Why is specialization important for international trade

The ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. Whenever a country has a comparative advantage in production it can benefit from specialization and trade. However, specialization can have both positive and negative effects on a nation's economy. The effects of specialization and trade include:. Boundless Economics. International Trade. Introduction to International Trade. Concept Version 7. Specialization leads to greater economic efficiency and consumer benefits.

Learning Objective Discuss the effects of specialization on production. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Specialization is a method of production whereby an entity focuses on the production of a limited scope of goods to gain a greater degree of efficiency.

Many countries, for example, specialize in producing the goods and services that are native to their part of the world, and they trade them for other goods and services. This specialization is thus the basis of global trade, as few countries have enough production capacity to be completely self-sustaining. Specialization is an agreement within a community, organization, or larger group in which each of the members best suited for a specific activity assumes responsibility for its successful execution.

Specialization can occur on both the microeconomic level and the macroeconomic levels. At the individual level, specialization usually comes in the form of career or labor specialization. Each member of an organization or economy, for example, has a unique set of talents, abilities, skills, and interests that make her uniquely able to perform a set of tasks. More generally, without establishing the significance of these results, it is important to notice that the robustness of these results are dependent on the sample of countries used.

Yet, I still find some pattern of re-specialization in NNR countries. In the next subsection, I explore whether the disaggregation level of the export data can play a role in explaining it. Disaggregation level of export data. The level of disaggregation of exports data can play an important role in explaining the documented patterns. Because even if re-specialization occurs at higher levels of economic development, it might be only at highly aggregated sectors.

For instance, East Asian countries are concentrated in a few clusters, electronics being the most prominent one, but within such clusters there is wide diversification. Thus, the limitations of data as well as the conceptualization of what a sector actually is might bias the interpretation of the results. I explore this by using in the same analysis concentration indexes computed using different levels of data disaggregation.

Note: This figure estimates the non-linear relationship between export concentration using the Herfindahl-Hirschman Index based on two, three, and six digit HS categorization and PPP-adjusted income per capita.

For visualization purposes, the lines are moving averages. The results show that the re-specialization pattern at higher levels of income is much more pronounced the more aggregated data is used to compute the index. This also holds true for NNR countries, as can be seen in Figure 5. Note: This figure estimates the non-linear relationship between export concentration using the Herfindahl-Hirschman Index based on two, three, and six digit HS categorization and PPP-adjusted income per capita, for non-natural resource rich countries.

What are the implication of these results? It implies that while rich countries tend to concentrate in particular sectors, in terms of export varieties, they remain highly diversified, much more than poor countries. As more disaggregated data is being used to compute the level of concentration, the re-specialization pattern documented by IW disappears.

Thus, it might be the case that the re-specialization pattern that has been documented by IW is, in fact, that the process of growth is associated with the development of highly diversified clusters of economic activity. Looking at the bigger picture. A more careful analysis of the numbers ratifies the above visualizations. Table 1 summarizes the level of concentration in different percentiles of the income distribution: the 1st percentile, the median and the 99th for the HHI computed using two, four, and six digits of aggregation of exports data.

The table also presents the ratio of the concentration level in the 99th to the 1st percentile of the income distribution. When looking at exports concentration computed using two digits categories, countries in the 1st percentile of the income distribution have, on average, an HHI of 0.

Countries in the median of the distribution have an HHI of 0. The level of concentration for the countries in the 99th percentile of the income distribution is about 53 percent of that in the 1st percentile. A similar pattern occurs with NNR countries, where the re-specialization in the upper end of the income distribution reaches levels that are about 84 percent of the concentration in the bottom of the distribution. However, as more disaggregated exports data is used to compute the HHI, the ratio of the concentration of income levels in the 99th percentile to income levels in the 1st percentile drops.

At the four digit levels, the ratio is Thus, the evidence here suggests that, as more disaggregated data is used to compute concentration, the re-specialization pattern documented in the data becomes progressively less pronounced. In economics, the production possibility frontier PPF is a graph that shows the combinations of two commodities that could be produced using the same total amount of the factors of production.

It shows the maximum possible production level of one commodity for any production level of another, given the existing levels of the factors of production and the state of technology. PPFs are normally drawn as extending outward around the origin, but can also be represented as a straight line. An economy that is operating on the PPF is productively efficient, meaning that it would be impossible to produce more of one good without decreasing the production of the other good.

For example, if an economy that produces only guns and butter is operating on the PPF, the production of guns would need to be sacrificed in order to produce more butter. If production is efficient, the economy can choose between combinations i. Production Possibilities Frontier : If production is efficient, the economy can choose between combinations on the PPF. Point X, however, is unattaible with existing resources and technology if trade does not occur. If the economy is operating below the curve, it is operating inefficiently, because resources could be reallocated in order to produce more of one or both goods without decreasing the quantity of either.

Points outside the curve are unattainable with existing resources and technology if trade does not occur with an outside producer. The PPF will shift outwards if more inputs such as capital or labor become available or if technological progress makes it possible to produce more output with the same level of inputs.

An outward shift means that more of one or both outputs can be produced without sacrificing the output of either good. Conversely, the PPF will shift inward if the labor force shrinks, the supply of raw materials is depleted, or a natural disaster decreases the stock of physical capital.

Without trade, each country consumes only what it produces. In this instance, the production possibilities frontier is also the consumption possibilities frontier. Trade enables consumption outside the production possibility frontier. This shows that in a free trade system, the absolute quantity of goods available for consumption is higher than the quantity available under autarky.

A country has an absolute advantage in the production of a good when it can produce it more efficiently than other countries. Absolute advantage refers to the ability of a country to produce a good more efficiently than other countries. In other words, a country that has an absolute advantage can produce a good with lower marginal cost fewer materials, cheaper materials, in less time, with fewer workers, with cheaper workers, etc.

Absolute advantage differs from comparative advantage, which refers to the ability of a country to produce specific goods at a lower opportunity cost. A country with an absolute advantage can sell the good for less than a country that does not have the absolute advantage.

For example, the Canadian economy, which is rich in low cost land, has an absolute advantage in agricultural production relative to some other countries.

China and other Asian economies export low-cost manufactured goods, which take advantage of their much lower unit labor costs. China and Consumer Electronics : Many consumer electronics are manufactured in China. China can produce such goods more efficiently, which gives it an absolute advantage relative to many countries.

Imagine that Economy A can produce 5 widgets per hour with 3 workers. Economy B can produce 10 widgets per hour with 3 workers. Assuming that the workers of both economies are paid equally, Economy B has an absolute advantage over Economy A in producing widgets per hour. This is because Economy B can produce twice as many widgets as Economy B with the same number of workers. Absolute Advantage : Party B has an absolute advantage in producing widgets.

It can produce more widgets with the same amount of resources than Party A. If there is no trade, then each country will consume what it produces. Adam Smith said that countries should specialize in the goods and services in which they have an absolute advantage.

When countries specialize and trade, they can move beyond their production possibilities frontiers, and are thus able to consume more goods as a result.