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.
Articles On David Ricardo's Theory ↓
- Ricardo's Theory of Comparative Advantage - International Trade.
- Practical Applicability Ricardian Theory of Comparative Cost.