Adam Smith's theory of absolute advantage and Ricardo's theory of comparative advantage offer two economic approaches to international trade. Each theory contributes to the field of international economics in different ways. This literature review will compare the two theories through the lens of scholarly articles published on the respective subjects.
By the 18th century (1776 to be exact), the development of international trade had reached a critical nexus: the colonies in America had revolted against the British Crown and a revolutionary character was evident throughout much of Western society. (The French would have their own Revolution before the century was out). Tackling the question of economic theory and its place in trade (in the light of this emerging climate) was Adam Smith with his massive treatise Wealth of Nations. Smith's concern focused on the specialization of labor -- the ability of producers to divide labor into parts to maximize output and achieve the greatest amount of profit as a result. When this theory was applied to international trade, a vision of all the countries of the world competing in a global marketplace emerged. As Smith pointed out, in a mercantilist system it would not be possible for all countries to maximize profitability if all were exporting more than they imported. Instead of placing harsh restrictions on imports and aggressively pursuing exports, Smith suggested that the theory of specialization be applied to trade and that a system of free trade be developed in which countries specialized in exporting only those items in which they had absolute advantage. Absolute advantage was defined thus: according to Smith's theory, some countries would be better than others at producing certain items -- such as cloth or wheat -- and therefore the better producer would be said to have absolute advantage over the other. It would therefore be in both countries interests (in terms of saving hours/labor) for the country with absolute advantage in producing a specific item to export it and for the other country to import it and vice-versa. In short, all countries would benefit through specialization and free trade: this was the heart of absolute advantage. The contribution it made to the field of international economics was that a system of free trade can in fact -- and must -- replace a mercantilist form of trade in the modern era.
However, if a country had no absolute advantage whatsoever, what would become of it? How would it ever profit in international trade? David Ricardo attempted to answer this question in 1817 when, building on the concept of absolute advantage, he devised the theory of comparative advantage. This theory held that even if a country does not have absolute advantage over another, it may have comparative advantage in that its labor productivity ratios are better. For Ricardo, labor was "the only source of value," which is why he devised the equation price = [rate of wages x labor production] / output. Thus, if a country's price of wheat was cheaper than in another country as a result of labor ratios, it would be able to be profitable in international trade (Chipman, 1966). Therefore, the contribution Ricardo's theory made to the field of international economics was that it showed that absolute advantage is not necessary for all countries to be profitable in free trade: comparative advantage is really all that is needed.
While both theories have been extremely important for modern economics, each has its limitations -- mainly because of the innumerable variables...
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