THEORY OF ABSOLUTE ADVANTAGE: ADAM SMITH

The Scottish economist Adam Smith developed the trade theory of absolute advantage in 1776 through his legendary book “An Enquiry into the Nature and Causes of Wealth of Nations”. He developed the theory as an attack against the then prevailing mercantilist view of restrictive trade with the slogan ‘free trade’. Smith's argument was that the wealth of nations depends upon the goods and services available to their citizens, rather than the gold reserves held by the nation. Maximizing this availability depends primarily on fuller utilization of resources and then, on the ability

·     to obtain goods and services from where they are produced most cheaply (because of

“natural” or “acquired” advantages), and

·       to pay for them by production of the goods and services produced most cheaply in the country,

Human skill up gradation, division of labour and specialization and the economies of scale are the sources of acquired advantage for cheaper production. Natural advantages may emerge out of natural factors.

As the name indicates this theory proposes that a country should engage in the production and exchange of those commodities where it has an absolute advantage. Such a country produces greater output of a good or service than other countries using the same amount of resources. Absolute  advantage  is  defined  as  the  ability  to  produce  more  of  a  good  or  service  than competitors, using the same amount of resources. Smith stated that tariffs and quotas should not restrict international trade; it should be allowed to flow according to market forces. Contrary to mercantilism Smith argued that a country should concentrate on production of goods in which it holds an absolute advantage. No country would then need to produce all the goods it consumed. The theory of absolute advantage destroys the mercantilist idea that international trade is a zero- sum game. According to the absolute advantage theory, international trade is a positive-sum game, because there are gains for both countries to an exchange.

Assumptions

Ø  There are two countries and two commodities

Ø One country has absolute advantage in one commodity and the second country has advantage in another commodity

Ø  Technology is assumed to  be constant

Ø  Labour is the only factor of production

Ø  labour is homogeneous, that means each unit of labour produces same level of output

Ø  value of a commodity is measured in terms of its labour content

Ø  There is no technological improvement

Ø  Labour  is  perfectly  mobile  within  the  country  but  perfectly  immobile  between  the countries. It means that workers are free to move between industries within the nation but migration to other countries is impossible.

Ø  A system of barter prevails

Ø  Zero transportation cost

Based on these assumptions the theory can be explained with an example. Suppose there are two countries- India and Cuba producing tea and sugar. By employing a worker for one hour India can produce either 10kilograms of tea or 5 kilograms of sugar. Similarly if a Cuban worker is employed she is capable of producing 10 kilograms of sugar or 5 kilograms of tea.

Table 1: Output per hour (kg)

Country	Sugar	Tea
India	5	10
Cuba	10	5

From the table it is clear that by spending an hour’s labour India is capable of producing twofold of tea than Cuba similarly in the case of sugar Cuba is able to generate double the production in India. In short Cuba has absolute advantage in sugar and India in tea. In this situation by concentrating on the respective absolute advantageous areas both nations can benefit by fully channelizing their resources to absolutely advantageous commodity.

Since there is perfect factor mobility within a country, India can channelize labourers into tea sector and Cuba into sugar industry. If India transfer one labour from sugar to tea sector sugar production may fall by 5 kilograms but can produce 10 more kilograms of tea. By exchanging this one unit effort India is capable of purchasing 10 kilograms of sugar from Cuba. So it is beneficial for India. If India goes for domestic exchange, due to the increased cost it will not benefit India. The same is true for Cuba in the case of sugar.

There is a potential problem with absolute advantage. If there is one country that does not have an absolute advantage in the production of any product, will there still be benefit to trade, and will trade even occur? The answer may be found in the extension of absolute advantage, the theory of comparative advantage.