Absolute Advantage Theory
- Theories
- Economic Theory
- International trade
- What is international trade
- Mercantalism
- Classical Trade Theory
- Absolute Advantage Theory
- What is the Comparative Advantage Theory?
- Factor Proportion Theory
- Heckscher-Ohlin theory
- Product Life Cycle Theory
- Theories of Outsourcing
- What is the Theories of Outsourcing?
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- Technology adoption Theories
What is the Absolute Advantage Theory?
The theory of absolute advantage destroys the mercantilist idea that international trade is a zero-sum game. Unlike mercantilism this theory measures the nation’s wealth by the living standards of its people and not by gold and silver. There is a strong disadvantage with absolute advantage theory.
If there exists a nation that does not have an absolute advantage in the manufacture of any product, will there still be gain to trade? It can further be extended to “will trade even occur?” To clarify such questions the theory of comparative advantage is proposed as an extension to absolute advantage theory.
Merits
If salaries were similar in the two nations prior to the inception of trade, the home country might have a ‘competitive’ or absolute advantage in both goods: it can sell at a low price than the foreign country in both the commodities.
Foreign businessmen would obviously fear their lack of grip over the market. Thus “universal bankruptcy” cannot be equilibrium. The inequity between spending and profits would also reflect the lack of exports to pay for imports. Market equilibrium would be attained through price alterations, lowering the foreign wage or raising the home wage until the foreign workers could be engaged in the industry in which the foreign economy has the comparative advantage.
More generalized models of production lead us to the same inference: equilibrium costs will regulate to offer absolute advantage in the material in which each country has a comparative advantage. Thus the theory of absolute advantage is feeble in the mathematical logic in the case where both nations continue to produce the material (Bloom & Durlauf 1986).
Demerits
This has been illustrated in the issues of the rapid productivity growth of China assessed in relation to the US. A 10% improvement in productivity will obtain a 10% cost advantage for the businessman over his competitor.
A 10% improvement in all Chinese output in comparison to the US is not likely to alter comparative advantage as wages of the Chinese will be raised in comparison relative to wages in the US. Also a 10% fall in all productivity of US due to strict ecological regulations will be highly unlikely to alter the comparative advantage because US factor returns will be down.
The extensive practice of doing comparisons internationally of ‘competitive advantage’ is basically mistaken as it suggests the symbol of a competition. This instils a fear in countries making a effort to state the predicament of environmental pollution or standards in labour practices.
They are greatly forced to being pressured to fewer standards by their rivalry with overseas countries that have low standards. But countries do not ‘compete’ as organizations and moreover a firm may not be able to cope up.
After putting into practice reduction in pollution when other competing nations overseas do not put into practice such observations and no other costs alter in the new equilibrium. Countries also would not be able to throw themselves out of business because prices of factor will alter in the new equilibrium.
Pollution reduction is expensive with or without trade; nothing about the nature of a trading economy makes any essential difference to the nation’s ability to implement desired standards (Bloom & Durlauf 1986).
References:
Mahoney, D, Trigg, M, Griffin, R, Pustay, M 1998, International Business: A Managerial Perspective, Addison Wesley Longman, Melbourne.
Mcculloch, B 1999, International Business: The Challenge of Global Tripodnet,Competition, Irwin/McGraw-Hill. Viewed 22 March 2010, <http://members.tripod.lycos.nl/Japan_industry/three.html>
Morgan, RE 1997, ‘Theories of international trade, foreign direct investment and firm internationalization: a critique’, Management Decision, vol.35, no.1, pp. 68-78.