10 main defects of Comparative Cost Theory

The comparative cost theory of international trade is one of the major contributions of the classical economists. Until the World War I, the theory remained unattached and was generally considered the most appropriate explanation of the basis of international trade.

Even the modern modifications and developments in the theory of international trade are more of a complementary rather than destructive nature.

Prof. Samuelson has aptly remarked; “If theories, like girls, could win beauty contests, comparative advantage could certainly rate high in that it is an elegantly logical structure.”

However, comparative cost theory has been extensively criticised by many economists like Ohlin and Graham mainly because of its unrealistic assumptions and hypothetical character. Some of the defects of the theory are given below.

1. Assumption of Labour Cost:

The most important criticism of the theory of comparative cost is that it is stated in labour or real terms. It assumes that labour is the only factor of production and the cost of production consists of labour cost alone. The theory ignores the basic fact that labour is not the only factor of production and the production costs include non-labour costs too.

2. Defects of Labour Theory of Value:

The labour theory of value on which the comparative cost theory is based has long been discarded because of the following defects: (a) The labour theory is based on the unfounded assumption that labour is the only factor used in the production of commodities, (b) The labour theory assumes homogeneous labour, while in reality labour differs in efficiency and skill, (c) Labour theory of value assumes that if other factors are used along with labour, they are combined in fixed proportions. But, in reality, capital- labour ratio varies from industry to industry, (d) The labour theory of value is also based on the unrealistic assumptions of- perfect competition and perfect mobility of labour, (e) The labour theory of value was discarded by the neo-classical economists since it ignored the role of utility in the determination of value.

3. Assumption of Constant Cost:

The theory of comparative cost assumes the existence of constant cost conditions. It maintains that the additional units of the same commodity can be produced at the constant average cost.

The reality on the other hand, is that there are either increasing costs or decreasing costs because of the operation of the laws of diminishing returns or increasing returns respectively. Constant costs are the exception rather than the rule.

4. Assumption of Factor Mobility:

The classical theory of international trade is based on another unrealistic assumption that factors of production are perfectly mobile within the country and perfectly immobile between the countries.

The reality is quite different: (a) Within in a country, factors of production do not move freely from one industry to another and from one region to another. This is evident from the existence of different wage rates and interest rates in different industries and regions, (b) Factors are not perfectly immobile internationally. There have been many cases of movement of labour and capital from factor-surplus to factor-scarce countries.

5. Assumption of Two Commodities and Two Countries:

Another unrealistic assumption of the theory of comparative cost is that its operation is restricted to two commodities and two countries. The theory breaks down when it is applied to the normal and more realistic situation of international trade among more than two countries and involving more than two countries.

6. Neglect of Transport Costs:

The theory of comparative cost does not take into consideration the transport costs. Neglect of transport costs is highly unrealistic because in practice transport costs play an important role in influencing the pattern of world trade. In fact, international trade occurs only when the comparative cost advantage exceeds transport costs.

7. Static Theory:

The unrealistic assumptions like the existence of full employment, fixed and constant supply of factors of production etc., make the theory of comparative cost a static theory and render it unfit for the changing and dynamic world.

8. One-Sided theory:

The comparative cost theory of international trade has been regarded as one-sided theory because it takes into account only the supply or cost side and ignores the demand side. The neglect of demand conditions is responsible for the theory’s inadequate explanation for the determination of terms of trade.

In the words of Ohlin. “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.

9. Growing Emphasis on Self Sufficiency:

In modern times, because of defence and other strategic reasons, almost every country tries to achieve the objective of self-sufficiency and may decide to produce certain goods even though they can be cheaply imported from other countries.

For instance, all countries prefer to produce military equipment at home even if it can be imported from abroad at cheaper rates. Thus the theory of comparative cost is unrealistic and has little relevance in the actual world.

10. Impossibility of Complete Specialisation:

Even if the various assumptions of the theory are accepted, the existence of comparative advantage may not lead to complete specialisation on the part of two countries which enter into international trade. As pointed out by Frank Grahm, this may happen when one trading country is big and the other is small.

The small country will be in a position to specialise fully as it can dispose of its surplus in the big country.

But the big country cannot have complete specialisation because of the two reasons: (a) the small country will not be able to meet all the requirements of the big country, (b) The surplus of the big country will not be entirely absorbed by the small country.