The theory of absolute advantage was developed by Adam Smith in 1776 in response to the previous theory that a country’s wealth depended upon its reserve of gold. Contrary to this belief, Smith proposed that the wealth of a nation was dependant upon its goods and services available to its citizens. The theory of absolute advantage states that global efficiency can increase through free trade since different countries produce some goods more efficiently than other countries.
Smith questions in this theory why citizens would buy domestic products if they could be more cheaply purchased abroad, and states that, if there were unrestricted trade, each country would specialize in those products and services that gave it a competitive advantage. Through specialization, countries could increase their efficiency because a) labour would become more skilled by repeating the same tasks, b) labour would not lose time in switching from the production of one kind of product to the other, and c) long production runs would provide incentives for the development of more effective working methods. Through these three increases in efficiency, a country could then use its excess specialized production to buy more imports than it could have otherwise produced.
A country’s advantage, according to Smith, would be either natural or acquired. Due to climatic conditions, access to certain natural resources, or availability of certain labour forces, a country may have a natural advantage in one given industry. No single country is large enough or sufficiently rich in natural resources to be independent of the rest of the world except for short periods. However, in today’s society and economic environment, most countries depend on acquired advantages (advantages derived from the competitive production of manufactured goods, usually in either product or process technology). An advantage to product technology is that one country can produce a unique, or easily-distinguishable product, such as Italian tile. Because most technological advances originate in the more industrialized countries, these countries hold a greater opportunity for acquired advantage. Developing countries must rely more often than not on natural advantage.
In 1817, David Ricardo expanded upon Smith’s theory of absolute advantage with the theory of comparative advantage, which explains why countries that can produce all products at an absolute advantage, don’t. Comparative advantage suggests that there are still economic and efficiency gains to be had from trade if a country specializes in not only what it can produce, but those products that it can produce more efficiently than other products, regardless of whether other countries can produce those same products even more efficiently.
For example, the most qualified physician in an area may also be the most qualified medical secretary. However, comparative advantage states that this physician would not also handle all of his secretarial needs. Since the physician would make more money as a physician, he would remain in that position, even if it meant hiring a less qualified medical secretary. Similarly, Ricardo explains, countries will gain if they concentrate their efforts and resources on producing commodities that it can produce most efficiently. It will then trade some of these commodities for those which it has foregone.
Some basic assumptions must be understood in the absolute and comparative advantage theories. The first assumption is that of full employment of labour and resources. Unemployment and untapped resources may result in restriction of imports or use of idle resources. Moreover, countries’ goals may be greater than output efficiency, and countries may want to avoid overspecialization due to changes in technology and price fluctuation. Many businesses and governments are also concerned with relative as well as absolute economic growth, meaning that if they perceive that they feel a trading partner is gaining too large a share of benefits, they may forgo absolute gains so as to prevent relative losses. Similarly, if costs to transport goods are greater than the gains achieved through specialization, then the advantages of trades are nullified. Resources are neither as mobile nor as immobile as the theories of absolute and comparative advantage assume. Furthermore, the absolute and comparative advantage apply to countries’ advantages at one singular point in time, viewing them statically rather than dynamically. Therefore, it is unsafe to assume that the future of absolute and comparative advantages will remain the same over time. Smith and Ricardo also both assume that these transactions would be limited to two countries and two commodities. However, economists have been able to use the same theories to multiple countries and multiple products.
