6 Alternative Theories of Trade Alternative Theories of Trade 1 Why do we need alternative theories 2 Three Alternative Theories a Significant Internal Economies of Scale Hysteresis b Significant External Economies of Scale Hysteresis c Modest Internal Economies and Differential Product Monopolistic Competition Model 3 Note about Transportation Costs and Trade 4 General Conclusions New Trade Theory vs Standard Model H O Standard Model 1 Countries differ in real abundance of resources 2 Different goods differ in relative intensive use of resources eg different labor Standard Model does a good job at explaining trade that is 1 Between rich and poor countries Relative abundance 2 In real life Inter industry Country imports from 1 industry exports from another o Poor city s perspective About 80 of trade is with rich country and mostly inter industry o Rich country s perspective 70 80 of trade is with other rich countries mostly intra industry Eg US both exports and imports the same good eg cars Internal Economies of Scale Increased opportunities for specialization 1 2 Spreading the cost of lumpy imports eg High sunk costs Eg X Ray machines Internal Diseconomies of Scale 1 Costs of monitoring employees 2 Costs of bureaucratic decision making Minimum Efficient Scale MES Point at which all IEOS are exhausted Lowest possible cost per unit that could be achieved Lowest possible price each firm can charge to stay in business MES is large relative to the global market Limited number of possible firms the market can support Assume all firms in this industry have identical LRATC curves Draw LRAC for each single firm o High EOS High MES Lowest possible price corresponds to maximum possible market size Cost disincentive for having more firms than the market can support 6 Alternative Theories of Trade Hysteresis Process by which a sometimes random historical event permanently semi permanently influences a future equilibrium Eg Financial crisis has permanently lowered the labor force participation rate Difference between Internal and External Economies of Scale Internal Economies Each individual firms output increases o Cost per unit for that firm decreases Rightward shift along that firm s LRATC curve towards MES External Economies New firms are added o Cost per unit of all firms decrease LRATC curves for all existing firms move down Strategic Trade Policy Industrial Policy STP Government tries to enter an industry that another country already has a first mover advantage in subsidizing that industry and incurring years of loss to develop a comparative advantage in that industry IP Official strategic effort to encourage the development and growth of specific sectors Alternative Theory 1 Internal Economies followed by Hysteresis Significant internal economies relative to global market o Only a few firms countries can produce the good Historical accident Supports the initial allocation of the countries comparative advantage locked in o Steve Jobs and Bill Gates are both born in US country with market for personal computers allowing them to build their companies and have their companies prosper here Intra industry trade o Products can differentiated across countries Results in rich rich trade too Alternative Theory 2 External Economies followed by Hysteresis External Economies of Scale Occur when an increase in the industry output lowers the cost per unit for all firms in the industry o As a result of geographic clusters neighborhood city o Cluster of firms will have a cost advantage over those outside the cluster Types of External Economies of Scale 1 Transportation cost 2 Marketing cost 3 Recruitment cost Historical accident Hysteresis decides where the clusters form o Comparative advantage locked in where clusters first began 6 Alternative Theories of Trade Implications of Theory 1 and 2 1 Explains Rich Rich Trade a Random event yes but the conditions have to be right certain level of development or economic characteristics for the random event to develop the industries 2 Stolpher Samuelson Theorem need not apply a H O model explains trade that a rich country does with a poor country 3 All types of workers can gain even without side payments a Opposition always occurs towards international trade with poorer countries 4 Theories open the door to government intervention to improve the outcome for the intervening country 5 Missing intra industry trade explanation Alternative Theory 3 Modest Internal Economies and Differential Product Monopolistic Competition Model Assumptions Under autarky o Differentiated product unit o Country A must choose between 2 varieties of product at a low cost per o More than 2 varieties at a higher cost per unit o Because the domestic market can only support 2 firms 2 varieties Suppose that there are 4 such countries A B C and D o All allow trade Country must now choose between 8 varieties at low cost or more than 8 varieties at higher cost per unit o Each country just needs to produce 1 variety to get a total of 4 varieties Explains o Rich rich intra industry trade o No reason for Stolper Samuelson to apply Total demand ratio for high skilled and low skilled labor is the same after trade as before Because same firm is producing the same number of cars after trade production doesn t change Just swapping between countries o All types of workers gain Relatively high transportation costs help us understand 1 Why certain goods are not traded 2 Why proximity increases trade for some goods 3 Why trade has expanded so rapidly in recent decades a Trade has expanded so rapidly in recent decades i 1950s 60s Container shipping ii 1980s 90s Smaller lighter more affordable goods iii 2000s Services over the internet