11 Criticisms to the Theory of Comparative Costs

Some of these criticisms are stated below:

1. The theory is stated in real terms: in terms of the labour cost:

It is held that the theory runs 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 the labour cost but the money cost alone that can serve as the basis of comparison.

2. The Ricardian theory of comparative costs based on the labour theory of value which itself is unrealistic:

Moreover, the labour theory of value itself is very defective as it is based on realistic assumptions like labour being 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 is shattered to pieces.

3. The Ricardian theory wrongly assumes labour as a homogeneous factor:

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.

4. The theory is based on constant returns to scale:

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 specialises 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 import all cloth from England. Such an analysis is based on the constant 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.

5. It is based on the unrealistic assumption of full employment condition of equilibrium:

The main drawback of the classical theory of comparative costs is that it is based on the assumption of full employment.

Its later refinements also assumed full employment conditions. It was Keynes who falsified the celebrated assumption of full employment of classical economists as unrealistic. To that extent, the comparative cost theory is obviously unrealistic.

6. The Ricardian theory of comparative costs ignores transport cost differences:

The comparative differences in cost ratios will be nullified sometimes by increasing transport costs, and the commodity may not enter into international trade. To ignore transport costs in determining comparative cost differences is a serious defect of the theory. In fact, for international trade, comparative costs advantage must exceed transport costs.

7. Ricardo uses a restrictive model:

The Ricardian model is restrictive in operation as it relates to two commodities and two countries only. In actual practice, international trade is among many countries with many commodities. A scientific rational theory should not have such limitations.

8. It is only a supply-side theory:

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 would export and import, but gives no exposition whatsoever as to what determines the rate of exchange and terms of trade between two countries. “It is indeed nothing more than an abbreviated account of the conditions of supply.” says Ohlin.

9. The theory assumes free trade:

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.

10. The theory is based on unrealistic assumptions of the perfect mobility:

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.

11. Ohlin’s Criticism:

Professor Bertil Ohlin 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.

Despite these limitations, the theory has a stand. It has narrated the truth that comparative advantage is definitely an advantage which should be gainfully exploited in international trade. To quote Professor Samuelson, “Whether or not one of two regions is absolutely more efficient in the production of every good than is the other, if each specialise in the products in which it has a comparative advantage (greater relative efficiency), trade will be mutually profitable to both regions.

Real wage of productive factors will rise in both places.” He also appreciates Ricardo’s presumption of free trade policy and writes, “An ill-designed probability tariff or quota, far from helping the protected factor of production, will instead reduce its real wage by making imports expensive and by making the whole world less productive through eliminating the efficiency inherent in the best pattern of specialisation and division of labour.” Indeed, in this way, the doctrine of comparative advantage does provide an unshakeable basis for international trade.

Submitted by : Professor Santiago, Category : Money, Tag : Comparative Costs