The classical system evolved in a particular setting provided by the country of its origin, and it is often contended that its significance is confined to the limits of that particular setting.’Classical theory’ flowered on the British soil; would it not wither elsewhere?’ is a question which is very often asked.
Because of its association with a policy which was found inappropriate in other countries with dissimilar conditions, classical theory itself became suspect. Now this is a mistake. It is not enough to show certain obvious limitations of the Torrens-Ricardo comparative cost theory—although even there, with slight modifications to allow for non-labour costs, the theory can perhaps be used as an ‘explanatory hypothesis’ in relation to a short period over which fundamental changes do not occur. As a guide to policy the theory undoubtedly is deceptive.
To get at the more significant element of the classical theory of foreign trade one must go further back to Adam Smith.
In spite of its subsequent recognition as the classical theory, the doctrine of comparative costs just does not fit in with the general framework of classical economics. The doctrine of comparative costs is based on a static, ‘constant return’ assumption, whereas classical economics is moulded in a dynamic framework and does allow for increasing returns-Classical economic? has suffered in prestige considerably on account of its apparent association with a doctrine which takes no account of the possibility of increasing returns.
For you cannot properly explain the secular movement of international trade except in terms of increasing returns. Adam Smith perceived it. In his famous dictum—’Division of labour is limited by the extent of the market’—you have a proposition which is perfectly general, not only as an explanation of the phenomena of international trade but also as a guide to policy.1 Consider a country which exhibits conditions unlike those that the classical economists postulated—a country big in size, exporting ‘corn’ and importing manufactures.
Here it is the presence of foreign trade—the import of low cost manufactures— that limits the scope of division of labour. For such a country the policy prescription that emerges from the Smithian doctrine is Protection, not Free Trade. If ‘theories are nets’,1 one must know how to cast, if one is to catch.