Limitations of Ricardian Comparative Cost theory ↓
For considerable period the theory of comparative costs formulated by David Ricardo was the most acceptable explanation of the international trade. However, Ricardo's theory was subjected to number of criticisms.
Following are the important limitations of Ricardian Comparative Cost Theory.
1. Restrictive Model
Ricardo's Theory is based on only o nly two countries and only two commodities. But international trade is among many countries with many commodities.
2. Labour Theory of Value
Value of goods is expressed in terms of labour content. Labour Theory of value developed by classical economists has too many limitations and thus is not ap plicable to the reality.
Value of goods and services in the real world is expressed in money i.e. the prices are the values expressed in units of money.
3. Full employment
The assumption of full employment helps the theory to explain trade on the basis of comparative advantage. The reality is far from full employment. Cost of production, even in terms of labour, may change as the countries, coun tries, at different levels of employment move towards full employment.
4. Ignore transport cost
Another serious defect is that the transport costs are not consider in d etermining comparative cost differences.
5. Demand is ignored
The Ricardian theory concentrates on the supply of goods. Each country specialises in the production of the commodity based on its comparative advantage. The theory explains international trade in terms of supply and takes demand for granted.
6. Mobility of factor of production
As against the assumptions of perfect immobility between the countries, we witness difficulties in the mobility of labour and capital within a country itself. At the same time their mobility between nations was never totally absent.
7. No Free Trade
Ricardian theory assumes free trade i.e. no restriction on the movement of goods between the countries. Though it is unrealistic to assume not to ha ve any restriction. what the real world witnesses is a lot tariff and non-tariff barriers on international trade. Poor countries find it difficult to enjoy the comparative advantage in the production of labour intensive commodities due to the protectionist policies followed by developed countries.
8. Complete specialisation specialisation
The comparative advantage theory comes to conclusion of complete specialisation. In the Ricardian example, England is specialising fully on cloth and Portugal on wine. Such complete specialisation is unrealistic even in two countries and two commodities model. It is possible if two countries happens to be almost identical in size and demand. Again, a complete specialisation in the production of less important commodity is not possible du e to insufficient demand for it.
9. Static Theory
The modern economy is dynamic and the comparative cost theory is based on the assumptions of static theory. It assumes fixed quantity of resources. It does not con sider the effect of growth.
10. Not applicable to developing countries
Ricardian theory is not applicable to developin g countries as these countries are nowhere n ear to full employment. They are in the process of change in quality of their labour force, quality of capital, technology, tapping of new resources etc. In other words developing countries ex hibit all the characteristics of dynamic economy.
11. Constant Returns to Scale
Another drawback of the Ricardian principle p rinciple of comparative costs is that assumes constant Returns to scale and thus constant cost of o f production in both the countries. cou ntries. The doctrine holds that if England specialises in cloth; there is no reason why it should produce wine. Similarly if Portugal has a comparative advantage in producing wine, it will not produce cloth; but import all cloth from England. If we examine the pattern of international trade in practice, we find it is no t so. A time will come when it will not no t be reasonable for Portugal to import cloth from England because of increasing cost of production. Moreover, in actual practice a country produces a particular commodity and also imports a part of it. This phenomenon has not been explained by the theory of comparative costs.
15 Important Criticism of Comparative Advantage Theory In Relation To International Internati onal Trade Trade By Monisha Agarwal The principle of comparative advantage has been the very basis of international inte rnational trade for over a century until after their First World War. Since then critics have been able only to modify and amplify it. As rightly pointed out by Professor Samuelson, “If theories theories like girls, could win beauty beaut y contests, comparative advantage would certainly rate high in that it is an elegantly logical structure. But the theory is not free from some defects. In particular, it has been several times criticised by Bertin Ohlin and Frank D. Graham. We discuss some of the important criticism as under:
1. Unrealistic assumption of labour cost: The most severe criticism of the comparative advanta ge doctrine is that it is based on the labour theory of value.
In calculating production costs, it takes only labou r costs and neglects non-labour costs involved in the production commodities. This is highly unrealistic because it is money costs and not labour costs that are the basis b asis of national and international transactions of goods. Further, the labour cost theory is based on the assumption of homogeneous labour. This Th is is again unrealistic because labour is heterogeneous-of different kinds and grades, some specific or specialized, and other non-specific or general.
2. No similar tastes: The assumptions of similar tastes are unrealistic because tastes differ with different income brackets in a country. Moreover, they also change with the growth of an economy and with the development of its trade relations with other countries.
3. State assumption of fixed proportions: The theory of comparative costs is based on the assumption that labour is used in the same fixed proportions in the production of all commodities. This is essentially a static analysis and hence unrealistic. As a matter of fact, labour is used in varying proportions in the production of commodities. For instance, less labour is used per unit of capital in the production of steel than in the production of textiles. Moreover, some substitution of labour for capital is always possible in production.
