Revealed Comparative Advantage - Example

Revealed Comparative Advantage Name Institution Lecturer Course Date Revealed Comparative Advantage (RCA) Introduction Revealed Comparative Advantage (RCA) is an index that economists’ use, in international economics, to determine the relative position of a given country with respect to certain commodities. The country’s revealed advantage or disadvantage with respect to the commodity under consideration is evidenced by trade flows in or out of the country. Serin and Civan postulate that Revealed Comparative Advantage describes a country’s tendency to export the products and/or services it produces effectively and in plenty when compared to the rest of the world (Serin & Civan, 2008, 29). Increased globalization has largely affected the extent to which countries export goods and services they are relatively adept at producing. On the other hand, countries import the goods and services they cannot produce effectively and efficiently. This paper focuses on Revealed Comparative Advantage and presents RCA values for India for three classes of products. The Mathematical Representation of Revealed Comparative Advantage and the Implications of RCA Values Mathematically, Relative Comparative Advantage, is represented by the following formula: RAC = (∑dXisd/∑dXsd)/ (∑wdXiwd/∑wdXwd) Where s represents the country of interest, i represents the class of goods or services under interest, d and w represent the set of all world countries and x represents the flow of commodity export. The Relative Comparative Advantage formula shown above is comprised of two parts, the numerator and the denominator, which makes it a ratio. The numerator shows the commodity’s share (i) in the export country (s) while the numerator shows the commodity’s share (i) in world export. Therefore, the RCA formula is fundamentally a ratio that compares a given country with the world in terms of export share. In fact, according to Serin and Civan (2008), a nation’s RCA is a ratio of the relative weight of the total export of a given commodity in the nation to the percentage of the global export of the commodity. Serin and Civan (2008), in their research, argued that the Revealed Comparative Advantage is an economic tool that evaluates a country (economy) by measuring strong and weak sectors of the economy. When RCA is greater than unity, it shows that the country under consideration has a revealed comparative advantage on the respective commodity. In other words, the country is better off than other countries in the world with respect to the commodity under consideration. The higher the RCA value, the better the country with respect to the commodity. On the other hand, an RCA value lower than unity shows that the country under consideration has a revealed comparative disadvantage with respect to the respective commodity than other countries of the world. The lower the RCA value below 1, the worse the country is with respect to the commodity under consideration. The concept of RCA is based on the theory, that countries export goods and services they are relatively adept at producing vis-à-vis other countries (Batra & Khan, 2005, 5). Therefore, if a country finds out that it has a relative advantage than the rest of the world in the production of a product, the country should then devote its resources to produce the given product abundantly. The country should then export the given product it is adept at producing. Also, it should get other products it cannot produce efficiently and effectively from other countries where production is abundant and at a lower price. Such a trade would lead to exchange of goods and services between countries whereby each country exchanges products and services it produces abundantly with another country. With this regards, the country under consideration has a comparative advantage. Trade specialization and improvement in world demand for a commodity RCA. This affects RCA’s movement for a given country. These factors affect a country’s export and import when compared to the rest of the world (Batra & Khan, 2005, 5). Improvement in world demand for a product produced by a country affects the country’s export of the product. Consequently, it leads to an increase in the RCA level because it puts the country at a better position than the rest of the world. Trade specialization also occurs when a country specializes on the production of a given commodity. The impact of improved demand for a commodity, in combination with trade specialization leads to abundant production of the given commodity. Forms of RCA Indices, their Difference and what they reveal about a Country The concept of RCA index was introduced by Balassa in the mid 1960s (Yu, Cai and Leung, 2009, 268). Balassa’s RCA index is the most common RCA index that shows a country’s comparative advantage in a given commodity. However, this index can only show whether a country has a comparative advantage or disadvantage in a given commodity. In addition, the index use can lead to incorrect results owing to its inability to compare countries where world export market share is small (Yu, Cai and Leung, 2009, 268). Scholars among them Yu, Cai and Leung have established other RCA indices that are aimed at improving the original BRCA (Yu, Cai & Leung, 2009, 268). Symmetrical RCA (SRCA) has symmetrical RCA values