What Are the U.S. and China’s Current Comparative Advantages?

To understand where we’re going – how free trade might change the U.S. and China’s comparative advantages, we need to first know where we are.  Today, where do the U.S.’ comparative advantages lie?  China’s?

China’s comparative advantage today lies largely in labor-intensive manufactured goods.  According to Leonard K. Cheng, head of the economics department at the Hong Kong University of Science and Technology, “Labor-intensive industries would be in China's comparative advantage, but natural resource-intensive industries, capital-intensive industries, and technology-intensive industries are in China's comparative disadvantages. It may have comparative advantage in some of the skill-intensive industries but comparative disadvantage in others.”[1]

Lu Zheng, director of the Institute of Industrial Economics under the Chinese Academy of Social Sciences, said that “China enjoys a comparative advantage in cheap educated laborers.”  That advantage will “last at least two decades and play an important role in promoting China's economic growth.”[2]

According to the U.S. Bureau of Labor Statistics, “In 2007, compensation costs relative to the United States in Mexico and the Philippines were 13 percent and 4 percent of the U.S. level, respectively.”[3]  In 2006 (the most recent year available), compensation costs in China were 2.7 percent of the U.S. level. 

Even assuming that compensation costs in China increase at a rate of 12.5 percent annually (the average annual growth between 2002 and 2006 was 5.15 percent), it would take thirty years for compensation costs in China to match 2006 U.S. levels (not assuming any growth in U.S. compensation costs – clearly a false assumption).

US-China Trade Data: Hourly compensation costs of manufacturing employees in China, 2002-2006

(Click to enlarge.)

And Paul Krugman explains that “China’s dominant role in the export of many labor-intensive manufactured goods surely reflects its combination of relatively abundant labor and relatively high manufacturing competence.”[4]

The United States’ comparative advantage today lies increasingly in services (financial and otherwise), agricultural products and processed food, and high-tech manufacturing (“integrated circuits”).  Considered most simply, a country’s comparative advantage is in those products that it exports more than it imports.  That advantage may be the result of not-free trade practices (as is likely the case with America’s advantage in agriculture) or it may be the result of more production efficiencies.

US-China Trade Data: China and the US Merchandise and Commercial Services Trade, Net Trade Balance, 2008

(Click to enlarge.)

The U.S. service sector also has a global comparative advantage.  In the last two decades, the share of services in U.S. GDP rose from about 60 percent to 72 percent, and that shift continues.  “The demand for high-quality services at home contributes to a global comparative advantage in the delivery of many different professional services.  In part because the domestic market is so well developed, the United States is also the world’s leading exporter of business and professional services. . . The comparative advantage enjoyed by the U.S. in the service-sector industries is reflected not only in their rising share in total exports but also in the positive and increasing net export balance in services.”[5]

Some people point out that America’s surplus in service exports doesn’t begin to match the size of America’s deficit in goods imports.  That is true.  But consider it this way: China makes things that everyone – rich and poor, developed and developing – uses.  Today, not everyone can buy an American financial asset or purchase services from America’s service providers. 

But as developing countries like China become wealthier (because they’re selling goods to the U.S.) they become increasingly able to buy those financial assets and services.  As long as the U.S. does what it will take (not protecting inefficient industries but rather bolstering education and improving infrastructure) to maintain its advantage in financial assets and services, America stand to reap huge gains from China’s rise.

The Peterson Institute for International Economics explained it well: “The U.S. service sector has global comparative advantage.  As our trading partners develop and grow, their demand for services will rise.  Ensuring open markets for competitive U.S. exporters will raise U.S. export levels and will benefit the recipients.”[6]

Yet the U.S. will no doubt have competition.  History clearly demonstrates that as developed economies have matured, their services sectors have become more important and manufacturing less so.  The U.S. will have to remain an innovation leader to retain its comparative advantage in the services sector.

US-China Trade Data: Share of total employment in manufacturing and service sectors, 1965 and 2005

Source: U.S. Bureau of Labor Statistics

Bill George, former CEO of Medtronic, current Harvard Business School professor, and author of the recent book True North: Discover Your Authentic Leadership has argued that the U.S. in fact has a comparative advantage in the kind of “innovation and entrepreneurship” that will allow America to retain its advantage in services and financial assets. 

Once there are no productive differences between the U.S. and China (once wages and productivity rates are roughly the same), the country that grows the fastest will be the one that innovates most quickly and efficiently.  Robert Samuelson called those U.S. advantages “qualities that are hard to distill into simple statistics.”  Among them, “ambitiousness, openness to change (even unpleasant change), competition, hard work and a willingness to take and reward risks.”[7]

In addition to a decent-sized trade surplus in services, the U.S. has a clear comparative advantage in financial assets as well.  In 2009, the value of the inflow of foreign-owned financial assets into the U.S. (what we call the U.S.’ exports of financial assets) was $306 billion; the value of the outflow of U.S.-owned financial assets abroad (what we call the U.S.’ imports of financial assets) was $140 billion.  That’s clearly a far way off compared to 2006 and 2007, when foreigners were buying more than $2 trillion in U.S. financial assets (and Americans were buying more than $1 trillion in foreign assets).  Still, even at 2009 levels, the U.S.’ “exports” of financial assets was almost two-thirds of all U.S. services exports.

US-China Trade Data: US Imports and Exports of Financial Assets, 1980-2009

(Click to enlarge.)

This article is part of Issues in Depth: Free Trade and Comparative Advantage.  Click here to explore this issue in depth – to read more articles similar to this one, see relevant data charts and graphs, and hear from the experts.


[1] Leonard K. Cheng, “China's Economic Benefits from Its WTO Membership”

[2] People’s Daily, “Researcher: China Enjoys Comparative Advantage in Labor Cost”

[3] U.S. Bureau of Labor Statistics, International Comparisons of Hourly Compensation Costs in Manufacturing, 2007. 

[4] Paul Krugman, “Increasing Returns in a Comparative Advantage World”

[5] Peterson Institute for International Economics, “Has US Comparative Advantage Changed?”

[6] ibid.

[7] Robert Samuelson, “US Shouldn't Fear Rise of China, India,” The Business Times, 26 May 2005.

 

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