International Trade Theory

Abstract

International trade theory provides explanations for the pattern of international trade and the distribution of the gains from trade. The theory convinces most economists of the benefits of liberal trade. But many non-economists oppose liberal trade. Opponents include some who may have encountered trade theory but nevertheless fall prey to fallacious reasoning. This article attempts to convey why trade theory is so persuasive to economists and also to deal with why many non-economists are not persuaded.

This chapter was originally published in The New Palgrave Dictionary of Economics, 2nd edition, 2008. Edited by Steven N. Durlauf and Lawrence E. Blume

Appendix

The general statement of comparative advantage is that on average a country will import goods that are relatively expensive in autarky. Let m denote the vector of excess demands in equilibrium, positive for imports and negative for imports. Let p denote the vector of relative prices in autarky in the home country and let p ^* denote the vector of relative prices in autarky in the foreign country. Then the vector inner product (p − p*)'m ≥ 0.

The key requirement for the proposition is ‘as if’ optimization by consumers and producers, leading downward-sloping demand and upward-sloping supply in the generalized sense (the substitution effects matrix of real income-compensated excess demands, ${m}_p^c$, is negative semi-definite). If the actual trade equilibrium involves trade distortions, the additional requirement is that trade not be on balance subsidized. Let t be the vector of trade taxes, positive for import taxes and negative for export taxes (and negative for import subsidies and positive for export subsidies). The requirement is t’m ≥ 0.

The ‘buy low, sell high’ logic implies that a surplus is captured by trade, so comparative advantage trade is closely linked to the gains from trade. ‘As if’ optimization means that consumers lower the expenditure required to support given real income by reallocating consumption in trade equilibrium as compared with autarky, while optimization by producers means that income is raised by reallocating production in trade equilibrium as compared with autarky.

Similar comparative advantage statements can be made concerning the factor content of trade; countries tend to import (embodied in goods) the factors that are relatively expensive in autarky (see Neary and Schweinberger 1986).