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Summary: Fuller Answers to the Four Trade Questions
This chapter examined several theories that have broadened our answers to the four major questions about trade. The alternative theories focus on
- Product differentiation and monopolistic competition.
- Substantial internal scale economies and global oligopoly.
- External scale economies.
According to the standard trade theory emphasizing comparative advantage, the similarity of industrialized countries in factor endowments and technological capabilities suggests little reason for trade among them. Yet we observe the opposite. Trade among industrialized countries represents close to half of world trade. Furthermore, an increasing fraction of world trade consists of intra-industry trade (IIT), in which a country both exports and imports items in the same product category. A challenge for trade theory is to explain why we have so much IIT and whether the standard model's conclusions about the gains from trade and the effects of trade still hold.
Much IIT involves trade in differentiated products—exports and imports of different varieties of the same basic product. Part of the reason that we have rising intraindustry trade is that product variety is a luxury in a prospering world. Rising per capita incomes cause an even faster rise in demand for luxuries. Yet, by itself, increasing demand does not explain intra-industry trade. To put intra-industry trade in proper perspective, we need to consider features on the producers' side of the same expanding markets.
Moderate internal economies of scale and monopolistic competition are important to understanding intra-industry trade. Firms competing using differentiated products are able to export to some consumers in foreign markets even as they face competition from imports of varieties produced by foreign firms. Net trade in these differentiated products may still be based on comparative advantage.
Another major fact is that some industries are dominated by a few large firms. Global oligopoly can arise when there are substantial scale economies internal to each firm. These large firms choose production locations to maximize their profits, and comparative advantages are likely to be prominent in such location decisions. Over time, conditions may change, but the production locations and the trade pattern do not necessarily change, because of the scale advantages of the established locations.
Some other industries, while competitively populated by a large number of firms, also tend to concentrate in a few production locations because of scale economies that are external to the individual firm. External scale economies depend on the size of the entire industry in the location. It can be difficult to predict or explain which production locations prosper. Home market size, history, luck, and government policy may affect which country locations capitalize on the external economies.
Thinking about imperfect competition and economies of scale also adds to our understanding of the gains from trade and the effects of trade on different groups. It does not contradict the main conclusions of the standard competitive-market analysis of Chapters 2 through 5. Rather, it broadens the set of conditions under which we see gains from trade, with some changes in how any gains or losses are distributed among the groups. Figure 6.6 summarizes gains and losses for three kinds of trade: the standard competitive trade of Chapters 2 through 5 plus two of the three kinds of trade analyzed in this chapter. Oligopoly is not included because we do not have a single generally accepted model.
Relative to standard competitive trade, both trade based on monopolistic competition and trade based on external economies provide additional benefits to consumers, especially consumers of exportable products. In the case of monopolistic competition, the additional gains come from (1) access to greater product variety and (2) a tendency for additional competition to lower product prices. In the case of external economies, gains to consumers in the exporting country arise from the decline in the price for the good as the local industry expands and achieves greater external economies. Relative to standard competitive trade, trade based on monopolistic competition has less of an impact on producing firms and factor incomes, because firms under pressure from import competition also have the opportunity to export into foreign markets.
Although not portrayed fully in Figure 6.6, global oligopoly (or monopoly) also has implications for well-being. Trade allows firms to concentrate production in a few locations, achieving scale economies that lower costs. Furthermore, a global oligopoly (or monopoly) firm can earn pure profits on its export sales. In comparison with standard competitive trade, these pure profits on exports add to both the gains to export producers and the national gains from trade for the exporting country.
Where does the theory of trade patterns stand?
The standard model of Chapters 2 through 5, complete with both demand and supply sides, has the virtue of breadth. We can use it to explain most trade patterns as long as we equip it with a long list of explanatory variables. Its weakness lies in that same breadth, that same ability to expand to explain any case: The problem is that we need to equip it with a long list of explanatory variables to explain all the real-world trade patterns. That gets cumbersome. For example, to explain why Toyota Corporation developed an advantage in exporting automobiles to the whole world, we have to start with the personal entrepreneurial vision of Eishi Toyoda and call it a "factor endowment" of Toyota Corporation and of Japan. This is a valid way to use our standard model in explaining Toyota's success, but it does not give us any predictive power, any ability to forecast.
The Heckscher-Ohlin variant of the standard model makes the stronger assertion that the way to explain who exports what to whom is to look at factor proportions alone, concentrating on a few main factors of production. That has the scientific virtue of giving more testable and falsifiable predictions than the broadest standard model (of which it is a special case). But, as we saw in Chapter 5, the tests of the Heckscher-Ohlin model give it only a middling grade. It is only part of the explanation of trade patterns.
Our ability to predict (explain) trade patterns is improved if we add technology differences and models based on scale economies and imperfect competition. Technology differences can be a basis for comparative advantage. We will explore in depth the relationship between technological progress and trade in the next chapter.
The monopolistic competition model suggests that product differentiation can be a basis for successful exporting, although it does not predict which specific varieties of a differentiated product will be produced by which countries. The models based on substantial scale economies (internal or external) indicate that production tends to be concentrated at a small number of locations, but they do not precisely identify which specific countries will be the production locations. History, luck, and perhaps early government policy can have a major impact on the actual production locations.
FIGURE 6.6
Summary of Gains and Losses from Opening Up Trade in Three Cases
* In monopolistic competition that results in intra-industry trade (IIT), producers are both exporters and importcompeting at the same time. If trade is mostly or completely IIT, then the effects on producers as a group tend to be small.
Note: The gains and losses to producers and consumers in all cases refer to changes in producer surplus and consumer surplus in the short run. In the long run, these gains and losses shift to the factors most closely tied to the export or import-competing industries (according to the Stolper-Samuelson theorem).
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