4. Unrealistic assumption of constant costs: The theory is based on another weak assumption that an increase of output due to international specialization is followed by constant costs. But the fact is that there are either increasing costs or diminishing costs. If the large scale of production reduces costs, the comparative advantage will be increased. On the other hand, if increased output is the result of increased cost of production, the comparative advantage will be reduced, and in some cases it may even disappear.
5. Ignores transport costs: Ricardo ignores transport costs in determining comparative advantage in trade. This is highly unrealistic because transport costs play an important role in determining the pattern of world trade.
Like economics of scale, it is an independent factor of production. For instance, h igh transport costs may nullify the comparative advantage and the gain from international trade.
6. Factors not fully mobile internally: The doctrine assumes that factors of production are p erfectly mobile internally and wholly immobile internationally. This is not realistic because even within a count ry factors do not move freely from one industry to another or from one region to another. The greater the degree of specialization in an industry, the less is the factor mobility from one industry to another. Thus, factor mobility influences costs and hen ce the pattern of international trade.
7. Two-country two-commodity model is unrealistic: The Ricardian model is related to trade between b etween two countries on the basis of two commodities. This is again unrealistic because in actuality, international trade is amon g countries trading many commodities.
8. Unrealistic assumption of free trade: Another serious weakness of the dosctrine is that it assumes perfect and free world trade. But in reality, world trade is not free. Every country applies restrictions on the free movement of goods to and from other countries. Thus, tariffs and other trade restrict ions affect world imports and exports. Moreover, products are not homogeneous but differentiated. By neglecting these aspects, the Ricardian theory becomes unrealistic.
9. Unrealistic assumptions of full employmen employment: t: Like all classical theories, the theory of comparative advantage is based on the assumption of full employment. This assumption also makes the theory static. Keynes falsified the assumption of full employment and proved the existence of underemployment in an economy. Thus the assumption of full employment makes the theory unrealistic.
10. Self-interest hinders its operation: The doctrine does not operate if a country having a comparative disadvantage does not wish to import a commodity from the other country due to strategic, military or development
considerations. Thus, often self-interest stands in the operation of the theory of comparative costs.
11. Neglects the role of technology: The theory neglects the role of technological innovations in international trade. This is unrealistic because technological changes help in increasing the supply of goods not only for the domestic market but also for the international market. World trade has gained much from innovations and research and development (R & D).
12. One-sided theory: The Ricardian theory is one-sided because it considers only the supply side of international trade and neglect the demand side. In the words of Professor Ohlin, “It is indeed nothing more than an abbreviated account of the conditions of supply.”
13. Impossibility of complete specialization: specialization: Professor Frank Graham has pointed out that co mplete specialization will fie impossible on the basis of comparative advantages in producing commodities entering into international trade. He explains two cases in support of his argument: one, relating to a big country cou ntry and a small country, and two, relating to a commodity of high value and low value.
14. A clumsy and dangerous tool: Professor Ohlin has criticized the classical theory of international trade on the following grounds: (i) The principle of comparative advantage is not applicable to international trade alone, rather it is applicable to all trade. To Ohlin, “International trade is but a special case of inter -local -local or interregional trade.” Thus there is little difference between internal trade and international trade. (ii) Factors are immobile not only internationally but also within different regions. This is proved by the fact the wages and interest rates differ in different different regions of the same country. Further labour and capital can also move between countries in a limited way, as they do within a region. (iii) It is a two-country two- commodity model based on the labour theory of value which is sought to be applied to actual a ctual conditions involving many countries and man y commodities. He, therefore, regards the theory of comparative advantage as cumbersome, unrealistic, and as a clumsy and dangerous tool of analysis. As an alternative, Ohlin has propounded a new theory which is known as the modern theory of International Trade.
15. Incomplete theory:
It is an incomplete theory. It simply explains how two countries gain from international trade. But it fails to show how the gains from trade are distributed between the two countries. 15 Important Criticism of Comparative Advantage Theory In Relation To International Trade By Monisha Agarwal
The principle of comparative advantage has been the ver y basis of international trade for over a century until after their First World War.
Since then critics have been able only to modify and amplify it. As rightly pointed out by Professor Samuelson, “If theories like girls, could girls, could win beauty contests, comparative advantage would certainly rate high in that it is an e legantly logical structure.
But the theory is not free from some defects. In particular, it has been several times criticised by Bert in Ohlin and Frank D. Graham. We discuss some of the important criticism as under: 1. Unrealistic assumption of labour cost:
The most severe criticism of the comparative advantage doctrine is that it is based on t he labour theory of value.
In calculating production costs, it takes only labour costs and neglects non-labour costs involved in the production commodities.
