Essay on Comparative Cost Theory and Actual World Trade

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Historical evidence since World War II has shown that the theory of comparative cost does not sufficiently explain the trend and pattern of actual international trade.

If we divide the world into two blocks, i.e., (a) the developed countries and (b) the less developed countries; and the commodities into two groups, i.e., (a) the manufactured goods and (b) the primary goods, then on the basis of the comparative cost principle we expect that

(i) The developed countries have a comparative advantage over the less developed countries in manufac­tured goods relative to primary goods;

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(ii) The larger and growing part of the world trade is between developed and less developed countries; and

(iii) The developed countries produce and export manufactured goods in exchange for primary goods from less developed countries.

But, the actual pattern of world is not in accordance with the theory of comparative cost. The following features of world trade make this clear.

(i) The largest part of world trade is among the developed countries themselves, rather than between developed countries and the less developed countries.

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(ii) Although, in accordance with the theory of comparative cost, the developed countries, on balance, export manufactured goods to the less developed countries in exchange for primary production, but the largest part of world trade is the intra-industry exchange of manufactures among the developed countries themselves.

(iii) As against the comparative cost principle, export of manufactures from less developed countries are the fast growing part of world trade, although their absolute share is still small.

(iv) Economics of scale, which arise from the division of labour and product differentiation, imply that trade between countries with modest comparative cost differences will be largely intra- industry, and that trade between countries with substantial comparative cost differences will be largely interred-in- dusty.

A notable feature of trade among the developed countries is that it is a large and growing volume of intra-industry trade, both absolutely and relative to inter-industry trade.

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