What is Absolute Advantage?
In economics, absolute advantage refers to the capacity of any economic agent, either an individual or a group, to produce a larger quantity of a product than its competitors. Introduced by Scottish economist, Adam Smith, in his 1776 work, “An Inquiry into the Nature and Causes of the Wealth of Nations,” which described absolute advantage as a certain country’s intrinsic capability to produce more of a commodity than its global competitors.
Smith also used the concept of absolute advantage to explain gains from free trade in the international market. He theorized that countries’ absolute advantages in different commodities would help them gain simultaneously through exports and imports, making the unrestricted international trade even more important in the global economic framework.
Adam Smith’s Theory of Absolute Advantage
The mercantilist economic theory, which was widely followed between the 16th and the 18th century, came under a lot of criticism with the emergence of economists like John Locke and David Hume. Mercantilism advocated a national economic policy designed to maximize the nation’s trade and its gold and money reserves. Mercantilism gained influence due to the emergence of colonial powers such as Britain and Portugal, before Adam Smith, and later Daniel Ricardo, both staunch critics of the concept, came up with their own theories to counter mercantilism.
Smith was the first economist to bring up the concept of absolute advantage, and his arguments regarding the same supported his theories for a laissez-faire state. In “The Wealth of Nations”, Smith first points out that, through opportunity costs, regulations favoring one industry take away resources from another industry where they might have been more advantageously employed.
Secondly, he applies the opportunity cost principle to individuals in a society, using the particular example of a shoemaker not using the shoes he made himself because that would be a waste of his productive resources. Each individual thus specializes in the production of goods and services in which he or she has some sort of an advantage.
Thirdly, Smith applies the same principles of opportunity costs and specialization to international economic policy, and the principle of international trade. He explains that it is better to import goods from abroad where they can be manufactured more efﬁciently because it allows the importing country to put its resources into its own most productive and efficient industries. Smith thus emphasizes that a difference in technology between nations is the primary determinant of international trade flows around the globe.
Assumptions of the Absolute Advantage Theory
- Smith assumed that the costs of the commodities were computed by the relative amounts of labor required in their respective production processes.
- He assumed that labor was mobile within a country but immobile between countries.
- He took into consideration a two-country and two-commodity framework for his analysis.
- He implicitly assumed that any trade between the two countries considered would take place if each of the two countries had an absolutely lower cost in the production of one of the commodities.
Achieving an Absolute Advantage
An absolute advantage is achieved through low-cost production. In other words, it refers to an individual, company, or country that can produce at a lower marginal cost. Such an advantage is established when (compared to competitors):
- Fewer materials are used to produce a product
- Cheaper materials (thus a lower cost) are used to produce a product
- Fewer hours are needed to produce a product
- Cheaper workers are (in terms of hourly wage) used to produce a product
Advantages of an Advantage
Absolute Cost Advantage
Absolute cost advantage results from the specialization of labor proposed by Smith in his theory. Specialization of labor, or division of labor, results in a significantly higher productivity per unit of labor, and in turn, a lower cost of production. Smith also used the concept of “Economies of Scale” to explain the lowering of production costs, as a higher output due to labor diversification would significantly reduce production costs.
A country should produce those goods that are naturally favoring its climatic environment. The type of goods produced would also depend on the availability of natural resources. The presence of lots of natural resources would significantly provide an advantage to such a country while producing the goods.
Acquired advantage includes advantages in technology and level of skill development.
Absolute Advantage vs. Comparative Advantage
Absolute and comparative advantage are commonly misunderstood concepts. An absolute advantage looks at the financial costs of production, while a comparative advantage looks at the opportunity cost of production. The two terms are contrasted below:
The ability to produce more of a good or service while using fewer resources compared to a competing entity.
The ability to produce a good or service at a lower opportunity cost.
Criticisms against Absolute Advantage
The Absolute Advantage Theory assumed that only bilateral trade could take place between nations and only in two commodities that are to be exchanged. Such an assumption was significantly challenged when the trade, as well as the needs of nations, started increasing. Thus, the theory did not take into account the multilateral trade that could take place between countries.
The Absolute Advantage Theory also assumed that free trade exists between nations. It did not take into account the protectionist measures that are adopted by countries. The protectionist measures included quantitative restrictions, technical barriers to trade, and restrictions on trade on account of environmental protection or public policy.
Ricardo later came up with his own criticisms of Adam Smith’s theory. Ricardo’s 1817 work, “On the Principles of Political Economy and Taxation,” introduced a theory that later attained fame as the theory of comparative advantage, which places opportunity cost at the focus of agents’ production decisions.
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