This is highly unrealistic because it is money costs and not labour costs that are the basis of national and international transactions of goods.
Further, the labour cost theory t heory is based on the assumption of homogeneous labour. This is again unrealistic because labour is heterogeneous-of different kinds and grades, some specific o r specialized, and other non-specific or general. 2. No similar tastes:
The assumptions of similar tastes are unrealistic because tastes differ w ith different income brackets in a country.
Moreover, they also change with the growth of an economy and with the development of its trade relations with other countries. 3. State assumption of fixed proportions:
The theory of comparative costs is based o n the assumption that labour is used in the same fixed proportions in the production of all commodities.
This is essentially a static analysis and hence unrealistic. As a matte r of fact, labour is used in varying proportions in the production of commodities.
For instance, less labour is used per unit of capital in the production of steel than in the production of textiles. Moreover, some substitution of labour for capital is always possible in production. 4. Unrealistic assumption of constant costs:
The theory is based on another weak assumption that an increase of output due to international specialization is followed by constant costs.
But the fact is t hat there are either increasing costs or diminishing costs. If the large scale of production reduces costs, the comparative advantage will be increased.
On the other hand, if increased output is the result of increased cost of production, the comparative advantage will be reduced, and in some c ases it may even disappear. 5. Ignores transport costs:
Ricardo ignores transport costs in determining comparative advantage in t rade. This is highly unrealistic because transport costs play an important role in determining the pattern of world trade.
Like economics of scale, it is an independent factor of production. For instance, high transport costs may nullify the comparative advantage and the gain from international trade. 6. Factors not fully mobile internally:
The doctrine assumes that factors of production are perfectly mobile internally and wholly immobile internationally.
This is not realistic because even within a country factors do not move freely from one industry to another or from one region to another.
The greater the degree of specialization in an industry, the less is the factor mobility from one industry to another. Thus, factor mobility influences costs and hence the pattern of international trade. 7. Two-country two-commodity model is unrealistic:
The Ricardian model is related to t rade between two countries on the basis of two commodities. This is again unrealistic because in actuality, international trade is among countries trading many commodities. 8. Unrealistic assumption of free trade:
Another serious weakness of the dosctrine is that it assumes perfect and free world trade. But in reality, world trade is not free.
Every country applies restrictions on the free movement of goods to and from other countries. Thus, tariffs and other trade restrict ions affect world imports and exports.
Moreover, products are not homogeneous but differentiated. By neg lecting these aspects, the Ricardian theory becomes unrealistic.
9. Unrealistic assumptions of full employment:
Like all classical theories, the theory of comparative advantage is based on the assumption of full employment.
This assumption also makes the theory static. Keynes falsified the assumption of full employment and proved the existence of underemployment in an e conomy. Thus the assumption of full employment makes the theory unrealistic. 10. Self-interest hinders its operation:
The doctrine does not operate if a country having a comparative disadvantage does not wish to import a commodity from the other country due to strategic, military or development considerations. Thus, often self-interest stands in the operation of the theory of comparative costs. 11. Neglects the role of o f technology:
The theory neglects the role of technological innovations in international trade. This is unrealistic because technological changes help in increasing the supply of goods not only for the domestic market but also for the international market. World tr ade has gained much from innovations and research and development (R & D). 12. One-sided theory:
The Ricardian theory is one-sided because it considers only the supply side of international trade and neglect the demand side. In the words of Professor Ohlin, “It is indeed nothing more than an abbreviated account of the conditions of supply.” 13. Impossibility of complete specialization:
Professor Frank Graham has pointed out that complete specialization will fie impossible on the basis of comparative advantages in producing commodities entering into international trade.
He explains two cases in support of his argument: one, relating to a big c ountry and a small country, and two, relating to a commodity of high value and low value. 14. A clumsy and dangerous tool:
Professor Ohlin has criticized the classical theory of international trade on the following grounds:
(i) The principle of comparative advantage is not applicable to international trade alone, rather it is applicable to all trade. To Ohlin, “International trade is but a special case of inter-local inter -local or interregional trade.” Thus there is little little difference between internal trade and international trade.
(ii) Factors are immobile not only internationally but also within different regions. This is proved by the fact the wages and interest rates differ in different regions of the same country. Further labour and capital can also move between countries in a limited way, as they do within a region.
(iii) It is a two-country two- commodity model based on the labour theory of value which is sought to be applied to actual conditions involving many countries and many commodities. He, therefore, regards the theory of comparative advantage as cumbersome, unrealistic, and as a clumsy and dangerous tool of analysis. As an alternative, Ohlin has propounded a new theory which is known as t he modern theory of International Trade. 15. Incomplete theory:
It is an incomplete theory. It simply explains how two countries gain from international trade. But it fails to show how the gains from trade t rade are distributed between the two co untries.
