Question

“New trade theory is at variance with the Heckscher-Ohlin theory, which suggests a country will predominate in the export of a product when it is particularly well endowed with those factors used intensively in its manufacture.” (Hill & Hult, 2019)

Explain New Trade Theory. What is it? What does it depend on?

Answer 1

New trade theory (NTT) argues that the very large economies of scale and network effects that may exist in key industries are a crucial factor in determining international trade patterns.These economies of scale and network effects can be so large that they overshadow the more conventional comparative advantage concept. In some sectors, at a specific point in time, two countries may have no discernible differences in the cost of opportunity. But if one country specializes in a particular industry, it can achieve economies of scale and its specialization benefits other networks.

Another aspect of the new theory of trade is that companies that have the benefit of being an early entrant can become a leading business on the market. This is because the first firms are achieving large economies of scale which means that new firms can not compete with the existing firms. This means that there is likely to be limited competition in these international industries with very large economies of scale, with the market dominated by early companies joining, resulting in a form of monopoly competition. Monopolistic rivalry is an important element of New Trade Theory, implying that businesses frequently compete on branding, value and not simply cost.

New trade theory suggests that policymakers can play a role in promoting new industries and fostering the growth of key industries. Many refer to the 1950s Japanese automotive industry, which received substantial support from the government. There was also some policy security and aid from other S.E. Asian economies. To encourage the creation of capital-intensive industries, a developing economy may need tariff protection and domestic subsidy. It will be able to exploit economies of scale and then be profitable without government support if the industry gets funding for a few years. This is analogous to earlier claims about the industries of children.

New trade theory is not solely about promoting government intervention in industry; it is more about recognizing that economies of scale are a key factor in shaping trade growth. It also indicates that free trade and government interference by laissez-faire may be far less attractive for developing economies that find themselves unable to compete with developed multinationals.