New Trade Theory
Encyclopedia
New Trade Theory is a collection of economic models in international trade
which focuses on the role of increasing returns to scale
and network effect
s, which were developed in the late 1970s and early 1980s.
New Trade theorists relaxed the assumption of constant returns to scale, and some argue that using protectionist measures to build up a huge industrial base in certain industries will then allow those sectors to dominate the world market.
Less quantitative
forms of a similar "infant industry
" argument against totally free trade have been advanced by trade theorists since at least 1848 (see: History of free trade.)
'infant industries' (an idea offered in theory since the 18th century, and in trade policy since the 1880s) what was new in "New Trade Theory" was the rigour of the mathematical economics
used to model the increasing returns to scale
, and especially the use of the network effect
to argue that the formation of important industries was path dependent
in a way which industrial planning and judicious tariff
s might control.
The models developed were highly technical, and predicted the possibilities of national specialization-by-industry observed in the industrial world (movies
in Hollywood, watches in Switzerland
, etc.). The story of path-dependent industrial concentrations can sometime lead to monopolistic competition
or even situations of oligopoly
.
Some economists, such as Ha-Joon Chang
, had argued that free trade would have prevented the development of the Japan
ese auto industries in the 1950s, when quota
s and regulations prevented import
competition. Japanese companies were encouraged to import foreign production technology but were required to produce 90% of parts domestically within five years. It is said that the short-term hardship of Japanese consumers (who were unable to buy the superior vehicles produced by the world market) was more than compensated for by the long-term benefits to producers, who gained time to out-compete their international rivals.
, which doesn't require arbitrary judgements from the researchers.
Japan is cited as evidence of the benefits of "intelligent" protectionism, but critics of NTT have argued that the empirical
support post-war Japan offers for beneficial protectionism is unusual, and that the NTT argument is based on a selective sample of historical cases. Although many examples (like Japanese cars) can be cited where a 'protected' industry subsequently grew to world status, regression
s on the outcomes of such "industrial policies" (which include failures) have been less conclusive; some findings suggest that sectors targeted by Japanese industrial policy had decreasing returns to scale and did not experience productivity gains.
in the late 1970s; Krugman claims that he heard about monopolistic competition from Robert Solow
. Looking back in 1996 Krugman wrote that International economics
a generation earlier had completely ignored returns to scale.
"The idea that trade might reflect an overlay of increasing-returns specialization on comparative advantage
was not there at all: instead, the ruling idea was that increasing returns would simply alter the pattern of comparative advantage." In 1976, however, MIT-trained economist Victor Norman had worked out the central elements of what came to be known as the Helpman-Krugman theory. He wrote it up and showed it to Avinash Dixit
. However, they both agreed the results were not very significant. Indeed Norman never had the paper typed up, much less published. Norman's formal stake in the race comes from the final chapters of the famous Dixit-Norman book (Theory of International Trade : A Dual, General Equilibrium Approach, ISBN 0-521-29969-1).
James Brander, a PhD student at Stanford at the time, was undertaking similarly innovative work using models from industrial organisation theory— cross-hauling— to explain two-way trade in similar products.
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
which focuses on the role of increasing returns to scale
Returns to scale
In economics, returns to scale and economies of scale are related terms that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable...
and network effect
Network effect
In economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.The classic example is the telephone...
s, which were developed in the late 1970s and early 1980s.
New Trade theorists relaxed the assumption of constant returns to scale, and some argue that using protectionist measures to build up a huge industrial base in certain industries will then allow those sectors to dominate the world market.
Less quantitative
Quantitative property
A quantitative property is one that exists in a range of magnitudes, and can therefore be measured with a number. Measurements of any particular quantitative property are expressed as a specific quantity, referred to as a unit, multiplied by a number. Examples of physical quantities are distance,...
forms of a similar "infant industry
Infant industry
In economics, an infant industry is a new industry, which in its early stages is unable to compete with established competitors abroad.Governments are sometimes urged to support the development of infant industries, usually through subsidies or tariffs...
" argument against totally free trade have been advanced by trade theorists since at least 1848 (see: History of free trade.)
The theory's impact
Although there was nothing particularly 'new' about the idea of protectingProtectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...
'infant industries' (an idea offered in theory since the 18th century, and in trade policy since the 1880s) what was new in "New Trade Theory" was the rigour of the mathematical economics
Mathematical economics
Mathematical economics is the application of mathematical methods to represent economic theories and analyze problems posed in economics. It allows formulation and derivation of key relationships in a theory with clarity, generality, rigor, and simplicity...
used to model the increasing returns to scale
Returns to scale
In economics, returns to scale and economies of scale are related terms that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable...
, and especially the use of the network effect
Network effect
In economics and business, a network effect is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.The classic example is the telephone...
to argue that the formation of important industries was path dependent
Path dependence
Path dependence explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant....
in a way which industrial planning and judicious tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s might control.
The models developed were highly technical, and predicted the possibilities of national specialization-by-industry observed in the industrial world (movies
Film
A film, also called a movie or motion picture, is a series of still or moving images. It is produced by recording photographic images with cameras, or by creating images using animation techniques or visual effects...
in Hollywood, watches in Switzerland
Switzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
, etc.). The story of path-dependent industrial concentrations can sometime lead to monopolistic competition
Monopolistic competition
Monopolistic competition is imperfect competition where many competing producers sell products that are differentiated from one another...
or even situations of oligopoly
Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
.
