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The paper focuses on two economic theories that play a major role in international trade—the theory of absolute advantage and the theory of comparative advantage. The critical examination of these theories has been conducted within a framework of wine production with an emphasis on the Australian wine industry. The paper has outlined the differences between the two approaches to trade. It has been argued that it is economically beneficial for a country to specialize in the production of a good that is associated with the lowest opportunity cost. The ever-increasing internalization of wine production has been attributed to the application of the theory of comparative advantage.
Transformation of the Global Wine Industry
The global wine industry has been substantially transformed by globalization and changing patterns of international trade. The wine-production evolution is driven by latecomers in the market such as Australia and the US whose shares in exports of the product in 2015 were 2.9 percent and 0.7 percent, respectively (Morrison & Rabellotti 2016). Wine production in these countries was facilitated by resource endowments, scientific approach, and, in cases like Chile and South Africa, by cheap labor (Morrison & Rabellotti 2016). As a result, leading Italian and French wine-makers who have 17.5 percent and 29 percent of European market share are facing competition from wine enterprises that operate in the international context (Rossi, Vrontis & Thrassou 2012).
This paper aims to critically examine the theories of absolute and comparative advantage of the Australian wine industry. The paper will also assess the large and continuing influence of these theories on the patterns of international trade.
The theory of absolute advantage was developed by a Scottish economist, Adam Smith, in the late eighteenth century (Hill & Hutt 2016). In his magnum opus The Wealth of Nations, the economist exposed the shortsightedness of mercantilists who had regarded trade as a situation in which one party’s gains are equivalent to the other party’s losses. Smith proposed that countries were at variance in their ability to produce goods.
At his time, French wine producers were a part of ‘the most efficient wine industry,’ whereas the English had the most efficient textile industry, which prompted the economist to argue that ‘a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it’ (cited in Hill & Hutt 2016, p. 164). From this vantage point, it is apparent why Smith was a proponent of narrow specialization in the production of a certain good that could benefit countries engaging in trade (Hill & Hutt 2016).
To better understand the theory, it is necessary to consider the effects of trade between countries that have differences in their absolute advantage in the production of a product. Assume that Italy and Australia have the same amount of inputs that can be used in the production of either wine or dairy products. Australia can use all of its resources to produce either 20 units of dairy products or 10 units of wine.
Italy, on the other hand, can use all of its inputs for the production of either 10 units of dairy products of 20 units of wine. Both countries can produce some combination of wine and dairy products. It follows that Italy has an absolute advantage in the production of wine because the combination of the country’s resources will produce more units of the products. In contrast, Australia has an absolute advantage in the production of dairy products. By specializing in the production of a good in which they have an absolute advantage, the two countries can increase their consumption of both dairy and wine. In light of this information, it is clear why the economist opposed the proposition that there were winners and losers in trade.
The theory of comparative advantage was put forward by a prominent English economist, David Ricardo, in the early nineteenth century (Hill & Hutt, 2016). The economist expanded Smith’s theory of absolute advantage and maintained that a country could benefit from engaging in international trade even though its goods fall outside the spectrum of its absolute advantage.
It means that even if a country’s trading partner is more efficient in the production of two products, the country should specialize in the production of a good in which it has a comparative advantage. Thus, drawing on the example outlined above, if Australia is less efficient than Italy in the production of both wine and dairy products, it should specialize in the manufacturing of a good that is associated with lower opportunity costs.
Opportunity cost is an economic measure that quantifies the cost of an option as the cost of the forfeited benefits associated with choosing the alternative (Keuschnigg 2012). Thus, if Australia can produce either 20 units of wine or 10 units of clothing, the opportunity cost of each unit can be calculated as follows: 10/20 or 0.5 units of clothing for wine and 20/10 or 2 units of wine for clothing.
Assume that Italian producers can turn their inputs into 25 units of wine and 15 units of clothing. It means that the opportunity costs of the production of clothing and dairy would be 25/15 or 1.66 units of wine and 15/22 or 0.68 units of clothing, respectively. Taking into consideration the fact that the production of wine is associated with lower opportunity costs for Australia, the country should devote its resources to the production of products to which they are best suited.
Patterns of International Trade
Australian foray into the global wine market has been on the rise since the 1990s (Fleming et al. 2014). A steady increase in the imported volume of the product can be ascribed to both the comparative advantage in the production of wine and the ever-decreasing costs of transportation. Currently, Australia is one of the largest exporter of the product in the world (Fleming et al. 2014).
According to Hakanson and Dow (2012, p. 763), globalization has substantially reduced ‘the costs of the search, negotiations, and information exchange preceding cross-border transactions.’ It means that the dislodging of dominant positions of France and Italy in the global wine market represents a shift in the patterns of international trade. The application of the theory of comparative advantage has resulted in the dispersion of the global export shares (Keuschnigg 2012).
During the last decades Argentina, Chile, and South Africa emerged as considerable players in the global wine industry, which shows that wine-producing economists are constantly fluctuating as a result of the growing export market penetration of latecomers (Fleming et al. 2014). It has to do with the fact that it is possible to increase a country’s welfare by engaging in mutually beneficial bilateral trade based on the comparative advantages of trading partners.
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The paper has analyzed the theories of absolute and comparative advantage within the framework of wine production. It has been argued that the ever-increasing export value share of the Australian wine industry can be attributed to the country’s comparative advantage in the production of the goods and the diminishing costs of transportation.
Fleming, E, Mounter, S, Grant, B, Griffith, G & Villano, R 2014, ‘The New World challenge: performance trends in wine production in major wine exporting countries in the 2000s and their implications for the Australian industry’, Wine Economics and Policy, vol. 3, no. 2, pp. 115-126.
Hakanson, L & Dow, D 2012, ‘Markets and networks in international trade: on the role of distances in globalization’, Management International Review, vol. 52, pp. 761-789.
Hill, C & Hutt, G 2016, Global business today, 9th edn, McGraw-Hill Education, New York, NY.
Keuschnigg, M 2012, Comparative advantage in international trade: theory and evidence. Springer Science & Business, New York, NY.
Morrison, A & Rabellotti, R 2016, ‘Gradual catch up and enduring leadership in the global wine industry’, Research Policy, vol. 24, no. 1, pp. 1-14.
Rossi, M, Vrontis, D & Thrassou, A 2012, ‘Wine business in a changing competitive environment—strategic and financial choices of Campania wine firms’, International Journal of Business and Globalization, vol. 8, no. 1, pp. 112-130.