Modern trade theory and trade policy

1
Modern trade theory and trade policy

• What comes after neo-classical theory?
• New policy options

2
GATT and WTO based on neo-classical trade theory

• All countries gain from trade
• More trade more benefits
• All industries equal
• Free trade is optimal
• Specialization in areas of comparative advantage
  is optimal

3
Problems with neo-classical trade theory

• Some of the assumptions in the models are not
  realistic
• the world does not have perfect competition,
  identical preferences, constant returns to scale
• Empirical findings have contradicted the
  predictions of the models
• lots of trade between similar countries, large
  amounts of intra-industry trade (exports and
  imports of the same goods)

4
Modern trade theory

• Relaxes central assumptions of older theory
• identical preferences
• economies of scale
• perfect competition
• externalities
• No consistent theory yet, but important building
  blocks
• Preferences The Linder-hypothesis
• Models with economies of scale
• Strategic trade policy

5
The Linder Model

• Staffan Burenstam Linder (1961), An essay on
  trade and transformation
• demand important determinant of trade
• domestic demand determines what product varieties
  a country manufactures
• these varieties can mainly be sold in countries
  with similar demand
• demand connected to income levels
• lots of trade between similar countries

6
Economies of scale and competitive strategies

• Not easy to compete head-on with bigger companies
  from bigger countries
• Need to devise new strategies
• Need to consider implications for trade policy

7
Economies of scale and competitive strategies

• Strategy 1
• Product differentiation create a product that is
  a little bit different, and that can be priced a
  little bit higher than the incumbent
• specialization and intra-industry trade

8
Economies of scale and competitive strategies

• Strategy 2
• Make sure that you grow large as soon as possible
• government intervention to support domestic
  actors strategic trade policy
• export subsidization or infant industry
  protection
• Boeing vs Airbus

9
Economies of scale and competitive strategies

• Strategy 2 also tempting when all industries are
  not of equal value
• some industries may have strategic value because
  of better growth potential or positive
  externalities
• externalities will give competitive advantage to
  first location chosen by emerging industry

10
Tempting conclusions for economic policy

• Free trade and WTO may be good for potato chips
• but other solutions look tempting for micro
  chips
• Problems with strategic policy
• Not WTO consistent others will complain or
  retaliate
• Hard to identify industries with strategic value.
  How do you pick the winners?

11
Economies of scale and competitive strategies

• Strategy 3
• Become a big country
• free trade agreements and regional integration
  will create a big home market
• EC White Paper on the Common Market integration
  will allow European firms to grow as large as US
  and Japanese firms

12
Conclusions

• GATT / WTO not sufficient to guarantee fair trade
  in strategic industries
• Firms in small countries will rarely manage to
  compete with larger US and Japanese firms
• Regional integration necessary? Competition with
  US and Japan requires larger market with fair
  rules
• Foreign direct investment essential component of
  adjustment
• Industrial policy important to attract
  international investors