that range from -1 to +1. Zero denotes the neutral point, negative values show comparative disadvantage while positive values signify a comparative advantage (Yu, Cai & Leung, 2009, 269). Another proposed RCA index is the WRCA that uses the arithmetic mean of the BRCA scores of a country for purposes of comparative analysis (Yu, Cai and Leung, 2009, 269). Additive RCA (ARCA), like SRCA, ranges from -1 to +1. Positive values signify comparative advantage, negative values show comparative disadvantage and zero is the neutral point. SRCA, ARCA and WRCA are similar, in that, RCA values are constrained between -1 to +1 unlike in BRCA where RCA values run indefinitely on either side of the neutral point, 1. Further, the neutral point for SRCA, ARCA and WRCA is 0 while, in the case of BRCA, the neutral point is 1. RCA Results for India on Three Products for the Period between 1996 and 2005 Table 1: RCA values for various product classes in India between 1996 and 2005. Product Class Year 1996 97 98 99 2010 01 02 03 04 05 Animal and Vegetable Fats 1.51 0.99 0.97 1.6 1.66 1.22 0.73 0.77 0.94 0.69 Raw Hides and Skins 3.32 3.75 4.18 3.74 3.94 3.57 3.07 3.03 2.70 2.57 Machinery and Mechanical Appliances 0.20 0.20 0.18 0.17 0.20 0.22 0.21 0.24 0.22 0.24 Source: Burange & Chaddha, (2008). Figure 1: the movement of RCA values for various product classes in India between 1996 and 2005. Source: Burange and Chaddha, 2008, 9 Table 1 shows the RCA indices for three classes of products between 1996 and 2005. From the table, it is apparent that the RCA indices for the three product categories differ. Raw hides and skins have the highest RCA values for all years followed by animal and vegetable fats and then machinery and mechanical appliances. This is further explicated graphically using the bar chart shown in figure 2, which shows that animal and vegetable fats have high RCA values for all years while machinery and mechanical appliances have the lowest values for all years. The graph also shows that Revealed Comparative Values for raw hides and skins had a positive movement between 1996 and 1998 before falling gradually between 2000 and 2005. Revealed Comparative Advantage values for animal and vegetable fats have not been stable over the period, nor depicted a predictable movement. However, the values were higher for the period between 1996 and 2010 than in later years (between 2001 and 2005). Finally, the RCA values for machinery and mechanical appliances are relatively constant for the entire period with a slight increase during the later years. Discussion The relative comparative advantage for raw hides and skins for India is higher than that for animal and vegetable fats, which is higher than that for machinery and mechanical appliances for all the years. India has a comparative advantage with respect to raw hides and skins because RCA values for this class of commodities are higher than unity. Based on the RCA formula aforementioned, the relative weight of the total export of raw skins and hides for India is relatively higher than the percentage global export of the same. In the case of animal and vegetable fats, India has a comparative advantage vis-à-vis other countries in the world for some years. However, in some other years, it has a comparative disadvantage because RCA values for this class of commodities range from below unity to above unity. Finally, RCA values for machinery and mechanical appliances remain below unity for all years, which implies that India has a comparative disadvantage vis-à-vis, other countries in the world with respect to machinery and mechanical appliances. This further implies that India’s export of this class of commodities is not as high as other countries in the world. Combined, these results show that a country can have a comparative advantage compared to other countries on one class of commodity while having a comparative disadvantage on other classes. This follows the aforementioned theory, that a country produces the products it is adept in producing and then exchanges them with other products from other countries at a comparative advantage. This is the basis of trade specialization. Conclusion RCA is a crucial economic tool that describes a country’s tendency to export the products and/or services it produces effectively and in plenty when compared to the rest of the world. The results of India’s Revealed Comparative Advantage show that India has the tendency to produce raw hide and skins than other countries thereby exporting these products. On the contrary, the country’s production of machinery and mechanical appliances is not high. References Batra, A. & Khan, Z. 2005. Revealed Comparative Advantage: An Analysis for India and China. Working Paper no. 168. Indian Council for Research on International Economic Relations. Accessed 6 October 2012 from Burange, L.G. & Chaddha, S.J. 2008. India’s Revealed Comparative Advantage in Merchandise Trade. Working Paper UDE28/6/2008. University of Mumbai Department of Economics. Accessed 6 October 2012 from Serin, V. & Civan, A. 2008. ‘Revealed Comparative Advantage and Competitiveness: A Case Study for Turkey towards the EU.’ Journal of Economic and Social Research, 10(2): 25-41. Yu, R., Cai, J. & Leung, P. 2009. ‘The Normalized Revealed Comparative Advantage Index.’ Annals of Regional Science, 43: 267-282. Read More