Trade Theory
Intra-Industry International Trade
Standard trade theory and its deviations
The classical theory of international trade can be traced back to the founding father of capitalism Adam Smith: Smith's 1776 Wealth of Nations theorized that free trade would be beneficial to all nations. Smith stated that much like merchants, nations should specialize in the particular goods and services which they could produce most efficiently and trade with other nations who could produce alternate goods and services equally efficiently. Thus free trade resulted in advantages for both trading parties. Smith's theory was later fleshed out by David Ricardo in his Principles of Economics. Riccardo stated that free trade could optimize efficiency for every country on a global level by reducing the inefficiencies generated by the excess resources involved in producing the goods and services the nation was not suited to produce (Sen 2010: 2).
This common wisdom remained relatively consistent for many years: the concept that trade was mutually beneficial for nations at the macro level and consumers at the micro level. What became known as the Heckscher-Ohlin Samuelson (HOS) model of free trade doctrine "modified that Ricardian comparative cost doctrine to an endowment-based explanation for nations having similar access to technology" (Sen 2010: 4). In short all access to resources being relatively equal (such as technology) results in advantageous free trade in which the goods and services one nation can produce cheaply get exchanged with those of another nation in a mutually advantageous relationship; however, in the real world, things do not always proceed so smoothly. Politics and other influences disturb the neat equilibrium that supposedly should manifest itself according to the pure concepts of free trade theory.
Economies of scale
The assumptions of once commonly-accepted theories of free trade have been challenged by a number of theories. One common criticism is that HOS assumptions focus primarily upon how economies of scale and comparative advantages create value. The concept of comparative advantages, simply put, is that it 'makes sense' for a nation like Jamaica to specialize in producing coffee, which it can do at a lower price while it makes sense for Canada to import coffee and to export products it produces in abundance such as maple syrup (Heakal 2013). However, economies of scale are another important factor in creating comparative advantages. This means that high-level producers in the developed world are in a better position to control market prices, not just market share, because of the imperfect competition that results from their first-mover advantage and greater access to resources (Sen 20010: 6).
Larger entities, regardless of the natural resources present within the nation, generate comparative advantages simply by being large. Simply being part of a developed world nation can create a comparative advantage which is "disruptive to the predictive power, as well as the major theorems, of the traditional HOS model" (Sen 2010: 8). Just as larger firms domestically have an advantage over smaller firms, this is also true internationally of small and large nations. Returns to scale on a national level can be generated via lower input costs and taking advantage of volume discounts in bulk; spreading the cost of inputs over production units; using technology and access to specialized labor and knowledge to increase efficiency and also the development of support industries (Heakal 2013).
Comparative advantages alone cannot explain why certain nations thrive in an environment of free trade while others do not. Furthermore, there is argument that similarity amongst nations and cultures likewise generates a freer flow of trade. As the "range of goods that are typically demanded at the respective per capita income, determine… [so does] the feasibility of trade across nations. To produce and trade, representative demand in the respective countries needs to have an overlapping zone in terms of the range of goods that are produced and consumed in common," thus questioning the specialization emphasis and the theory of comparative advantages (Sen 2010: 6). In other words, the reason that industrialized nations trade with one another, despite having similar types of economies which would seem to cancel out some comparative advantages for certain goods in services, is generated by feasibility and the convergence of shared economic, political, and cultural factors which generate similar goods and services and encourage a free flow of trade.
Monopolistic competition and the gravity model of trade
In contrast to HOS assumptions, the gravity model of trade is based upon a kind of economic formula of 'gravity' similar to that of Newtonian theories of gravity. Rather than comparative advantage, factors such as national distance from one another; common languages; colonial links; common currency; institutions;...
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