Question

Describe David Ricardo’s theory of comparative advantage and explain the importance of the assumptions he makes. Do you think that organizations like the IMF and WTO have misinterpreted his theory in ways that benefit some groups of people and not others

Answer 1

David Ricardo developed the classical theory of comparative advantage in 1817 to explain why countries engage in international trade even when one country's workers are more efficient at producing every single good than workers in other countries.

Ricardo's Theory of Comparative Advantage ?

David Ricardo stated a theory that other things being equal a country tends to specialise in and exports those commodities in the production of which it has maximum comparative cost advantage or minimum comparative disadvantage. Similarly the country's imports will be of goods having relatively less comparative cost advantage or greater disadvantage.

1. Ricardo's Assumptions :-

Ricardo explains his theory with the help of following assumptions :-

1. There are two countries and two commodities.
2. There is a perfect competition both in commodity and factor market.
3. Cost of production is expressed in terms of labour i.e. value of a commodity is measured in terms of labour hours/days required to produce it. Commodities are also exchanged on the basis of labour content of each good.
4. Labour is the only factor of production other than natural resources.
5. Labour is homogeneous i.e. identical in efficiency, in a particular country.
6. Labour is perfectly mobile within a country but perfectly immobile between countries.
7. There is free trade i.e. the movement of goods between countries is not hindered by any restrictions.
8. Production is subject to constant returns to scale.
9. There is no technological change.
10. Trade between two countries takes place on barter system.
11. Full employment exists in both countries.
12. There is no transport cost.

The IMF and the WTO are international organizations with about 150 members in common. While the IMF’s central focus is on the international monetary and financial system, and the WTO’s is on the international trading system, both work together to ensure a sound system for global trade and payments.

The International Monetary Fund (IMF) is an international organization of 189 member countries that works to ensure the stability of the international monetary and financial system. The IMF’s mandate includes facilitating the expansion and balanced growth of international trade, promoting exchange stability, and providing the opportunity for the orderly correction of countries’ balance of payments problems. The IMF was established in 1945.

The World Trade Organization (WTO) is an international organization of 164 members that deals with the rules of trade between nations. With Russia’s accession in August 2012, the WTO encompasses all major trading economies. The WTO works to help international trade flow smoothly, predictably, and freely, and provides countries with a constructive and fair outlet for dealing with disputes over trade issues. The WTO came into being in 1995, succeeding the General Agreement on Tariffs and Trade (GATT) that was established in 1947.

The work of the IMF and the WTO is complementary. A sound international financial system is needed to support vibrant international trade, while smoothly flowing trade helps reduce the risk of payments imbalances and financial crisis. The two institutions work together to ensure a strong system of international trade and payments that is open to all countries. Such a system is critical for enabling economic growth, raising living standards, and reducing poverty around the globe.