How Comparative Advantage Benefits Global Investors, As Per Fisher Investments UK

In the modern economy, relatively few goods are produced entirely using inputs and labour sourced from one country – the supply chain is fully global and highly complex. Now, though, supply chain disruptions tied to COVID lockdowns, reopenings and other constraints have some commentators Fisher Investments UK follows seemingly questioning if global trade’s benefits outweigh the costs. We think it is worth exploring why nations trade with one another in the first place to illustrate global commerce’s contributions to global growth – and the associated benefits we see for globally minded investors.

In Fisher Investments' view, comparative advantage – an economic theory pioneered by 19th century British economist David Ricardo – underlies global trade. Comparative advantage describes a country’s ability to produce a good or service at a lower opportunity cost (the loss of a potential benefit that would be received through alternative choices). It means a country gives up less to produce a good or service than another country would by focussing on its most efficient area of domestic production.

To illustrate international trade’s mutual benefits, Ricardo shared the following example in his book, On the Principles of Political Economy and Taxation: Portugal and England each produce wine and cloth of equal quality. [i] Portugal produces both goods more efficiently (i.e., with less labour) than England, so it has an absolute advantage in producing each. However, Portugal produces wine more efficiently than it produces cloth. Conversely, England produces cloth more efficiently than wine. Ricardo argues Portugal has a comparative advantage in producing wine, whilst England has a comparative advantage in producing cloth. By trading with one another, both countries would end up with more cloth and wine at a lower cost than if they produced each good domestically. How? Each country could focus on what they produce most efficiently and trade for the rest. Portugal could produce more wine by giving up its less-efficient cloth production, whilst England could produce more cloth and give up its less-efficient wine production.

The theory of comparative advantage applies to today’s economy, too. On the domestic level, take France’s Paris and Oyonnax. Oyonnax is a rural commune in an area known as “Plastics Valley” due to the region’s domestic plastics industry.[ii] Given just 20,000 people live in Oyonnax, why doesn’t Paris – home to a much larger labour force of over 2 million people – produce France’s plastic instead? [iii] Fisher Investments UK think comparative advantage helps explain this. Paris could produce plastic – it might even be better at it. But Paris has a comparative advantage in other goods and services, so focussing on plastics may divert Parisian resources from other, more financially lucrative industries (e.g., tourism). Oyonnax gives up less to produce plastic – hence, its comparative advantage over Paris is plastic.

To see comparative advantage at an international scale, see Switzerland. Roughly 74% of its 2021 gross domestic product (GDP, a government-produced measure of economic output) came from its services sector whilst its agricultural sector contributed less than 1%. [iv] Switzerland could focus its production efforts on agriculture, but the country is just 41,285 square kilometres – tiny. The Alps cover nearly 60% of it, too. [v] Limited, mountainous geography makes large-scale farming difficult, so agriculture carries a high opportunity cost. Services sectors – like Swiss banking or its real estate services – carry lower opportunity costs. [vi] They aren’t as land-intensive, and they capitalise on Switzerland’s central European location and highly educated workforce, making it a competitive services hub.

Switzerland can fulfil much of its agricultural needs via imports. In 2019, the largest individual supplier of Swiss food imports was the Netherlands – a relatively flat and temperate nation. [vii] The Netherlands is the world’s second-largest exporter of agricultural goods (after the US). [viii] It capitalises on its comparative advantage (flat geography) just as Switzerland does (central location). Of course, trade isn’t limited to only two participants. This concept plays out worldwide, amidst many nations, provinces, companies and individuals – all concurrently.

In our view, comparative advantage benefits individual investors, too. We think it underlies global trade – adding to world economic growth through increased efficiencies and lowered costs. Fisher Investments UK thinks global trade is a net economic positive – and investors can benefit from trade-driven growth by investing globally. Since many countries develop concentration and expertise in equity sectors and industries through specialisation, we think a global portfolio provides the broadest exposure. Investors can benefit from this by analysing the sector and industry weights of a given country to help understand the region’s emphasis. That may help uncover what that country specialises in – and what it lacks, requiring broader country diversification. Yes, global trade can create winners and losers. Foreign competition may displace domestic industries and jobs, and we don’t dismiss those losses. However, when nations focus on their respective comparative advantages, our research has found more people and companies benefit. Fisher Investments UK think this helps explain why global trade exists, and how its resulting benefits can contribute to individual portfolio growth.