Absolute advantage theory

Absolute advantage theory of Scottish economist Adam Smith (1723-1790) was an international trade history theory that asserted individuals or nations trade because they have superior productivity in particular industries. Nations should produce and export goods for which they possess an absolute advantage and import others which other nations possess an absolute advantage for. Governments may attempt to counter absolute advantage by erecting trade barriers, allowing young, uncompetitive, industries enough time to become established. Adam Smith’s absolute advantage theory was superseded by the comparative advantage approach.

The concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication The Wealth of Nations in which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nation’s import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves.

Because Smith only focused on comparing labor productivities to determine absolute advantage, he did not develop the concept of comparative advantage. While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchanges.

In economics, the principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce a greater quantity of a good, product, or service than competitors, using the same amount of resources. Adam Smith first described the principle of absolute advantage in the context of international trade, using labor as the only input. Since absolute advantage is determined by a simple comparison of labor productiveness, it is possible for a party to have no absolute advantage in anything.

Example 1

According to Figure 1, England commits 80 hours of labor to produce one unit of cloth, which is fewer than Portugal’s hours of work necessary to produce one unit of cloth. England is able to produce one unit of cloth with fewer hours of labor, therefore England has an absolute advantage in the production of cloth. On the other hand, Portugal commits 90 hours to produce one unit of wine, which is fewer than England’s hours of work necessary to produce one unit of wine. Therefore, Portugal has an absolute advantage in the production of wine.

If the two countries specialize in producing the good for which they have the absolute advantage, and if they exchange part of the good with each other, both of the two countries can end up with more of each good than they would have in the absence of trade. In the absence of trade, each country produces one unit of cloth and one unit of wine, i.e. a combined total production of 2 units of cloth and 2 units of wine. Here, if England commits all of its labor (80+100) for the production of cloth for which England has the absolute advantage, England produces (80+100)÷80=2.25 units of cloth. On the other hand, if Portugal commits all of its labor (90+120) for the production of wine, Portugal produces (90+120)÷90=2.33… units of wine. The combined total production in this case is 2.25 units of cloth and 2.33 units of wine which is greater than the total production of each good had there been no specialization. Assuming free trade this will lead to cheaper prices for both goods for both countries.

Example 2

You and your friends decided to help with fundraising for a local charity group by printing T-shirts and making birdhouses.

• Scenario 1: One of your friends, Gina, can print 5 T-shirts or build 3 birdhouses an hour. Your other friend, Mike, can print 3 T-shirts an hour or build 2 birdhouses an hour. Because your friend Gina is more productive at printing T-shirts and building birdhouses compared to Mike, she has an absolute advantage in both printing T-shirts and building birdhouses.
• Scenario 2: Suppose Gina wasn’t as agile with the hammer and could only make 1 birdhouse an hour, but she took a screen printing class and could print 10 T-shirts an hour. Mike on the other hand takes woodworking and so he can build 5 birdhouses an hour, but he doesn’t know the first thing about making T-shirts so he can only print 2 T-shirts an hour. While Gina would have the absolute advantage in printing shirts, Mike would have an absolute advantage in building birdhouses.

Also see: comparative costs, Heckscher-Ohlin trade theory, technological gap theory