New trade theory of international trade

The New Trade Theory (NTT) is a branch of international trade theory that emerged in the 1970s and 1980s. It challenges the traditional Heckscher-Ohlin (H-O) model of international trade, which assumes that countries trade goods based on their relative factor endowments. Instead, the NTT emphasizes the role of imperfect competition, increasing returns to scale, and product differentiation in shaping international trade patterns.

Key features of the New Trade Theory:

  1. Product differentiation: Firms produce differentiated products, which are unique or have distinct characteristics. This leads to imperfect competition, as firms compete with each other for market share.
  2. Increasing returns to scale: Firms can achieve economies of scale by producing larger quantities, which reduces their average costs. This encourages firms to specialize in specific products or markets.
  3. Imperfect competition: Firms have market power, which allows them to influence prices and output. This leads to a departure from perfect competition, where firms are price-takers.
  4. Trade in varieties: Countries trade not only in quantities of goods but also in varieties of goods. This means that countries can specialize in producing specific products or varieties that are in high demand.
  5. Intra-industry trade: Countries trade not only between industries but also within industries. This means that countries can import and export similar products, such as cars or electronics.

The New Trade Theory has several implications for international trade:

  1. Trade liberalization: The NTT suggests that trade liberalization can lead to increased trade and economic growth, as firms can specialize in producing specific products or varieties.
  2. Intra-industry trade: The NTT predicts that countries will engage in intra-industry trade, which can lead to increased competition and innovation.
  3. Trade in services: The NTT emphasizes the importance of trade in services, such as finance, transportation, and communication, which are often characterized by imperfect competition and increasing returns to scale.
  4. Regional trade agreements: The NTT suggests that regional trade agreements can be effective in promoting trade and economic integration, as they can reduce transaction costs and increase market access.
  5. Global value chains: The NTT highlights the importance of global value chains, where firms specialize in specific stages of production and trade with other firms to produce final goods.

Some of the key models and theories within the New Trade Theory include:

  1. Krugman's model of intra-industry trade: Paul Krugman's model (1979) shows that intra-industry trade can occur even in the absence of factor endowment differences.
  2. Helpman and Krugman's model of trade in varieties: Elhanan Helpman and Paul Krugman's model (1985) demonstrates how trade in varieties can lead to increased trade and economic growth.
  3. Brander and Spencer's model of trade and competition: James Brander and Barbara Spencer's model (1985) shows how trade and competition can lead to increased innovation and productivity.

The New Trade Theory has been influential in shaping our understanding of international trade and has been applied to a wide range of policy issues, including trade liberalization, regional trade agreements, and global value chains.