Ricardo's "comparative advantage" still holds true today
The 19th-century British economist David Ricardo recognized that even when a nation is more efficient than another at producing all goods, it benefits by focusing on the one for which it is internally most efficient, and trading for the others.
Globalization, connectivity, trade liberalization, and technological innovation have all had a deep and lasting effect on international trade patterns and supply chain dynamics over the last 20 years. Although the way we conduct business in general and world trade in particular has changed a great deal, the fundamental principle that determines the direction of trade—that is, which countries produce what, and who imports from whom—has not changed. The major driver of world trade integration today continues to be the 19th-century British economist David Ricardo's often cited but little understood idea of "comparative advantage."
Ricardo (1772-1823) is best known for his classic work On the Principles of Political Economy and Taxation (1817), in which he adapted, reworked, and extended the works of other economist-philosophers such as Adam Smith, author of the seminal 1776 book The Wealth of Nations, and Ricardo's mentor, James Mill.
[Figure 2] Purchasing managers' indexes for manufacturingEnlarge this image
While David Ricardo's main contributions related to the "labor theory of value" (an economic theory, first proposed by Smith, that the value of a product depends upon the labor required to produce it) he also extended Smith's and other 18th-century free-traders' advocacy of free trade, anti-protectionism, and the importance of free interplay in the international division of labor.
Smith and other free traders had emphasized "absolute advantage," which said that nations should specialize in whatever they are best or most efficient at producing. Ricardo, however, demonstrated that "comparative advantage" also influences free trade. This principle holds that a country will profit by producing the product or commodity for which it enjoys a lower **italic{relative internal} opportunity cost, and then trading it for the ones other countries can produce at a lower relative internal opportunity cost.
Ricardo demonstrated that even when a nation is more efficient than another at producing all goods, it should focus on the one for which it is internally most efficient, and trade for the others. He brilliantly showed this with his famous example of English and Portuguese cloth and wine production.
In his example (Figure 1), Portugal could produce both wine and cloth with fewer resources (labor) than England could, but Portugal required **italic{relatively} more resources to produce cloth than wine. Ricardo used simple, deductive logic to show that since wine was harder to produce in England than cloth, both countries would increase both the volume and profits from trade if Portugal focused on wine production while England focused on the production of cloth, and they imported each other's product.
In Ricardo's example, it is assumed that cloth and wine are exchanged in standardized quantities at a homogenous international price. According to the law of comparative advantage, gains will be maximized if England exports cloth, which involves 100 labor hours, while importing Portuguese wine, which requires 80 work hours in Portugal (compared to 120 in England). Even though Portugal can produce cloth with less labor than England does, it has a greater comparative advantage in production costs for wine than for cloth. Portugal should therefore export wine and import cloth from England, thereby reducing its labor hours by 10. In other words, through free trade Portugal and England can both reduce their labor hours and redirect those resources to their best relative use.
Thus, the direction of trade is not determined by the absolute advantage in the production process that one country has compared to another, but rather by the internal, relative advantage necessary to produce alternative products. The key implication of the law of comparative advantage is that if free trade is allowed, then all nations can and will be integrated through the international division of labor. No nation is so poor or inefficient that it cannot gain from free trade.
The perils of overspecialization
There have been many modern, theoretical extensions of Ricardo's work on free trade, as well as qualifications related to transaction costs. However, as is easily seen from the above example, free trade generates a high degree of specialization that has the added benefits of economies of scale via the division of labor, as described by Adam Smith:
"As it is the power of exchanging that gives occasion to the division of labor, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market."
Therefore, as the size of the market expands, so do the extent of labor specialization and the overall benefit to society.
The level of trade globalization and integration has increased at a rapid pace in the last three decades. The entry of China into the World Trade Organization (WTO) and the economic paradigm shifts of India and many other developing countries toward free-market economies have increased global trade volumes and supply chain dynamics. Clearly—as predicted by Ricardo—the world has moved closer to a highly specialized universe of comparative advantage.
A look at world trade patterns today supports that observation. Certain areas of China, for example, are producing the vast majority of the world's low-end, traded consumer goods; Thailand is a key source of electronic component production; India hosts a cluster of call centers and outsourced information technology services. Many of these centers benefit from economies of scale and agglomeration, and are a key source of world profits for multinational corporations.
