Ricardian trade theory — how is this still a thing?

24 April, 2017 at 09:40 | Posted in Economics | 2 Comments

On Saturday, April 19th 1817, David Ricardo published The Principles of Political Economy and Taxation, where he laid out the idea of comparative advantage, which since has become the foundation of neoclassical, ‘mainstream’ international trade theory …

This week we saw lots of praise of Ricardo, by the likes of The Economist, CNN, Forbes and Vox. Mainstream economists today tend to see the rejection of free trade implicit in Trump and Brexit as populist nonsense by people who don’t understand the complicated theory of comparative advantage …

class_th_of_int_trade_-_lecture_4_7However, there are fundamental problems with the assumptions embedded in Ricardo’s theory and there’s little evidence, if any, to back up the Ricardian claim that free trade leads to benefits for all …

Perhaps the most fundamental assumption behind Ricardo’s theory is that a country’s terms of trade adjust to ensure balanced trade. This assumption is problematic on several accounts. First of all, a change in the terms of trade can have conflicting effects. Relatively low export prices means that each unit of export contributes less to the trade balance. At the same time, a lower price can lead to higher export volumes. In other words, the total value of exports can fall, remain the same, or rise, depending on the strengths of these conflicting effects. It is not given what will happen as the result of a change in the terms of trade, as it will depend on the price elasticity of the exports and imports …

There is a range of unrealistic assumptions underpinning Ricardian trade theory that are common to neoclassical economic theories. For example free mobility of capital and labor, perfect competition, and full utilization of domestic resources …

It can be difficult to understand why so many people are still staunch supporters of Ricardian trade theory, when it has seemingly been disproved. To understand it, we must first consider the obvious global dominance of neoclassical economics in classrooms, textbooks, academic journals and universities. It is not that difficult to understand why the basic tenets of Ricardo’s trade theory are still so widely respected, when we consider that alternative explanations are excluded from mainstream textbooks, journals and syllabi.

Ingrid Kvangraven

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2 Comments

  1. Even though the assumptions of Ricardo are not always true, it would be hard to replace them with approximations that are true. In other words the theory can still be satisfactory even if some of the assumptions are not always correct. It often happens that the assumptions preceding a theory are useful for presenting the theory, and for avoiding doubt about it, but later on the theory can stand alone, after a sense of its good qualities has been appreciated.

    • How are we doing with real world evidence or is it that we should see such theories as a form of intellectual jogging?


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