Comparative advantage was first described by David Ricardo who explained it in his 1817 book On the Principles of Political Economy and Taxation in an example involving England and Portugal. Is this theory still useful in our days?
The theory of comparative advantage is being used as the basic explanation of International trade for almost 20 decades. It is considered as the most potent explanation, as it addresses higher incomes and growth rates of income in open economies through gains from international trade.
It is admissible that the increased mobility of the factors of production world wide, the improved technology and enhanced goods and services has influenced significantly the world economy and commerce policies. The situation has become challenging for the policy makers to elaborate the comparative advantage hypothesis impacts and its relation to these changes.
The theory of comparative advantage states that specialization is a pre requisite for achieving the estimated gains from trade. Failing to achieve which can curtail or render the expected gains negative.
David Ricardo explained the theory in his 1817 book ‘On the Principles of Political Economy and Taxation’ by presenting a case involving two countries A and B and two commodities X and Y. For B it was possible to produce same quantities of X and Y using lesser labor as compared to Country A. For A it was very expensive to produce X, and only comparatively cheaper to produce Y, whereas in Country B it was easy to produce both. Therefore, though it was easy to produce Y in B than A, it was still cheaper enough for B to produce excessive quantities of good X, and trade that for good Y from Country A. On the contrary, country A lands in a satisfactory position from this trade as its cost for producing Y has not affected yet it can buy X at a cheaper price. It can be so deduced that both the countries can earn profits by specializing in a particular good and trading that for other goods.
Ricardo's theory of comparative advantage is generally considered as the backbone when augmenting for free trade. However, some prominent economists like Paul Samuelson, are of the view that Ricardo’s hypothesis being too simple are not strictly applicable to the present economic dimensions. They argue that the circumstances were much different in the early 19th century as compared to the present economic scenario. As at that time there were firm restrictions on the people on moving their assets and capital across the border.
Whereas other eminent economists complain about the simplicity of the comparative advantage theory that assumes, that each market is in perfect competition, there exists full employment, and that the displaced workers can comfortably switch to other jobs where they can give the same productivity level. Some argue that if the economies target to specialize in particular industries; this would result in reduced economic diversity, and would make them highly vulnerable to any changes in the circumstances.
Nevertheless, many of the economists still argue that Ricardo’s comparative advantage is yet one of the most important and fundamental economic theories of all, as it subjects world trade and globalization, concluding that nations can flourish even more by looking outwards rather than inwards.
The dissection of the theory makes it clear that though this theory is a valid and influential tool of economic analysis, yet it is not the only point that the economics has to consider while formulating the international free trade policies.
OECD Library. (n.d) Resources on the World Wide Web [www page]. URL http://www.oecdilibrary.org/docserver/download/fulltext/5kg3vwb8g0hl.pdf?expires=1345839959&id=id&accname=guest&checksum=302FB220D17E2546D4036055C46180C1
Nccr- trade. (n.d) Resources on the World Wide Web [www page]. URL http://phase1.nccr-trade.org/images/stories/mira/comparative%20advantage.pdf
The Telegraph (n.d) Resources on the World Wide Web [www page]. URL http://www.telegraph.co.uk/finance/economics/6122712/Ricardos-theory-shows-that-win-win-situations-do-exist.html