New trade theory

Traditional trade models relied on productivity differences (Ricardian model of comparative advantage) or factor endowment differences (Heckscher–Ohlin model) to explain international trade. New trade theorists relaxed the assumption of constant returns to scale, and showed that increasing returns can drive trade flows between similar countries, without differences in productivity or factor endowments. With increasing returns to scale, countries that are identical still have an incentive to trade with each other. Industries in specific countries concentrate on specific niche products, gaining economies of scale in those niches. Countries then trade these niche products to each other – each specializing in a particular industry or niche product. Trade allows the countries to benefit from larger economies of scale.

Some have used NTT to argue that using protectionist measures to build up a large industrial base in certain promising industries will then allow those industries to dominate the world market. Less quantitative forms of a similar "infant industry" argument against free trade have been advanced by previous trade theorists.

Development

Although aspects of trade with increasing returns had been worked out earlier, especially in work by Avinash Dixit, new trade theory is associated with Paul Krugman's work in the late 1970s, developing into what is known as the Dixit-Stiglitz-Krugman trade model and the Helpman–Krugman model. Krugman states that he originally learned about the effects of monopolistic competition on trade from Robert Solow, but that theories of International economics a generation earlier had completely ignored returns to scale. In 1996 he wrote, "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."

"New" new trade theory

Marc Melitz and Pol Antràs started a new trend in the study of international trade. While new trade theory put emphasis on the growing trend of intermediate goods, this new trend emphasizes firm level differences in the same industry of the same country and this new trend is frequently called 'new' new trade theory (NNTT). NNTT stresses the importance of firms rather than sectors in understanding the challenges and the opportunities countries face in the age of globalization.

As international trade is increasingly liberalized, industries of comparative advantage are expected to expand, while those of comparative disadvantage are expected to shrink, leading to an uneven spatial distribution of the corresponding economic activities. Within the very same industry, some firms are not able to cope with international competition while others thrive. The resulting intra-industry reallocations of market shares and productive resources are much more pronounced than inter-industry reallocations driven by comparative advantage.

Trade in intermediate products

A new conspicuous phenomenon in the recent world trade is the rise of trade in intermediate goods and services. A study of the Organization for Economic Cooperation and Development (OECD) has found that "intermediate inputs represent 56% of goods trade and 73% of services trade." This is a result of fragmentation of production and the increasing importance of outsourcing, which were in turn a result of rapid decrease of trade costs (including transportation costs, transaction costs and tariffs) and revolutionary development of information and communications technologies. Trade in intermediate products are related to many phenomena such as offshoring, vertical specialization, global sourcing, the Second Unbundling, trade in value added, trade in tasks, global supply chains, global value chains, and global optimal procurement. In short it is one of motive powers of internationalization and globalization.

Traditional trade theories including Heckscher–Ohlin–Samuelson theory and the new trade theory à la Krugman exclude trade of intermediates products by assumption and cannot explain fragmentation of production across countries. Fragmentation was first studied by Ronald Jones and Henryk Kierzowski (1990). They explained the fragmentation by the decrease of service link costs. Yoshinori Shiozawa (2017, Section 13) presented a new explanation by the decrease of trade costs. The service link explains how fragmentation occurs but does not explain how a pattern of specialization emerges. Trade cost explanation is naturally incorporated in Shiozawa's theory of international trade and can be used in the account of global value chain emergence, because it is a general framework which permits trade of intermediate goods and services.

Theoretical foundations

New trade theory and "new" new trade theory (NNTT) need their own trade theory. New trade theories are often based on assumptions such as monopolistic competition and increasing returns to scale. One of the typical explanations, given by Paul Krugman, depends on the assumption that all firms are symmetrical, meaning that they all have the same production coefficients. This is too strict as an assumption and deprived general applicability of Krugman's explanation. Shiozawa, based on a much more general model, succeeded in giving a new explanation on why the traded volume increases for intermediates goods when the transport cost decreases.

"New" new trade theory (NNTT) also needs a new theoretical foundation. Melitz and his followers concentrate on empirical aspects and pay little interest to theoretical aspects of NNTT. Shiozawa's new construction, or Ricardo-Sraffa trade theory, enables Ricardian trade theory to include choice of techniques. Thus the theory can treat a situation where there are many firms with different production processes. Based on this new theory, Fujimoto and Shiozawa analyze how different production sites, either of competing firms or of the same firms locating in the different countries, compete.