Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time using a lesser quantity of inputs, than its competitors.
The concept of absolute advantage was developed by 18th-century economist Adam Smith in his book The Wealth of Nations to show how countries can gain from trade by specializing in producing and exporting the goods that they can produce more efficiently than other countries. Countries with an absolute advantage can decide to specialize in producing and selling a specific good or service and use the generated funds to purchase goods and services from other countries.
Smith argued that specializing in the products that they each have an absolute advantage in and then trading the products can make all countries better off, as long as they each have at least one product for which they hold an absolute advantage over other nations.
Absolute advantage explains why it makes sense for individuals, businesses, and countries to trade with each other. Since each has advantages in producing certain goods and services, both entities can benefit from the exchange.
This mutual gain from trade forms the basis of Smith’s argument that specialization, the division of labor, and subsequent trade lead to an overall increase in prosperity from which all can benefit. This, Smith believed, was the root source of the eponymous "Wealth of Nations."1
Absolute advantage can be contrasted with comparative advantage, which is when a producer has a lower opportunity cost to produce a good or service than another producer. An opportunity cost is the potential benefits an individual, investor, or business misses out on when choosing one alternative over another.
Absolute advantage leads to unambiguous gains from specialization and trade only in cases where each producer has an absolute advantage in producing some good. If a producer lacks any absolute advantage, then Adam Smith’s argument would not necessarily apply.
However, the producer and its trading partners might still be able to realize gains from trade if they can specialize based on their respective comparative advantages instead. In his book On the Principles of Political Economy and Taxation, David Ricardo argued that even if a country has an absolute advantage over trading many kinds of goods, it can still benefit by trading with other countries if that have different comparative advantages.
Both Smith's theory of absolute advantage, and Ricardo's theory of comparative advantage, rely on certain assumptions and simplifications in order to explain the benefits of trade. Both theories assume that there are no barriers to trade: they do not account for any costs of shipping or additional tariffs that a country might raise on another's imported goods.
Another is that the factors of production are immobile: In these models, workers and businesses do not relocate in search of better opportunities. This assumption was realistic in the 1700s, but globalization has now made it easy for companies to move their factories abroad.
More crucially, these theories both assume that a country's absolute advantage is constant, and scales equally. In other words, it assumes that producing a small number of goods has the same per-unit cost as a larger number and that countries are unable to change their absolute advantages. In reality, countries often make strategic investments to create greater advantages in certain industries.
One advantage of the theory of absolute advantage is its simplicity: The theory provides an elegant explanation of the benefits of trade, showing how countries can benefit by focusing on their absolute advantages.
However, the theory of comparative advantage does not fully explain why nations benefit from trade. This explanation would later fall to Ricardo's theory of comparative advantage: Even if one country has an absolute advantage in both types of goods, it will still be better off through trade. In other words, if one country can produce all goods more cheaply than its trading partners, it will still benefit by trading with other countries.
Also, as explained earlier, the theory also assumes that absolute advantages are static—a country cannot change its absolute advantages, and they do not become more efficient with scale. Actual experience has shown this to be untrue: Many countries have successfully created an absolute advantage by investing in strategic industries.
In fact, the theory has been used to justify exploitative economic policies in the postcolonial era. Reasoning that all countries should focus on their advantages, major bodies like the World Bank and IMF have often pressured developing countries to focus on agricultural exports, rather than industrialization. As a result, many of these countries remain at a low level of economic development.