Absolute Advantage

Absolute advantage is the ability of a producer, whether a country, a company or a single worker, to make a good or service using fewer resources than another producer needs for the same output. Put the other way round, a producer with an absolute advantage gets more output from the same amount of labor, land or capital. Economists use the idea to explain why countries trade and why each tends to focus on certain industries.

The concept goes back to Adam Smith's The Wealth of Nations (1776), which argued that nations, like households, gain by buying what others make more cheaply and selling what they make best. It is usually taught alongside comparative advantage, the later and more general idea from David Ricardo, which shows that trade can benefit both sides even when one of them is better at producing everything. The two are often confused: absolute advantage compares raw efficiency, comparative advantage compares opportunity costs.

Picture two neighbors fixing up their houses. One is a trained electrician who can rewire a room in an afternoon; the other is a keen gardener who can lay a lawn in half the time it takes the electrician. Each is simply faster at one job. If they swap jobs, with the electrician doing both houses' wiring and the gardener both gardens, the work gets done sooner and both are better off.

That is absolute advantage: being plainly better at a task than someone else, measured by how much time or effort it takes. When each party is better at something different, the case for trading is obvious. The harder question, which comparative advantage answers, is what happens when one neighbor is faster at everything.

In its classic form, absolute advantage compares the labor needed to make one unit of a good. If $a_{A}$ is the hours country A needs per unit and $a_{B}$ is the hours country B needs, country A has the absolute advantage when:

Equivalently, A has the higher productivity, because output per hour is the reciprocal of hours per unit. In a worked example, suppose a worker in country A takes 4 hours to make a bicycle and a worker in country B takes 10 hours. Country A's productivity is $1 \div 4 = 0.25$ bicycles per hour, country B's is $1 \div 10 = 0.1$. Country A has the absolute advantage in bicycles. If country B needs 2 hours per tonne of rice and A needs 5, country B has the absolute advantage in rice. Each should make the good it is better at and trade for the other.

Modern studies rarely use labor hours alone. They compare output per worker, unit costs or total factor productivity, which also counts capital and other factors of production.

Smith wrote against mercantilism, the then-dominant view that a nation grows rich by exporting more than it imports and piling up gold. He argued instead that wealth is the goods and services a nation can consume, and that the division of labor raises output by letting each worker or region concentrate on what it does best. Extended across borders, this meant a country should buy from abroad whatever foreigners can supply more cheaply, and pay for it with goods in which it has the edge.

The argument underpinned the case for free trade and against high tariffs. It also explains a lot of everyday trade: tropical countries export coffee and bananas, which colder countries could only grow at huge cost in greenhouses, while countries with deep oil or mineral deposits export them. In such cases specialization by absolute advantage and by comparative advantage point the same way.

• Natural endowments. Climate, soil, minerals and location give some places a lower cost for specific goods, from Gulf oil to Brazilian soybeans.
• Skills and technology. Educated workforces and advanced methods raise output per worker, a theme of technological progress and growth theory.
• Capital and infrastructure. Ports, power and machinery cut unit costs.
• Scale. Large producers can benefit from economies of scale, which can turn an early lead into a lasting cost advantage.
• Institutions. Reliable courts, low corruption and stable monetary policy lower the cost of doing business.

Absolute advantage cannot explain why a rich, productive country still imports goods it could make more efficiently itself, or why a poor country with lower productivity in every sector still exports. Ricardo's comparative advantage resolves this: what matters is relative cost, so a country that is less efficient at everything still has a lowest-cost line of business. For this reason most economists treat absolute advantage as a starting point rather than a full theory of international trade.

Absolute advantage also matters in other ways. High absolute productivity is what makes a country rich: wages track output per worker, which is why wages in high-productivity economies are higher even when trade patterns follow comparative advantage. Business strategy also uses the term loosely, for a firm that can produce at the lowest cost in its industry. Finally, measured advantages shift over time, as investment, foreign direct investment and industrial policy change what each country can do, so today's export pattern is not fixed.

• Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Project Gutenberg)