Some economists, such as Ha-Joon Chang
Ha-Joon Chang
Ha-Joon Chang is one of the leading heterodox economists and institutional economists specialising in development economics...
, had argued that free trade would have prevented the development of the Japan
Japan
Japan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...
ese auto industries in the 1950s, when quota
Quota share
A quota share is a specified number or percentage of the allotment as a whole , that is prescribed to each individual entity ....
s and regulations prevented import
Import
The term import is derived from the conceptual meaning as to bring in the goods and services into the port of a country. The buyer of such goods and services is referred to an "importer" who is based in the country of import whereas the overseas based seller is referred to as an "exporter". Thus...
competition. Japanese companies were encouraged to import foreign production technology but were required to produce 90% of parts domestically within five years. It is said that the short-term hardship of Japanese consumers (who were unable to buy the superior vehicles produced by the world market) was more than compensated for by the long-term benefits to producers, who gained time to out-compete their international rivals.
Econometric testing
The econometric evidence for NTT was mixed, and highly technical. Due to the time-scales required, and the particular nature of production in each 'monopolizable' sector, statistical judgements were hard to make. In many ways, the available data have been too limited to produce a reliable test of the hypothesisHypothesis
A hypothesis is a proposed explanation for a phenomenon. The term derives from the Greek, ὑποτιθέναι – hypotithenai meaning "to put under" or "to suppose". For a hypothesis to be put forward as a scientific hypothesis, the scientific method requires that one can test it...
, which doesn't require arbitrary judgements from the researchers.
Japan is cited as evidence of the benefits of "intelligent" protectionism, but critics of NTT have argued that the empirical
Empirical
The word empirical denotes information gained by means of observation or experimentation. Empirical data are data produced by an experiment or observation....
support post-war Japan offers for beneficial protectionism is unusual, and that the NTT argument is based on a selective sample of historical cases. Although many examples (like Japanese cars) can be cited where a 'protected' industry subsequently grew to world status, regression
Regression analysis
In statistics, regression analysis includes many techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables...
s on the outcomes of such "industrial policies" (which include failures) have been less conclusive; some findings suggest that sectors targeted by Japanese industrial policy had decreasing returns to scale and did not experience productivity gains.
History of the theory's development
The theory was initially associated with Paul KrugmanPaul Krugman
Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
in the late 1970s; Krugman claims that he heard about monopolistic competition from Robert Solow
Robert Solow
Robert Merton Solow is an American economist particularly known for his work on the theory of economic growth that culminated in the exogenous growth model named after him...
. Looking back in 1996 Krugman wrote that International economics
International economics
International economics is concerned with the effects upon economic activity of international differences in productive resources and consumer preferences and the institutions that affect them...
a generation earlier had completely ignored returns to scale.
"The idea that trade might reflect an overlay of increasing-returns specialization on comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
was not there at all: instead, the ruling idea was that increasing returns would simply alter the pattern of comparative advantage." In 1976, however, MIT-trained economist Victor Norman had worked out the central elements of what came to be known as the Helpman-Krugman theory. He wrote it up and showed it to Avinash Dixit
Avinash Dixit
Avinash Kamalakar Dixit is an Indian-American economist originally of Indian nationality.-Education:Dixit received a B.Sc. from Bombay University in 1963 in Mathematics and Physics, a B.A...
. However, they both agreed the results were not very significant. Indeed Norman never had the paper typed up, much less published. Norman's formal stake in the race comes from the final chapters of the famous Dixit-Norman book (Theory of International Trade : A Dual, General Equilibrium Approach, ISBN 0-521-29969-1).
James Brander, a PhD student at Stanford at the time, was undertaking similarly innovative work using models from industrial organisation theory— cross-hauling— to explain two-way trade in similar products.
See also
- General equilibriumGeneral equilibriumGeneral equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
- Endogenous growth theoryEndogenous growth theoryEndogenous growth theory holds that economic growth is primarily the result of endogenous and not external force. In Endogenous growth theory investment in human capital, innovation and knowledge are significant contributors to economic growth. The theory also focus on positive externalities and...
was developed at a similar time to NTT, and is linked through the idea that industrial and trade policy can affect over-all productivityProductivityProductivity is a measure of the efficiency of production. Productivity is a ratio of what is produced to what is required to produce it. Usually this ratio is in the form of an average, expressing the total output divided by the total input...
growth. - Home-market effectHome-market effectThe home market effect is a hypothesized concentration of certain industries in large markets. The home market effect became part of New Trade Theory. Through trade theory, the home market effect is derived from models with returns to scale and transportation costs...
External links
- On The Smithian Origins Of "New" Trade And Growth Theories, Aykut Kibritcioglu Ankara UniversityAnkara UniversityAnkara University is a public university in Ankara, the capital city of Turkey. It was the first higher education institution founded in the Turkish Republic....
shows that Adam SmithAdam SmithAdam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
's "increasing returns to scale" conception of international trade anticipated NTT by two hundred years. - Krugman acknowledges NTT's debt to Ohlin. He writes that OhlinBertil OhlinBertil Gotthard Ohlin was a Swedish economist and politician. He was a professor of economics at the Stockholm School of Economics from 1929 to 1965. He was also leader of the People's Party, a social-liberal party which at the time was the largest party in opposition to the governing Social...
may have lacked the modelling technology necessary to incorporate increasing returns to scale into the Heckscher-Ohlin modelHeckscher-Ohlin modelThe Heckscher–Ohlin model is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based...
, but that his book Interregional and International Trade, discusses the consideration qualitatively.