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Theory of Comparative Costs and Its Shortcomings

Before we consider the theory of comparative cost advantage, it will be necessary to look at the concept of absolute advantage.

Absolute Advantage
Early economists, like Adam Smith, showed that trade between countries was beneficial if each country would produce one good cheaper than the other country, i.e. having absolute advantage over the other relative to the production of other goods.

In accordance with Adam Smith’s theory of absolute advantage, there would be no basis for international trade, as illustrated in the image below:

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From the above table, Nigeria has an absolute advantage over Sierra Leone because it can produce both commodities (cocoa and rice) much more cheaply than Sierra Leone. If Nigeria specialises in the production of both cocoa and rice because it has an absolute advantage in their production over Sierra Leone, it will succeed in selling to Sierra Leone. But Sierra Leone will have nothing to specialise in and, therefore, nothing to sell to Nigeria. Thus, where a country has an absolute advantage over other countries in the production of all products, Adam Smith’s theory breaks down because it will not benefit the countries to specialise.

It must be pointed out that absolute advantage is not a condition for increase in output. The gains of international trade through specialisation, can be realised provided the disadvantaged country has a comparative advantage in the production of those commodities in which it is relatively most efficient. This is why the theory was stated by another classical economist David Ricardo. He stressed that what matters is not absolute advantage, but comparative cost advantages.

 

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