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Absolute Advantage Trade Theory of Adam Smith

Updated on August 14, 2017
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IRSHAD CV has been a student in Economics. Now he is doing Masters in Economics. He completed B.A. Economics from the University of Calicut.

Introduction

International trade is one of the vital matters of any country. Trade practiced from the early time of human history. Now its scope has increased by manifold especially after the phenomenon of globalization. Merchentalists (mainly based in Germany) of the 17th century argued for international trade. They believed in trade and industry as the most productive activities. They traded for making more gain by earning gold and silver. They were also argued for surplus trade and so trade was exploitative in nature. Later the classical school of economics came with new trade concepts. Adam Smith was a great legend who argued for international trade. He was a supporter of free trade, laissez-faire and market mechanism. Smith’s trade theory is popularly known as the ‘Absolute Advantage Trade Theory’. Through this theory Smith explained the reason for the raising of international trade.

Assumptions of the Theory

Smith’s theory of trade is based on certain assumptions. The major assumptions are

a) There are two countries in the exchanges of imports and exports.

b) Two commodities are producing by the both countries (one each).

iii) Each country is using single factor for production.

Based on these assumptions, international trade occurs under absolute advantage theory.

The Theory

According to Adam Smith specialization is determined by the market size. International trade will expand the scope of market. So, there will be higher level of specialization in the production of each product in each country.

In simple words, international trade occurs when a country focuses on the production of a particular commodity, which can be produced at lower cost. And the country will export it. On the other side, the countries will imports commodities which are costlier for production.

The theory of absolute advantage can be explained with an example. See the table below.

Two Country Two Product Model

COMMODITY
Labour used for producing 1 Unit (INDIA)
Labour used for producing 1 Unit (ENGLAND)
wheat
10
20
Steel
20
10

In this example, there are two countries, India and England. And also there are two commodities, wheat and steel. The measure is in terms of labor hour. To produce one unit of wheat, England requires 20 labors while it is only 10 in India. Similarly, to produce one unit of steel, India requires 20 labors and England requires only 10. Here it can be vividly predicted that, India is absolutely advantaged to produce wheat. On the other side, England is absolutely advantaged to produce steel.

In fact, international trade will be mutually beneficial to both the countries, when a country focuses on the production of highest advantaged commodities and exports it. The disadvantaged commodity for production can be imported. In this way the benefits of international trade can be shared between countries.

Based on the above table, international trade will be beneficial to both the countries when India specialize on the production of wheat and exports it. On the other side England must specialize on the production of steel and export it to India. Then, India can meet the demand for steel by importing from England at lower cost. Therefore Smith’s theory is also based on the working of economies of large scale production.

Even though, absolute advantage trade theory is relevant today, it challenges some criticisms. Later many economists developed other trade theories also. Some of the major criticisms of Smith’s trade theory are mentioned below.

a) If a country enjoys absolute advantages in the production of all commodities, the scope of international trade may become nil.

b) Some of its assumptions are not working in today’s reality.

iii) It is very difficult to calculate the value of labor in different countries.

Conclusion

Absolute advantage trade theory was developed by Adam Smith. The theory has some scope even today. It can be regarded as the first trade theory developed to support a systematic or scientific form of international trade. It highlights the role of trade to ensure consumer welfare, better relations between countries, specialization etc.

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