Sources of Comparative Advantage
David Ricardo’s analysis teaches us that the gains from trade arise from
the pattern of comparative advantage. However, his analysis does not
explain the sources of a country’s comparative advantage. Why do
comparative advantages exist? Since a country’s comparative advantage
depends on its opportunity costs, we could also ask: Why do different
countries have different opportunity costs?
Different Factor Endowments
One answer to this question was offered early in the twentieth century by
two Swedish economists, Eli Heckscher and Bertil Ohlin. According to
their theory, the international cost differences that form the basis for
comparative advantage arise because factor endowments differ across
countries. This is often called the factor endowment theory of comparative
advantage.
To see how this theory works, consider the prices for various types of
goods in countries in the absence of trade. A country that is well endowed
with fertile land but has a small population will find that land is cheap but
labour is expensive. It will therefore produce land-intensive agricultural
goods cheaply and labour-intensive goods, such as machine tools, only at
high cost. The reverse will be true for a second country that is small in
size but possesses abundant and efficient labour. As a result, the first