Comprehensive Essay on the Ricardo’s Doctrine of International Trade
Perhaps the most celebrated doctrine of the classical economics is the theory of comparative costs. Ricardo’s doctrine of comparative advantage furnishes a logical explanation of the pattern of trade.
It also contains a strong argument for the gains of trade and the terms of trade. In fact, for more than a century since its publication in 1917, it has been widely acclaimed as the most correct explanation of international trade. Even later on until now, developments in this field are more or less of a complementary nature.
This basic classical principle has been only modified and elaborated in the modern context by many economists of the present generation. Professor Samuelson, thus, aptly remarks: “If theories, like girls, could win beauty contests, comparative advantage would certainly rate high in that it is an elegantly logical structure.” He further, adds that, “the theory of comparative advantage has in it a most important glimpse of truth…. A nation that neglects comparative advantage may have to pay heavy price in terms of living standards and potential rates of growth.”
This, however, does not imply that the theory is absolutely faultless. Though, the theory bears a perfect logical structure, its fundamental weakness lies in the unduly hypothetical character of its axioms. Thus, in recent years, most trenchant criticisms have been leveled against it by many economists like Ohlin and Graham.
Some of these criticisms are enlisted below:
1. A basic criticism is that the theory fundamentally does not attempt to explain pattern of international trade, i.e., export and import. It lacks positive aspect in approach. It has basically a normative approach. It mainly considers optimum allocation of resources and increase in welfare (emergence and distribution of gain) resulting from trade. Jagdish Bhagwati, therefore, observes that Ricardo’s theory should properly be construed as a welfare model whose purpose was to make the case for free trade rather than as a positive model designed to explain the facts of trade.
2. It is held that the theory is expressed in real terms and is based on the labour theory of value. It assumes labour cost to explain the exchange of goods. But the total costs include non-labour costs as well, because labour is not the only factor of production. Hence, critics assert that it is not labour cost but money cost alone that can serve as the best basis of comparison.
Moreover, the labour theory of value itself is also defective as it is based on unrealistic assumptions such as: labour as the only productive factor, homogeneity of labour units, perfect mobility of labour and free competition. Hence, this labour cost theory of value was later on discarded by the Austrian school putting forth the concept of utility and marginal utility in value theory. It goes without saying that, when we discard the labour theory of value, the classical theory of international trade falls to pieces.
This criticism was, however, answered by Prof. Taussig that, even if the labour theory does not hold good and even if the other factors are important in production of goods, if we assume that the countries which have relations with each other are at the same stage of technical development, then the proportion in which the other factors will combine with labour will be the same. We can then easily ignore the other factors and compare the relative efficiency of labour in different countries. Thus, Ricardo may be well-justified in assuming his one factor (labour) model.
It may, however, be pointed out that, this defence of Taussig is not very sound; because different countries which have trading relations with each other are not at the same stage of technical development. Therefore, factor proportions are different in different countries, and it is difficult to find out relative labour efficiency. Hence, Taussig’s defence falls on the ground of fundamental mistake.
Critics have further pointed out that in the comparative costs principle, homogeneity of labour is an implicit assumption. But labour is not a homogeneous factor. Then how can one compare costs in terms of labour? Obviously, so long as there is a difference in the units of labour in different countries, we cannot have comparison in terms of labour. Hence, the classical comparative costs theory is defective in its base.
Taussig, however, tried to defend it by saying that if we divide labour into certain groups, then within each group, we will have units of the same efficiency. This is called stratification of labour, if stratification of labour in both the countries is the same, then they must be at the same stage of economic development. But Taussig’s defence is weak, because stratification of labour in different countries will not be the same since different countries are at different stages of economic and technological advancement.
3. In the theory, why labour efficiency differs in the two countries is not explained. To examine this, production environment, technological advancement, other factor’s contribution, etc., have to be analysed. Therefore, the assumption of a single factor (labour alone to be the only productive factor) is incorrect.
4. Another drawback of the Ricardian principle of comparative costs is that, it assumes constant returns to scale and thus, constant costs of production in both the countries. This assumption is very vital to the classical theory of international trade.
