Countries can gain from trade because they use resources differently, but those gains are not shared equally.
Why countries trade
No country has unlimited land, workers, equipment, or time. Countries differ in climate, natural resources, skills, and technology. These differences affect what they can produce and how much production costs. A country might grow coffee easily but spend much more to produce it in a heated greenhouse. Trade allows people and businesses to buy goods or services from other countries instead of making everything themselves. Purchases from abroad are imports; sales to buyers abroad are exports. [1, 2]
Comparative advantage
An absolute advantage means producing more with the same resources. A comparative advantage means producing at a lower opportunity cost—the next-best alternative given up. A country can benefit from trade even if it has an absolute advantage in every product. What matters is what it gives up to produce one good rather than another. [1, 2]
Consider this hypothetical example. Each row shows two alternative uses of the same amount of work time. Assume workers can shift between the goods at these rates.
| Country | If it makes only phones | If it makes only shirts |
| A | 10 phones | 20 shirts |
| B | 4 phones | 12 shirts |
Country A produces more of either good, so it has an absolute advantage in both. Yet one phone costs A two shirts and costs B three shirts. A therefore has a comparative advantage in phones. B has a comparative advantage in shirts: it gives up one-third of a phone per shirt, while A gives up one-half.
Specialization means focusing production on fewer goods or services. If A makes more phones and B makes more shirts, both can gain from trading. Suppose A trades two phones for five shirts. Making those phones costs A four shirts, so receiving five shirts leaves it ahead. B pays five shirts for phones that would have cost it six shirts to make. Both gain from the exchange.
Gains and costs for different groups
Consumers may gain from lower prices and more choices. Exporting businesses may sell to larger markets. Businesses that use imported materials can also lower their costs. For example, a clothing retailer might buy shirts from a lower-cost foreign factory and charge customers less. The foreign producer and the retailer may gain sales, while shoppers save money. [2, 3]
Domestic factories competing with those imports may lose customers. Some cut production or close, causing workers to lose income. A worker may need new skills or may find that available jobs are far from home. Lost wages can also reduce spending at nearby stores. A country’s total gains can therefore rise while some workers and communities face serious losses. Those who gain do not automatically share their benefits with those who lose. [3, 4]
Tariffs and support for workers
A tariff is a tax on imported goods. It can make foreign products more expensive, helping competing domestic producers keep customers and possibly protect jobs. However, consumers may pay higher prices, and businesses using imported materials may face higher costs. A policy that protects some jobs can create costs for other groups. [3]
Governments can also fund job training to help workers who lose their jobs prepare for different work. These programs aim to support workers while preserving the benefits of trade. Training takes time, however, and suitable jobs may still be far from home. Helping workers adjust requires more than an increase in the country’s total economic output. [3, 4]
Sources for this reading
[1] Federal Reserve Bank of St. Louis, The Global Economy: It’s a Small World After All (2013).
[2] International Monetary Fund, International Trade: Commerce among Nations (2019).
[3] Federal Reserve Bank of St. Louis, Does International Trade Create Winners and Losers? (2017).
[4] International Monetary Fund, How Lowering Trade Barriers Can Revive Global Productivity and Growth (2016).
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