Absolute Advantages Theory By: Adam Smith

1. Absolute Advantages Theory By: Adam Smith

2. How to UnderstandTrade Benefit • Between whatever places foreign trade is carried on, they all of them derived two distinct benefits from it. • It carries out that surplus part of the produce of their land and labor for which, there is no demand among them, and brings back in return for something else for which there is demand. • It gives a value to their superfluities, by exchanging them for something else, which may satisfy a part of wants, and increase their enjoyments.

3. By means of it, the narrowness of the home market does not hinder the division of labor in any particular branch of art of manufacture from being carried to the highest perfection. • By opening a more extensive market for whatever part of the produce of their labor may exceed the home consumption, it encourages them to improve its productive powers, and to augment its annual produce to the utmost, and thereby to increase the real revenue and wealth of the society.”

4. Because of the tremendous benefit all the countries in the world must be positive to participate trade exchanging goods and services with each other. • “In every period, indeed, of every society, the surplus part both of rude and manufactured produce, or that for which there is no demand at home, must be sent abroad in order to be exchanged for something for which there is some demand at home.”（无论在什么时候，也无论在哪个国家，无论是原料生产，还是制成品生产，剩余的产品，或是在国内没有需求的产品，的确都必须向外国出口，以换取国内需要的某些产品。）

5. Sources of Trade Benefits • It was not enough only to say there were some generally existing trade benefits. • Adam Smith must present a further explanation of sources of those benefits. • Adam Smith did this by analyzing economic behaviors of individuals and the whole nation taking the invisible hand as the prerequisite.

6. “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to perfect that employment which is most advantageous to the society.”（每个人都在不停顿地竭力寻找某种途径，使他自己掌握的资本能够得到最为有利的使用。他眼里所看到的完全是他自己的利益，而不是全社会的利益。但琢磨自己的利益自然而然地，或者说不可不免地将驱使他对资本予以最佳的运用，这就会实现全社会的最大利益。）

7. It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The tailor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a tailor. The farmer attempts to make neither the one nor the other, but employs those different artificers. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbors, and to purchase with a part of its produce, or what is the same thing, with the price of part of it, whatever else they have occasion for.

8. What is prudent in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.（在每一个私人家庭的行为中是精明的事情，在一个大国的行为中也很少是荒唐的。如果外国能以比我们自己制造还便宜的商品供应我们，最好就用我们享有某些优势的产业生产出来的物品的一个部分向他们购买。）

9. Advantages Enjoyed by a Country • Natural Advantages The advantages derived from particular natural conditions of a country. Natural resources, geographical location, weather, and so on. • Acquired Advantages The advantages obtained by a country from particular unnatural conditions. Accumulated production experiences and skills, advanced production technologies, production capacity to manufacture some goods, the existing marketing channels, and so on.

10. Significance of Those Advantages • In some extreme cases, particular advantages of a country makes it capable to produce some particular goods while the others can not do. So the country must be an exclusive supplier of the goods. • In the most cases, many countries might manufacture particular goods. But the advantageous country can produce the goods with an absolutely lower production cost than its competitors. • In these sense, the advantages enjoyed by a country in trade might be termed as the absolute advantages.

11. The natural advantages which one country has over another in producing particular commodities are sometimes so great, that it is acknowledged by all the world to be in vain to struggle with them. By means of glasses, hotbeds, and hot-walls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be bought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?

12. Whether the advantages which one country has over another, be natural or acquired, is in this respect of no consequence. As long as the one country has those advantages, natural or acquired, and the other wants them, it will always be more advantageous for the latter, rather to buy of the former than to make. It is an acquired advantage only, which one artificer has over his neighbor, who exercises another trade; and yet they both find it more advantageous to buy of one another, than to make what dose not belong to their particular trades.

13. Classical Trade Model • Usually in trade theoretical analysis a “2×2 Model” (Two-Country-Two-Goods Model) is used. • To simplify the analysis it is assumed there are two countries in the world, Country A and Country B, and they are producing two goods, Good F and Good C.

14. Illustration of Trade Model on the Basis of the Absolute Advantages “2×2 Model” Based on Absolute Advantages In the above model labor requirements in producing a unit good in the two industries in the two countries are presented.

