Absolute Advantage

What is Absolute Advantage?

Absolute advantage refers to the argument that countries differ in their ability to produce goods efficiently, and hence one country may have an advantage in the production of a product that is absolute over any other country in producing it.

The word absolute refers to a fact, principle or an idea that is valid at all times. It exists independently and not in relation to anything else. Hence, absolute advantage refers to an advantage that holds true in all circumstances.

A country has an absolute advantage in the production of a commodity if it can produce that commodity more efficiently in absolute terms.

Efficiency has been defined as producing with a minimum of waste, expense, or unnecessary effort, and therefore includes low cost, fewer resources, and fewer labor hours.

Writing about agricultural trade, Luther Tweeten argues that the United States has an absolute advantage in wheat production because only one hour of labor is required to produce a ton of wheat versus four hours to produce a ton of wheat in the rest of the world.

In contrast, elsewhere in the world sugar production requires two hours of labor versus three in the United States to produce one ton of sugar.

Because labor supply is limited and transferable between commodities but not between countries, wheat output (elsewhere in the world) is forgone to produce sugar.

Similarly, the United States forgoes the expenditure of three hours of labor to produce one ton of sugar to produce three tons of wheat.

While the concept of absolute advantage is closely associated with David Ricardo, the concept actually originated with Adam Smith’s 1776 book The Wealth of Nations. Opens in new window

According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and trade these goods for goods for goods produced by other countries.

Smith’s argument is that a country should never produce goods at home that it can buy at a lower cost from other countries. Smith demonstrates that, by specializing in the production of goods in which each country has an absolute advantage, countries will benefit by engaging in trade.

Smith was attempting to explain the process by which markets and production actually operate in society. Absolute advantage is an extension of Smith’s concept of the division of labor in the production process to a division of labor and specialized product across countries.

As Smith observed the production processes of the early stages of the industrial revolution in England, he saw that fundamental changes were occurring. Whereas, in earlier days, a worker performed all stages of the production process, producing enough output for his own needs only, the factories of the industrializing world were separating production into distinct stages.

Each stage would be performed exclusively by one individual, hence the division of labor. The specialization increased the production of workers and industries.

David Ricardo expanded Adam Smith’s argument to consider the case of a country that has an absolute advantage in the production of all goods. In that case, would such a country derive any benefit from trade?

In his Principles of Political Economy, Ricardo Opens in new window argued that it made sense for a country to produce those goods that it produces more efficiently and to buy from other countries those goods that it produces comparatively less efficiently. This is the concept of comparative advantage, Opens in new window with which Smith’s absolute advantage is often confused.

While the industrialized world may have absolute advantage in the production of many commodities, much of the world’s natural resources are to be found in developing countries, from which they are mined, quarried, or extracted and shipped overseas for refining and fabrication where high levels of infrastructure (particularly utilities and transportation), skilled labor, and capital are available.

Mashaalah Rahnama-Moghadam and colleagues argue that the occurrence of natural resources in the less developed countries might suggest that economic growth had a base in those countries, but the lack of requisite economic resources has made these natural resources little more than export commodities.

Where absolute advantage derives from a unique natural resource, Raineesh Narula and other international trade and business scholars argue that current and future domestic and international investment activity will be focused on those industries related to the exploitation of this resource, often delaying the development of industry in such countries.

Countries with an absolute advantage in scarce natural resources, like Norway and Australia, are likely to receive a larger amount of inward investment from home countries that need scarce resources as inputs to higher value production. Resource-poor countries would seek to acquire these resources through outward direct investment. Hence, absolute advantage dictates foreign direct investment strategy.

Vivek Suneya takes this thought further, considering capital itself a scarce resource. He argues that when capital is mobile it will seek its absolute advantage by migrating to countries where the environmental and social costs of enterprises are lowest and profits are highest.

While greater productivity and efficiency are a strong argument for offshore outsourcing, Suneya would counter that unrestricted global capital mobility does not serve the needs of society, specifically the preservation of social cohesion and the avoidance of mass unemployment.