The combination of specialized, globalized production and, to a lesser extent, the adoption of "lean" inventory practices (such as just-in-time and build-to-order) has helped many companies achieve significant financial success and has provided many countries with development opportunities. However, such specialization has its downside. In Ricardo's example, a storm that would wipe out the clothing industry in England would leave both countries without new clothing, while a drop in the price of wine due to changing tastes or prohibition in England would devastate the Portuguese economy.
As the events of the past several years have shown lean, inventory-constrained global supply chains have become more vulnerable to highly disruptive supply-side shocks, such as natural disasters, political unrest, government instability, or exchange-rate volatility, in addition to the impacts of the usual demand-side shocks. One example is that of the extreme flooding in Thailand in October 2011, which devastated a key global center of hard disk-drive production. According to some estimates, Thailand produces more than 70 percent of the world's hard drives.
As Ricardo's theory suggests, the impact of a negative event in one source country can have wide-ranging impacts on trade flows across the world. This is especially true today since all advanced economies, as well as most developing ones, are highly integrated with each other via trade and financial markets. This connection can be seen through the highly correlated Purchasing Managers' Indexes (PMI) for manufacturing in the United States, the euro zone, the United Kingdom, China, and Brazil (Figure 2). While emerging markets have recently led the global expansion, they have not been able to decouple from the more advanced economies. This illustrates the fact that economic or political events in one country or region can have significant consequences around the world.
The key point is that companies that keep inventories lean and depend on a limited number of specialized centers of production remain highly vulnerable to supply chain disruptions. They can be negatively and significantly affected by small cracks in the supply chain that iterate throughout the international trade system.
Given that specialization of labor and production will continue to drive global trade integration, as noted by David Ricardo two centuries ago, supply chain managers must recognize that their trade networks will remain vulnerable, exposed to events in distant places where little control can be exerted. And since they cannot evade these global economic forces, supply chain managers should focus on what they can do: building key redundancies and backup plans, and avoiding an over-reliance on what may appear efficient but is in fact very fragile.
By the numbers, overall retail sales in August were up 0.1% seasonally adjusted month over month and up 2.1% unadjusted year over year. That compared with increases of 1.1% month over month and 2.9% year over year in July.
August’s core retail sales as defined by NRF — based on the Census data but excluding automobile dealers, gasoline stations and restaurants — were up 0.3% seasonally adjusted month over month and up 3.3% unadjusted year over year. Core retail sales were up 3.4% year over year for the first eight months of the year, in line with NRF’s forecast for 2024 retail sales to grow between 2.5% and 3.5% over 2023.
“These numbers show the continued resiliency of the American consumer,” NRF Chief Economist Jack Kleinhenz said in a release. “While sales growth decelerated from last month’s pace, there is little hint of consumer spending unraveling. Households have the underpinnings to spend as recent wage gains have outpaced inflation even though payroll growth saw a slowdown in July and August. Easing inflation is providing added spending capacity to cost-weary shoppers and the interest rate cuts expected to come from the Fed should help create a more positive environment for consumers in the future.”
The U.S., U.K., and Australia will strengthen supply chain resiliency by sharing data and taking joint actions under the terms of a pact signed last week, the three nations said.
The agreement creates a “Supply Chain Resilience Cooperation Group” designed to build resilience in priority supply chains and to enhance the members’ mutual ability to identify and address risks, threats, and disruptions, according to the U.K.’s Department for Business and Trade.
One of the top priorities for the new group is developing an early warning pilot focused on the telecommunications supply chain, which is essential for the three countries’ global, digitized economies, they said. By identifying and monitoring disruption risks to the telecommunications supply chain, this pilot will enhance all three countries’ knowledge of relevant vulnerabilities, criticality, and residual risks. It will also develop procedures for sharing this information and responding cooperatively to disruptions.
According to the U.S. Department of Homeland Security (DHS), the group chose that sector because telecommunications infrastructure is vital to the distribution of public safety information, emergency services, and the day to day lives of many citizens. For example, undersea fiberoptic cables carry over 95% of transoceanic data traffic without which smartphones, financial networks, and communications systems would cease to function reliably.
“The resilience of our critical supply chains is a homeland security and economic security imperative,” Secretary of Homeland Security Alejandro N. Mayorkas said in a release. “Collaboration with international partners allows us to anticipate and mitigate disruptions before they occur. Our new U.S.-U.K.-Australia Supply Chain Resilience Cooperation Group will help ensure that our communities continue to have the essential goods and services they need, when they need them.”
