The Ricardian Hypothesis

Abstract

The core idea of the Ricardian hypothesis is contained in the classic numerical example (as discussed in Chapter 4) which not only elucidated the concept of comparative advantage but also demonstrated welfare gains from free international trade. It has often been a matter of debate regarding whether Ricardo’s objective of the three paragraphs in chapter 7 of his Principles was to enquire into the fundamental causes of international trade or to demonstrate the universal benefits of free trade. One view asserts the latter objective and points out in evidence that, in a full enquiry of the pattern of international trade, Ricardo would have taken three factors of production (land, labour and capital) into account as in his model of economic growth. The alternative view asserts the former objective and believes that the celebrated England-Portugal example can be construed as being an explanation of the pattern of international trade. In evidence, it points out that the assumption of labour being the only factor of production is a direct implication of the classical labour theory of value. The role of ‘capital’ is complementary to labour, and ‘capital’ is not defined as ‘capital goods’ but rather as ‘wage fund’ which buys labour services and raw materials during the ‘period of production’. If labour is assumed to be homogeneous so that wage rates are identical between the sectors, then ‘wage fund’ will be proportional to employment of labour in each sector, and hence, total costs are proportional to wage costs. If this argument is valid, then one needs to concentrate only on labour requirements.