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International trade can be defined as the exchange of goods and services produced in one country with those produced in another. In the complex economic world, no country can be completely self-sufficient. The distribution of natural resources is uneven. Some countries are abundant in resources, while elsewhere reserves are scarce or even nonexistent. And a country may be rich in some resources but poor in others. For instance, Britain has large reserves of coal but lacks some metal reserves. Kuwait has vast oil deposits but little farm produce. And Japan relies heavily on import for most of the primary commodities. That is the reason why international trade first began.
With the development of manufacturing and technology, there arose another incentive for trade,i.e. international specialization-one country producing more of a commodity than it uses itself and selling the remainder to other countries. Such specialization constitutes an important basis for international trade.
Absolute advantage and comparative advantage are two theories of international specialization.Both theories attempt to determine which goods a country should produce for itself and export to other countries and which goods it should import from other countries.
The theory of absolute advantage holds that a commodity will be produced in the country where it costs least in terms of resources (capital, land and labour). This theory is illustrated in the following table. To be more illustrative, let us assume there are only two countries producing two commodities under perfect competition:
Output per man-year of labour
From the above table, we can see that a man in Country A can produce 50 computers in a year but only 10 in Country B. On the other hand, one man in Country B can produce 40 cars in a year but only 20 in Country A. So Country A is more efficient in producing computers than Country B,and we say the former has an absolute advantage over the latter. Similarly, Country B is more efficient with cars and has an absolute advantage over Country A. As a result, Country A would specialize in the production of computers and trade some of them for Country B’s cars, and Country B would specialize in cars and exchange some of them for Country A’s computers. Both countries will gain benefits through specialization and trade.
But, according to the above theory, trade occurs only when each country has an absolute advantage over the other in the production of one commodity. In reality, it is not rare that one country has no absolute advantage in any commodity. Will trade occur in these cases? The theory comparative advantage has offered satisfactory answer to this question.
The theory of comparative advantage holds that even if a country is less efficient than another in the production of both commodities, i.e. it has absolute disadvantage in producing both commodities, there is still a basis for mutually beneficial trade. The first country should specialize in the production and export of commodity in which its absolute disadvantage is smaller, i.e. the commodity of its comparative advantage, and import the commodity in which its absolute disadvantage is greater, i.e. the commodity of its comparative disadvantage. The above theory can be illustrated in this table:
Output per man-year of labour
The difference between this table and the previous one is that Country B has absolute disadvantage in the production of both computers and cars. Nevertheless, it still has a comparative advantage in cars since it is half as efficient in cars but 5 times less efficient in computers in comparison with Country A. On the other hand, Country A has absolute advantage over Country B in both computers and cars. However, we say it has comparative advantage in computers since it has greater absolute advantage in the commodity than in cars with respect to Country B. According to the theory, both countries can gain if A specializes in computers and B specializes in cars. Where comparative advantage exists, two trading partners are both able to share in the gains from trade. Trade to exploit comparative advantage promotes efficiency among countries; since it can make one country better off without making another worse off.
Comparative advantage is not a static concept. A country may develop a particular comparative advantage purely through its own actions, independent of the endowments of nature.Switzerland's comparative advantage in watch-making is a typical example. Similarly, the United States has developed comparative advantage in many lines that use the most up-to-date technology.
The idea of absolute advantage as the basis for economic specialization has a strong intuitive appeal. But the idea of comparative advantage introduced by the English economist David Ricardo makes more sense. Indeed it has become the cornerstone of modern thinking on international trade.