Limitations of the Theory
Definition
Over-specialisation: a situation where a country concentrates so heavily on one or a few products that it becomes vulnerable to a fall in their demand or price.
Key Assumptions
- The theory assumes constant costs, so opportunity cost does not change as output changes.
- It assumes there are no transport costs between countries.
- It assumes factors of production move freely within a country but not between countries.
- It assumes just two countries and two goods, with no trade barriers.
Key Idea
- The assumptions make the model simple but unrealistic.
- Transport costs, trade barriers and externalities are all ignored.
- So the model is a framework for thinking, not a literal account of trade.
Worked Example
- Transport costs can reverse a comparative advantage that looks decisive on paper.
- We work through a small cost advantage that shipping wipes out.
Example
- Suppose Chile can make cloth at an opportunity cost of 0.9 wheat, just below Peru's 1.0 wheat.
- On the pure theory Chile should export cloth, but shipping each unit costs the equivalent of 0.2 wheat.
- Adding transport to Chile's cost gives the delivered cost:
- At 1.1 wheat delivered > Peru's own 1.0 wheat, so the trade no longer pays and Peru makes its own cloth.
Why the Assumptions Bite
- Transport costs can reduce or reverse the gains from trade, as the example shows.
- Because factors are not mobile between sectors, specialisation can cause structural unemployment in declining industries.
- In reality, protectionism such as tariffs and quotas distorts the pattern of trade the theory predicts.
- Externalities such as pollution from production and transport are left out of the model.
Note
- With constant costs assumed, the model misses that specialising further can raise unit costs.
- Workers cannot switch instantly from a declining to a growing sector.
- Tariffs and quotas mean real trade rarely follows comparative advantage exactly.
Over-Specialisation and Dynamic Advantage
- Full specialisation can tip into over-specialisation, so a country that has abandoned other industries cannot easily fall back on them if its market collapses.
- The theory is static, yet comparative advantage shifts over time as countries invest in skills and capital.
- So today's pattern of advantage is not fixed for all time.
- A country may therefore protect an infant industry to build a future advantage.
Note
- South Korea moved from simple manufactured goods to advanced electronics over several decades.
- A country reliant on a single commodity can be badly hit when its world price falls.
- So over-specialisation and shifting advantage both limit the static theory.
Evaluation
- In favour of the model, it captures the core insight that opportunity cost drives trade.
- Against it, its assumptions are unrealistic and static.
- Transport costs, protectionism, externalities and over-specialisation all limit it.
- On balance it is a useful framework for why trade happens, but it depends on the assumptions and should guide thinking rather than describe trade literally.
Exam technique
- State the assumptions clearly before criticising them.
- Explain why each assumption limits the model in the real world.
- Treat the model as a framework, not a literal description of trade.
Common Mistake
- Do not present the model as a literal description of real trade.
- It is a simplifying framework built on strong assumptions.
Self review
- Name three assumptions of the theory of comparative advantage.
- Why can transport costs reverse a comparative advantage?
- How does the assumption of no factor mobility between countries limit the model?
- What is the risk of over-specialisation?
- Why does protectionism limit the theory's predictions?
