Criticism Limitations of Ricardian Comparative Cost

Theory
Post: Gaurav Akrani. Date: 2/06/2011. No Comments. Label: Economics.

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 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 applicable 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, 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 determining 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 have 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

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 due 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 consider the effect of growth.

10. Not applicable to developing countries

Ricardian theory is not applicable to developing countries as these countries are nowhere near 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 exhibit all the characteristics of dynamic economy.

11. Constant Returns to Scale

Another drawback of the Ricardian principle of comparative costs is that assumes constant Returns to scale and thus
constant cost of production in both the countries. 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 not so. A time will come when it will not 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.

Practical Applicability Ricardian Theory of Comparative

Cost
Post: Gaurav Akrani. Date: 2/06/2011. No Comments. Label: Economics.

Applicability of Ricardian Theory in Real World

Comparative cost theory inspite of all limitations has remained as a basic principle of international trade. Today when
the world is moving towards greater liberalisation and globalisation each country specialises in production of goods
and services on the basis of comparative cost advantage and enters into international trade.

Image Credits Sodaro K.

 Prof. Gottfried Haberler, Frank William Taussig and others attempted to prove the practical importance and
acceptability of comparative cost theory.

It is argued that :-

1. The two commodities two countries model can be extended to all the commodities and all the countries.
Each country then will specialises in the production of those commodities in which it enjoys comparative
advantage and export them to others and import the required goods from others where they are available at a
lower price than at home.

2. The theory which was explained in terms of labour can also be expressed in terms of money as it is possible
to express the total cost in terms of money. Specialisation would take place on the basis of comparative advantage
in terms of money cost.

3. The assumption of constant returns to scale and no change in technology can also be relaxed. With
changes in technology and production being subject to laws of returns, specialisation will still take place on the
basis of cost advantage under increasing and decreasing cost.

4. Assumptions of "no transport cost" makes the comparative advantage theory, it is argued very unrealistic. It
is pointed out that after adding transport cost to the cost of production, each country will produce those goods in
which it will have cost advantage. After adding transport cost, for example, India may not enjoy the cost advantage
against USA or Mexico but it certainly will have the advantage for selling them in the neighbouring countries.

5. It is suggested that cost would not undergo a change as the countries operate with assumptions like full
employment, perfect competition, static nature of the economy, free trade and many other restrictive assumptions.

The supporter of Ricardian theory argued that all the restrictive assumptions of the comparative cost theory could be
relaxed and make the theory practical in the real world situation where each country specialises in the production of
those goods and services in which it has comparative cost advantage under the changing conditions.

The doctrine of comparative advantage inspite of its limitations, has remained as the basic principle of international
trade. Today when the world is moving towards greater liberalisation and globalisation, each country specialises in
the production of goods and services on the basis of comparative cost advantage and enters intc international trade.
Each country attempts to lower its cost of production of internationally traded goods .to get an advantage in the global
market. Therefore, it could be argued that Ricardian explanation of the basis of international trade is valid and
applicable to the real world.

Conclusion
 On the basis of competitive cost advantage, countries can enter into international trade. Each country attempts to
lower its cost of production of internationally traded goods to get in advantage in the global market.

So Ricardian explanation of basic of international trade is valid and applicable to the real world situation.

Articles On Ricardian Theory

1. Ricardo's Theory of Comparative Advantage - International Trade.

2. Limitations of Ricardian Comparative Cost Theory.