What are the Merits and Demerits of Ricardian Theory of Comparative Advantage?

Merits of Ricardian Theory of Comparative Advantage:

1. Ricardian theory of comparative advantage has the merit of demonstrating that international trade is possible even when a country is able to produce all goods at cheaper cost, provided the cost advantage is comparatively more in some goods than in the others. This happens because though the lower-cost country suffers by importing some goods from the higher-cost country, it is more than compensated by concentrating its resources on the production of those goods in which it has greater cost advantage.

2. Ricardian model of two goods and two countries can easily be extended to cover additional goods and countries and make it more realistic. In such an expanded model, it is possible to show that a country may be exporting and importing several goods while there may also be some goods, which are not traded at all.

3. It is also possible to restructure Ricardian theory by incorporating costs other than labor and by converting them in money costs. In other words, it is possible to refine Ricardian theory which in its initial form is far removed from reality.

Demerits of Ricardian Theory of Comparative Advantage:

The demerits of the Ricardian theory lie in the nature of assumptions made by it. Attempts have been made to remove some of them with only a partial success.

1. This theory assumes that trading countries have given productive resources, which do not change over time; this is highly unrealistic as the availability of productive resources (labor, capital, technology, etc.) keep changing in every modern economy. This is more so because, these day, all countries are interested in economic development.

2. Ricardian theory assumes that the economies of trading countries are fully competitive. This is generally not so. Factually, most economies suffer from varying degrees of monopoly elements.

3. The theory of value used in this theory is based upon labor theory of value. It assumes that labor is the only cost of production and the prices of goods in the market are determined by their relative labor costs of production. This stand of the theory suffers from several drawbacks. Amongst them is the problem of measuring “labor cost of production”. Changes in wage rates can alter them and prices are also affected by monetary and fiscal policies of the government.

4. Trading costs are ignored in this theory.

5. It is assumed that the trading countries allow freedom of trade. They do not have a policy of protection or quantitative restrictions to safeguard their own economic interests or gains at the cost of their trading partners.

6. Another limitation of this theory is that it assumes the prevalence of constant returns. This is obviously very unrealistic as changes in economic structure of a country, its resources and other dimensions are necessarily operative.

7. Possible shifts in rate of exchange enhance the uncertainty associated with international trade transactions. Ricardian theory is not able to take account of this because it was formulated in the context of a metallic monetary standard.