A comparative advantage exists when a geographic area can produce an output at a lower opportunity cost than another.
Consider this example. Region A is the best region for producing both grapes and gold. In the production of both goods, Region A has an absolute advantage. Region B is relatively good at producing grapes (though not as good as Region A), but very poor at producing gold. What should each region do?
If Region A were to produce grapes, it would have to sacrifice the significant returns it could make from gold production. This is the opportunity cost for Region A. In contrast if Region B were to produce grapes, it would have a much smaller opportunity cost, as it is very poor at producing gold. Region B can produce grapes at a lower opportunity cost than Region A which means Region B, has a comparative advantage in the production of grapes.
When trying to isolate comparative advantages, many identify factors such as climate, proximity to potential markets, existing infrastructure, and availability of resources. These things are NOT comparative advantages. They are characteristics of an area. Depending on context, they can be advantages or disadvantages, strengths or weaknesses, opportunities or constraints. These things are potential sources of comparative advantage.
Comparative advantage is the result of the combination of a range of factors and characteristics, some within the control of decision makers, and many beyond. Potential sources of comparative advantage are important, but not as important is what you do with them.
Comparative advantage is dynamic. The competitive environment is constantly evolving. Consequently, maintaining existing comparative advantages is as important as the development of new ones.
A few general rules for examining advantages/disadvantages, strengths/weaknesses or opportunities/constraints.
- If you are not actually doing something with it, you don’t have a comparative advantage
- If you can’t identify what you’re going to do with it you’re unlikely to develop a comparative advantage
- If everyone else has it, you’re less likely to develop a comparative advantage with it
Comparative advantage is also distinct from competitive advantage, however that is a topic for another blog.