Theories of International Trade - Theory of Absolute Advantage

Portrait of Adam Smith by John Kay, 1790.

In the last post, we discussed the theory of Mercantilism. In response to Mercantilism, Adam Smith offered his own theory of Absolute Advantage. This theory believed that a nation should specialize in producing those goods that it can produce at a cheaper cost than that of other nations. These goods should be exchanged with other goods that are being cheaply produced by the other nations.

According to him, there are following advantages of this theory.

1. Absolute Cost Advantage -

a. Absolute Cost Advantage will exist because of specialization of labor that would in turn lead to higher productivity and less cost of labor.

b. Economies of Scale will also exist as one country would produce one type of goods at a large scale. This will significantly reduce the cost of the goods.

2. Natural Advantage – A country would produce those goods that are naturally favoring its climatic conditions. The type of goods produced would also depend upon the availability of natural resources. Presence of plenty of natural resources would significantly provide advantage to such a country while producing the goods.

3. Acquired Advantage – This would include advantage in technology and level of skill development.

Criticisms of this theory

This theory assumed that only bilateral trade could take place between the nations and only in two commodities that are to be exchanged. This assumption was significantly challenged when the trade as well as needs of a nation started increasing. Thus this theory did not take into account the multi-lateral trade that could take place between the countries.

This theory also assumed that free trade exists between the nations. It did not take into account that protectionist measures that are adopted by the nations. These protectionist measures were in many forms and included quantitative restrictions, technical barriers to trade, and restrictions on trade on account of environment protection or public policy.

Another criticism of this theory is that it considered labor as the only cost of production in manufacturing goods. It neglected other significant elements like transportation costs, technological costs etc. Also, it became hard for countries to have absolute advantage for many products. In the next post, we shall discuss the theory of comparative advantage.

Theories of International Trade:

1. Mercantilism
2. Theory of Absolute Advantage
3. Theory of Comparative Advantage
4. Hecksher-Ohlin Model

International Trade Law Notes