The doctrine holds that if England is specialised in cloth (because of its comparative advantage), 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 will import it from England. Such an analysis is based on constant cost assumption. But if we examine the pattern of international trade in practice, we find that it is not so.
A time will come when it will not be reasonable for Portugal to import cloth from England (because of increasing costs 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.
It may, however, be pointed out that, even if we take into consideration the laws of returns, the phenomenon of international trade can be still explained in terms of comparative costs. The only difference will be that if the country works on increasing returns or diminishing costs, then the comparative advantage will be narrowed down.
more suited to its field, must be evolved to supplement the older approach, or a very considerable amount of supplementary investigation must be undertaken.”
5. The Ricardian theory of comparative costs also ignores the element of transport costs. The comparative differences in cost ratios will be nullified sometimes by increasing transport costs and the commodity may not enter international trade.
To ignore transport costs in determining comparative costs differences is a serious defect of the theory. In fact, for international trade, comparative costs advantage must exceed transport costs. Moreover, the presence of transport cost will lead to incomplete specialisation, in spite of explicit comparative cost advantage.
Impact of transport cost on trade must be recognised because transport cost itself is an independent factor like economies of scale.
6. The Ricardian model is restrictive in operation as it relates only to two commodities and two countries. In actual practice, international trade is among countries with many commodities. A scientific and rational theory should not have such limitations.
7. Some critics have also pointed out that the comparative costs theory fails to consider the different varieties of a commodity in the phenomenon of international trade. It cannot be applied in the case of a country which imports one variety of the same commodity.
This criticism, however, holds no water when in economic analysis each variety is treated as a separate product.
8. Professor Graham, however, points out that the theory loses ground when we find that comparative advantages will never lead to complete specialisation (in producing different commodities) on the part of the two countries which enter into international trade.
This may happen when one country is big and the other small. The small country will be in a position to specialise fully as it can dispose of its surplus to the big country. But the bigger country cannot have such complete specialisation for two reasons: (i) It will not be able to meet all its requirements fully from a foreign country, and (ii) if it will fully specialise in a particular production, its surplus output will be of such large magnitude that it will not be entirely absorbed by the importing small country.
9. The comparative costs advantage does not work always in international trade phenomena. Sometimes, for military and strategic reasons even a country have a comparative disadvantage, will not import certain goods (even though they may be cheaply available). This may be in the interest of developing self-sufficiency or for some political reasons of avoiding undue dependence which is harmful in times of war. Thus, “the comparative costs theorem, the way in which he sets up his illustration, tended to obscure the problem of the terms of trade.”
On this point Ohlin, however, harshly puts that: “The comparative cost reasoning alone explains very little about international trade. It is indeed nothing more than an abbreviated account of the conditions of supply.”
10. The Ricardian principle of comparative costs is a one sided theory of international trade. It considers the supply side of international trade, but takes no account of the demand aspect. The theory explains what commodity a country will export and import, but gives no exposition whatsoever, as to what determines the rate of exchange -terms of trade between two countries.
11. Another weakness of the theory of comparative costs is that it assumes elastic markets and stable prices. Comparative advantages can be seen only if a country has a choice between increasing its exports or starting import substitution. If, however, the first alternative is not feasible, due to inelasticity of demand for exports (as in the case of underdeveloped countries, about their traditional exportable), the very notion of “comparative advantage” becomes futile.
12. An important factor in international trade, ignored by the Ricardian model, is that, actual imports and exports are greatly influenced by tariffs and a variety of other trade restrictions. Thus, as a champion of free trade, Ricardo moved away from reality.
13. The very assumption that factors of production have perfect mobility internally but they lack international mobility is a serious limitation of the comparative costs theory. Ohlin rejects the classical assumption of the immobility of factors of production between countries as the basis of international trade. For him, immobility of factors is not a special feature of international trade; it is also prevalent within the different regions of the same country.
Ohlin also objects to the theory of comparative costs as an explanation of international trade; for, in his view, the comparative cost principle was applicable to all trade and that international trade was no exception to it. He, thus, regards the classical doctrine of comparative costs as a clumsy and dangerous tool of analysis. It is also unrealistic as it considers only a two-country, two-commodity phenomenon based on the labour theory of value. Hence, Ohlin propounded a new theory of international trade based on the general theory of value.