How Misleading is Revealed Comparative Advantage?

Revealed comparative advantage (RCA) index, given by Bela Balassa, is widely used metric among trade-policy practitioners to measure comparative advantage of a country. Comparative advantage of a country is defined as its capacity to produce a particular good (or a service) at a lower cost than its trading partners. Theoretically, country’s global market share of a good and not its size should reflect its comparative advantage in that particular good. In this paper, trade-economist, Ben Shepherd demonstrates that while Germany and Switzerland have similar market shares in pharmaceuticals sector, Switzerland has higher RCA score being the smaller country. The author reasons that such misleading scores arise due the way RCA is calculated - relative share of a good in a country’s total export to its share in the total world export. Such an expression of RCA, the author elucidates, can be decomposed into two components. One is the country’s share of global exports of a particular good. The other is the country’s total exports of all products relative to total world exports of all products, i.e., country’s size. The variation in RCA across countries is heavily biased due to other peripheral factors as well, such as sectoral expenditures and trade costs, the paper argues. Thus, RCA index is an inconsistent measure of country’s comparative advantage. Therefore, trade-policy practitioners should derive theory consistent measures of comparative advantage rather than relying on RCA, suggests Shepherd.