The Comparative cost theory is the basis of international trade.
It explains that “it pays countries to specialize in the production of those goods in which they possess greater comparative advantage or the least comparative disadvantage.”
Suppose a unit of productive power produces in country A, 20 tooth-brushes or 20 kg of sugar and in country B, 15 tooth-brushes or 10 kg of sugar. In this case, country A has an advantage over country B in the production of both tooth-brushes and sugar. But she has a greater ‘comparative advantage’ in the production of sugar.
Country B is at a disadvantage in both commodities, but the ‘comparative disadvantage’ is less in case of tooth-brushes. Hence, A will specialize in sugar and B in tooth-brushes. This is the law of-comparative costs. When it is applied to international trade, the theory states that a country tends to specialize in the production of those articles in which it enjoys greater comparative advantage. What is important is not the cost of a commodity in country A arid its cost in country B, but the ratio between the costs of the commodities in the two countries.
In the words of Cairnes “The difference in the comparative cost of producing the commodities exchanged is essential to, and sufficient for, the existence of international trade.” This is the fundamental basis of international trade. In the example given above, the ratio of costs is different; being 20 kg of sugar: 20 tooth-brushes in A, and 10:15 in B. Here both countries stand to gain from trade.
It is strange indeed to find a country, importing a commodity from another even when she can herself produce it at a lower cost. For instance, we find that though Britain can produce both dairy products and machinery cheaper than Denmark, yet she imports dairy products from Denmark and exports machinery. How is this paradox explained? Well, like this
A professor can probably black his own shoes better than his servant and can, of course, lecture far better. But his time is more profitably used with his books than with brush and polish. A doctor may be a better dispenser than his assistant, but it pays him to examine patients and leave dispensing to his compounder.
In the same way, Britain imports cheese because she gains more by making machinery. Thus it is not very strange after all. Obviously, every nation uses its resources in such channels as will yield the best results. This is the real basis of all international trade.
Does the Actual Trade Conform to this Principle?
All the same, in the world today it is seen that many countries are trying to attain self-sufficiency and in develop industries in which they have not got a comparative advantage over others. They feel it essential to develop key industries even if they have to make some sacrifice to do it. Protection is adopted and other kinds of restrictions on trade are imposed. These nations are keen on developing their key industries out of fear of war. Thus the cost of production is ignored in anticipation of some future emergency.
Criticism of the Comparative Cost Theory:
The Comparative Cost Theory can be criticised on the following grounds:
(i) Wrong Assumptions:
The comparative cost theory is based on some assumptions which do not hold good in real life.
Some of these assumptions are:
(a) The unit costs remain the same,
(b) Static assumptions of fixed costs, fixed supplies of the factors of production, etc.,
(c) It is assumed that there are no transport costs,
(d) It assumes that there are no other costs except labour costs, and
(e) It assumes perfect mobility of factors inside, and perfect immobility outside a country. All these assumptions are not valid. Hence, the comparative cost theory is not applicable to real life i.e., international trade does not actually follow the law of comparative cost.
(ii) The comparative cost theory implies specialization; but complete specialisation is not always possible, nor considered always desirable so far as countries are concerned.
(iii) According to the comparative cost theory, international trade arises owing to differences in relative factor prices; but international trade also tends to narrow down these differences. Hence trade should come to an end if we accept the comparative cost theory.
(iv) The comparative cost theory ignores the fact that international trade takes place not only on account of differences in factor endowments, but also where the factor endowments are similar, e.g. between industrialized countries.
(v) The comparative cost theory is one-sided since it ignores the demand and concentrates only on the supply side. It does not say at what prices the goods will be demanded and traded.
(vi) Actual trade between countries may be dictated by military or strategic consideration and not merely by comparative costs. Hence, the comparative cost theory does not furnish an adequate explanation of international trade.