Chapter 3 Introduction

Introduction

In this chapter, we begin by discussing the Heckscher-Ohlin (H-O) theory of international trade and its key implications. This theory explains comparative advantage by indicating that countries should export products that intensively use the resources they have in abundance and import products that intensively use their scarce resources. It provides additional insight in the distribution of the gains by highlighting that owners of resources used heavily in the production of the export good will experience rising incomes at the expense of owners of more expensive scarce resources. One important implication of the H-O theory is that the prices of the resources embodied in traded products will tend to be the same across trading partners.

Second, while standard trade theory – including the H-O model – explains inter-industry trade well enough, it does not explain the two-way trade in similar products, i.e., intra-industry trade. Therefore, we examine other trade models which use different assumptions from those of the standard theory. Broadly, these models incorporate features of imperfect competition and enhances our understanding of trade as well as its implications for economic well-being. One particular model provides an intuitive explanation of intra-industry trade, largely in manufactured products. Specifically, these models were based on monopolistic competition, global oligopoly, product differentiation, and economies of scale.

Third, we note that the standard theory of trade provides an analysis of international trade at a particular time – that is, comparative advantage is analyzed on a static basis. However, we recognize that trade is dynamic and that comparative advantage can change over time. Among the possible reasons for shifts in comparative advantage are improvements in technology. In this regard, we consider the product life cycle theory of trade which demonstrates how changes in technology can alter the location of production across countries and the pattern of trade. The life cycle theory demonstrates how a country which develops and initially exports a new product can end up importing it.

Last, we explore increases in available resources or technological improvements that make economic growth possible and facilitate higher levels of production and consumption. Growth alters a country’s willingness and ability to engage in international trade. We note that, while the increase in production always provides a benefit, changes in international prices can either increase or reduce this positive effect on a country’s economic well-being.