage are positive both for the economy and for the standard of living in the countries involved in trade.

By Sarah Dougherty, economic and financial education specialist, Atlanta