Artificial intelligence (AI) tools can help users build “smart and responsive supply chains” by increasing workforce productivity, expanding visibility, accelerating processes, and prioritizing the next best action to drive results, according to business software vendor Oracle.
To help reach that goal, the Texas company last week released software upgrades including user experience (UX) enhancements to its Oracle Fusion Cloud Supply Chain & Manufacturing (SCM) suite.
“Organizations are under pressure to create efficient and resilient supply chains that can quickly adapt to economic conditions, control costs, and protect margins,” Chris Leone, executive vice president, Applications Development, Oracle, said in a release. “The latest enhancements to Oracle Cloud SCM help customers create a smarter, more responsive supply chain by enabling them to optimize planning and execution and improve the speed and accuracy of processes.”
According to Oracle, specific upgrades feature changes to its:
Production Supervisor Workbench, which helps organizations improve manufacturing performance by providing real-time insight into work orders and generative AI-powered shift reporting.
Maintenance Supervisor Workbench, which helps organizations increase productivity and reduce asset downtime by resolving maintenance issues faster.
Order Management Enhancements, which help organizations increase operational performance by enabling users to quickly create and find orders, take actions, and engage customers.
Product Lifecycle Management (PLM) Enhancements, which help organizations accelerate product development and go-to-market by enabling users to quickly find items and configure critical objects and navigation paths to meet business-critical priorities.
Nearly one-third of American consumers have increased their secondhand purchases in the past year, revealing a jump in “recommerce” according to a buyer survey from ShipStation, a provider of web-based shipping and order fulfillment solutions.
The number comes from a survey of 500 U.S. consumers showing that nearly one in four (23%) Americans lack confidence in making purchases over $200 in the next six months. Due to economic uncertainty, savvy shoppers are looking for ways to save money without sacrificing quality or style, the research found.
Younger shoppers are leading the charge in that trend, with 59% of Gen Z and 48% of Millennials buying pre-owned items weekly or monthly. That rate makes Gen Z nearly twice as likely to buy second hand compared to older generations.
The primary reason that shoppers say they have increased their recommerce habits is lower prices (74%), followed by the thrill of finding unique or rare items (38%) and getting higher quality for a lower price (28%). Only 14% of Americans cite environmental concerns as a primary reason they shop second-hand.
Despite the challenge of adjusting to the new pattern, recommerce represents a strategic opportunity for businesses to capture today’s budget-minded shoppers and foster long-term loyalty, Austin, Texas-based ShipStation said.
For example, retailers don’t have to sell used goods to capitalize on the secondhand boom. Instead, they can offer trade-in programs swapping discounts or store credit for shoppers’ old items. And they can improve product discoverability to help customers—particularly older generations—find what they’re looking for.
Other ways for retailers to connect with recommerce shoppers are to improve shipping practices. According to ShipStation:
70% of shoppers won’t return to a brand if shipping is too expensive.
51% of consumers are turned off by late deliveries
40% of shoppers won’t return to a retailer again if the packaging is bad.
Businesses were preparing to deal with the effects of the latest major storm of the 2024 hurricane season as Francine barreled toward the Gulf Coast Wednesday.
Louisiana was experiencing heavy rain and wind gusts at midday as the storm moved northeast through the Gulf and was expected to pick up speed. The state will bear the brunt of Francine’s wind, rain, and storm damage, according to forecasters at weather service provider AccuWeather.
“AccuWeather meteorologists are projecting a storm surge of 6-10 feet along much of the Louisiana coast with a pocket of 10-15 feet on some of the inland bays in south-central Louisiana,” the company reported in an afternoon update Wednesday.
Businesses and supply chains were prepping for delays and disruptions from the storm earlier this week. Supply chain mapping and monitoring firm Resilinc said the storm will have a “significant impact” on a wide range of industries along the Gulf Coast, including aerospace, life sciences, manufacturing, oil and gas, and high-tech, among others. In a statement, Resilinc said energy companies had evacuated personnel and suspended operations on oil platforms as of Tuesday. In addition, the firm said its proprietary data showed the storm could affect nearly 11,000 manufacturing, warehousing, distribution, fabrication, and testing sites across the region, putting at risk more than 57,000 parts used in everyday items and the manufacture of more than 4,000 products.
Francine, which was expected to make landfall as a category 2 hurricane, according to AccuWeather, follows the devastating effects of two storms earlier this summer: Hurricane Beryl, which hit the Texas coast in July, and Hurricane Debby, which caused $28 billion in damage and economic loss after hitting the Southeast on August 5.