MODERN TRADE THEORY AND TRADE POLICY

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

Ari Kokko

Problems with traditional 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)

Ari Kokko

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

Ari Kokko

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

Ari Kokko

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

Ari Kokko

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

Ari Kokko

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

Ari Kokko

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

Ari Kokko

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?

Ari Kokko

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

Ari Kokko

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 Ari Kokko