Exchange Magazine, Fall 2003 - Duke University's Fuqua School of ...

More documents

Recommendations

Info

The Fuqua School of Business INDUSTRY BYLINE 20 FUQUA EXCHANGE WHY THE WORLD WORKS IN THE LONG RUN: THE LAW OF COMPARATIVE ADVANTAGE FEATURE BY WILLIAM W. PRIEST David Ricardo, a nineteenth century economist, first conceived the Law of Comparative Advantage in 1817. The thesis of this law is that it is economically advantageous for countries to specialize in producing goods for international trade rather than solely for domestic consumption. The principle holds that even if two countries can produce the same commodities, it is in each of their best interests to specialize in producing only one of those commodities and trade it to accumulate the other. Moreover, specialization can be advantageous even when one of the countries can produce both goods more cheaply than the other country. Whenever there are differences in the relative efficiencies of producing the goods such that each country has a comparative advantage in the production of one of the commodities, it is in each country’s best interest to specialize in the product that it can most efficiently produce. The following example can help to illustrate the operation of the comparative advantage theory between two countries. COMPARATIVE ADVANTAGE PRODUCT COUNTRY A COUNTRY B 1 unit of food 1 day’s labor 3 days’ labor 1 unit of clothing 2 day’s labor 4 days’ labor Prior to joining Steinberg Priest & Sloane Capital Management as a co-managing partner and portfolio manager/analyst, Priest was chairman and CEO of Credit Suisse Asset Management (Americas); CEO and portfolio manager of its predecessor firm BEA Associates, which he co-founded in 1972. During his 29 years at BEA/Credit Suisse, he developed the company into a well-recognized investment manager in both equities and fixed income asset classes. Priest is a graduate of Duke University and the University of Pennsylvania Wharton Graduate School of Business. He is a CPA and CFA and author of several published articles and papers on investing and finance. Priest is a director of Globe Wireless, InfraReDx and member of Fuqua’s Board of Visitors. Although A is clearly more efficient than B in both products, its relative advantage is greater in food than clothing (1 day versus 3 days of labor needed to produce one unit of food, compared to 2 days versus 4 days of labor needed to produce one unit of clothing). If Country A specializes in food and Country B specializes in clothing, the two countries can produce more units of food and clothing in any time period than if they operated separately and without regard to their relative efficiencies. By trading with one another, both countries will end up with a sum of food and clothing units greater than would be possible if each country’s’ production was solely for internal consumption. This compelling principle is driving the dual engines of increased trade and globalization. They are further fueled by the fact that an economic world, dominated by the United States, Japan and Western Europe, has expanded by roughly three billion people since the fall of the Berlin Wall in 1989, and are both buyers and sellers of world goods. The integration of these newly economically liberated people continues to this day, causing, in many instances, considerable economic pain for the “old” developed world. As a result of the entrance of these new world citizens onto the global economic stage, foreign direct investment has found new locations, “old” manufacturing centers have lost some of their competitive advantages overnight, and the race to become or locate the low cost provider has accelerated at a speed never before imagined. Technology and telecommunications have been the rocket fuel for this evolution. Figures 1, 2 and 3 illustrate this point. Figures 1 and 2 indicate the location of the world’s present and anticipated population, labor if you will; Figure 3 illustrates the location of capital and technology in today’s world, which might be defined as wealth.
The law of comparative advantage should operate, in the long run, to create a more productive world. In the meantime, integrating three billion people into the world economy, when the bulk of those people are willing to work for less than a dollar an hour, is proving to be no easy task for the “old” developed nations. As production moves to the lowest cost source, what will happen to the standard of living of those “old” developed nations? Will their superior (in some cases) productivity (commonly measured by output per man-hour and unit labor costs) offset the sheer size of those populations being integrated? Ultimately, economic law should rule. A new trade paradigm, derived from the application of the law of comparative advantage, should emerge. This paradigm will integrate the cheaper labor supply of the developing countries, as illustrated in Figures 1 and 2, with the superior capital and technology of the developed countries, as seen in Figure 3, to create a more efficient world, with that efficiency inuring to the benefit of all of its citizens. Today’s challenge of integrating China with 1.3 billion people, India with over one billion people and a new Russia of over 200 million citizens into the world economy will delay the timing but will not alter the end result of this economic evolution. The integration will take a long time, but the end result will be advantageous to the entire world. The law of comparative advantage, which will drive the solution, has simplicity and elegance at its core. But, like most economic laws, it contains “ceteris paribas” assumptions. For example, the theory disregards sticky issues like wages and prices, transitional inflationary and deflationary gaps, and balance of payments problems as well as matters of national need. For example, even though the United States is not the most efficient ship building nation, it maintains and subsidizes that industry for defense purposes. Although the flaws in the theory of the law of comparative advantage may slow down its operation, the law will nonetheless wend its way through the world of commerce, the “unseen hand” if you will. Over time, we should see evidence of its application by looking at world trade relative to world GNP. Increases in the ratio of world exports divided by world GNP will prove that the theory is working. If we see a declining ratio we can state that politics are driving economics with rising tariffs and quotas impeding this laws’ implementation. Economics should determine politics however, and if so, the world will work for all of its citizens. Demographic & Political Changes: Current Population Comparisons Demographic and Geopolitical Changes: Projected Population Comparisons Distribution of Global Wealth by Gross National Product FALL 2003 21
Page 1 and 2: Exchange The Fuqua School of Busine
Page 3 and 4: Editor Angela Thomas acthomas@mail.
Page 5 and 6: Faculty News Two faculty members, A
Page 7 and 8: FINANCE (CONTINUED) Ron Kaniel Titl
Page 9 and 10: OPERATIONS MANAGEMENT (CONTINUED) J
Page 11 and 12: IMPACT: Jordan and QIZs over Fall B
Page 13 and 14: Companies in Classrooms FUQUA TAILO
Page 15 and 16: 405 28 5 704 30% 20% 34% 64 39 15 2
Page 17 and 18: class, has been very useful, and I
Page 19 and 20: and is now working in Baku, Azerbai
Page 21: Lynch believes our increasing empha
Page 25 and 26: A message from the Director of Alum
Page 27 and 28: opening party for her salon,” Dan
Page 29 and 30: Executive program. “My Fuqua expe
Page 31 and 32: Elizabeth B. N ’74 R ’81 & Walt
Page 33 and 34: Paul Eric Moentmann B ’02 Amanda
Page 35 and 36: ONE MBA. THREE FORMATS. UNMATCHED F

Exchange Magazine, Fall 2003 - Duke University's Fuqua School of ...

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?