15. Domestic Exchange ratios in the Autarky Economy • In this model domestic exchange ratios between Good F and Good C in Country A and Country B in the autarky economy might be determined in accordance with the law of equal exchanges following the labor value theory.

16. Respective Absolute Advantages of the Two Countries • Country A has its absolute advantages in producing Good F since it can produce Good F at an absolutely lower cost than Country B. • By the same token Country B enjoys its absolute advantages in producing Good F. • Such absolute advantages lay a foundation for the both countries to exchange with each other and acquire their respective trade benefits.

17. Readjust Domestic Production Structure • In order to fully bring the respective absolute advantages into play so that output of the advantageous good might be enlarged it must be necessary for the both countries to readjust their domestic production structure. • Such readjustment implies the reallocation of the existing production resources, in this example labor, between the two industries.

18. Welfare Increases in Such Readjustment • Suppose that in Country A 16 units of labor would be removed from Industry C to Industry F and in Country B 10 units of labor would be removed from industry F to Industry C. • Production structure changes and thus social welfare might be enlarged. • The increase of total output of the two goods of the world could be considered as the effect of the reallocation on the basis of absolute advantages. Changes in Production Structures in the Two Countries and Increase in Total Social Welfare in the World

19. The First Step for the Two Countries to Exchange with Each Other • At first the two countries must determine exchange ratio between Good F and Good C. That is the international exchange ratio since the exchanges are executed in international market. • Such international exchange ratio must be beneficiary to the both countries. It must be somewhere between the two countries’ domestic exchange ratios.

20. Exchange Ratios in Different Terms • In a barter system without using of money in exchanges. Exchange ratios might be expressed in terms of different goods. • In this example, either in terms of F or in terms of C. • By aserious bargaining in the international market between these two countries international exchange ratio of Good F over Good C would be at last determined.

21. Direct Trade Benefit • Trade benefit of Country A: 2 more units of Good C could be acquired for exporting each 1 unit of Good F; A quarter unit of Good F could be saved for importing each 1 unit of Good C. • Trade benefit of Country B: 1/20 more unit of Good F could be acquired for exporting each 1 unit of Good C; 1 unit of its exports, Good C, could be saved for importing each 1 unit of Good F from Country A. • Enjoy more imports and give up less exports.

22. Derived Trade Benefit • Both in terms of exports or in terms of imports the direct trade benefit are really save of labor in the both countries. The saved labor would be differently employed and thus leads to the derived trade benefit, increase in welfare of the world. • The saved laborers would be rehired in production and then produce more goods and services. • The saved laborers would attend a lot of the other activities and then enjoy their leisure time.

23. In international trade no zero-or-sum game at all. Instead, trade must be essentially a mutually beneficiary economic activity. In international market prevails a fundamental principle of equity just as in the domestic economy. • Every country participating trade because of its absolute advantages, that is it can produce at least one kind of goods with the absolutely lower production cost, can acquire considerable benefit, either direct or derived. • Trade on the basis of absolute advantage has clearly showed us a very beautiful picture of free trade.

24. Adam Smith’s Assumption • Without any testifying Adam Smith arbitrarily asserted that a country must have at least one industry in which it could produce particular than its trade partner. • Adam Smith’s assumption must be a theoretical pitfall of Absolute Advantages Theory.

25. Some Incisive Questions • Should countries like Country B be separated from the world trade system because of serious competition from the other countries? • Might those countries be forced to suffer in the overseas trade? • Is it possible for them to be benefit from trade? • If “Yes”, trade must be a zero-or-sum game to some extent. • If “No”, are there some universal trade benefits for all countries in the world? • How to lay a rational base of trade? • How can those disadvantageous countries participate international trade and acquire their trade benefits? • Absolute advantages theory of Adam Smith cannot compellingly answer the above questions. It sinks into a theoretical trap.

26. Questions and Problems • How can we conclude, from his theory, that Adam Smith represented the benefits of the industrial capital? • Briefly introduce Adam Smith’s criticism of mercantilism. • Try to describe the main meaning of the invisible hand. • What is the important starting point of Adam Smith’s argument of free trade policies? • How can we understand the terms of absolute advantages, natural advantages, and acquired advantages? • Try to raise an example to illustrate trade model of absolute advantages. • How to understand the theoretical trap of Absolute Advantages Theory introduced by Adam Smith?