An Evaluation of David Ricardo's Theory of Comparative Costs: Direct and Indirect Critiques

Abstract

Following Smith's advocacy of free trade and competition, David Ricardo attempts to strengthen his theory of absolute advantage, which excludes from international trade countries which have no advantages over others, by eliminating this weakness. To do so, Ricardo introduces to the economics literature a theory of comparative cost advantage which includes countries that do not have absolute advantages in international trade. In Ricardo's framework, these countries can still gain from free trade. We present direct and indirect critiques which reveal that their advocacy of free trade is questionable. In our direct critiques we find that Ricardo's attempt is questionable for the following reasons. First, the scale of production of cloth in Portugal and that of wine in England equal 1 even though there is no reason to believe that two countries have the same scale of production for two different commodities. Second, it is argued that his theory is incomplete because it is based on particular numbers, does not determine the terms of trade, and does not take into account the unintended curtailment of demand in both countries, which in turn can make trade non-beneficial for both countries. In our indirect critiques, first we argue that Ricardo assumes the equality between the relative price and relative labor cost of two commodities even though they are different. Second, it is shown that the outcome of complete specialization in his theory prevents a country from specializing in the production of a commodity that could generate for it a substantial profit in the long run, locking the country out of industrialization. We then point out that Samuelson who supports Ricardo's theory to some extent does not consider in his proof the possible destruction of the domestic industry in the case of free trade, even though this might make domestic consumers worse off and also lock a country out of industrialization.

Keywords: comparative costs, complete specialization, scale of production, relative price and labor cost, gain from free trade, lock out of industrialization

JEL Classification: F1, B12