Absolute advantage Theory

The theory of absolute advantage was put forward by Adam Smith who argued that different countries enjoyed absolute advantage in the production of some goods which formed the basis of trade between the countries.

Adam Smith’s theory of absolute cost advantage in international trade was evolved as a strong reaction of the restrictive and protectionist mercantilist views on international trade. He upheld in this theory the necessity of free trade as the only sound guarantee for progressive expansion of trade and increased prosperity of nations. The free trade, according to Smith, promotes international division of labour.

Every country tends to specialize in the production of that commodity which it can produce most cheaply. Undoubtedly, the slogans of self- reliance and protectionism have been raised from time to time, but the self-reliance has eluded all the countries even up to the recent times. The free and unfettered international trade can make the countries specialise in the production and exchange of such commodities in case of which they command some absolute advantage, when compared with the other countries.

In this context, Adam Smith writes; “Whether the advantage which one country has over another, be natural or acquired is in this respect of no consequence. As long as one country has those advantages, and the other wants them, it will always be more advantageous for the latter, rather to buy of the former than to make.”

When countries specialise on the basis of absolute advantage in costs, they stand to gain through international trade, just as a tailor does not make his own shoes and shoemaker does not stitch his own suit and both gain by exchanging shoes and suits.

Consider Table 1.1 where man-hours required to produce a unit of wheat or cloth in the U.S.A. and India are given:

It will be seen from the above table that to produce one unit of wheat in the U.S.A. 3 man-hours and in India 10 man-hours are required. On the other hand, to produce one unit of cloth, in the U.S.A. 6 man-hours and in India 4 man-hours are required. Thus the U.S.A. can produce wheat more efficiently (that is, at a lower cost), while India can produce cloth more efficiently.

To put it in other words, while the U.S.A. has an absolute advantage in the production of wheat, India has an absolute advantage in the production of cloth. Adam Smith showed that the two countries would benefit and world output will increase if the two countries specialize in the production of goods in which they have absolute advantage and trade with each other. How such specialization and trade would lead to gain in output and would be mutually beneficial for the two countries is shown in Table 1.2.

Suppose to specialize in the production of Wheat, the U.S.A. withdraws 6 man-hours from the production of cloth and devote them to the production of wheat, it will lose 1 unit of cloth and gain 2 units of wheat.

Similarly, to specialize in the production of cloth if India withdraws 10 hours of labour from wheat and use them for the production of cloth, it will lose one unit of wheat but gain 2.5 units of cloth.

In this way, transfer of labour resources to the goods in which they have absolute advantage, will result in the net gain of one unit of wheat and 2.5 units of cloth. The gain in output can be distributed between the two countries through voluntary exchange.

It is also clear from above that without any increase in productive resources international divi­sion of labour and trade leads to the expansion in world output and wealth. According to Adam Smith, given perfect competition in the industries and free trade between the countries, it is the market forces that would ensure specialization and trade on the lines of absolute advantage.