Question

What are the theoretical and practical problems of using Ricardo’s theory of comparative advantage in the account of the real-world trade between countries?

Answer 1

The theoretical and practical problem of comparative advantage -

1. First and foremost Ricardo's theory assumes a perfect competition with perfect mobility and perfect knowledge. In reality, markets are not perfect but imperfect and have high asymmetry of information which leads to an increased cost

2. These costs are not taken into consideration like transport cost and even external cost like pollution hence we tend to overstate the benefits received from specialization

3. Assuming a 2 good, 2 country is too simplistic and idealistic as a single economy is involved in exporting and importing many goods

4. Specialization may lead to unemployment specifically structural unemployment as we won't be able to transfer the labor from one sector to another

5. The theory is not static, that is if a country is having an advantage in one good maybe over 40 to 50 years that resource might deplete and the country may develop an advantage over another good

6. With increased innovation and development of new technology, economies don't specialize in a few goods but a variety of goods, for instance, China hence disregarding the comparative advantage theory.