Wikipedia on New Trade Theory

It looks like the Wikipedia entry on “new trade theory” could use some work. For example, the initial summary currently reads:

New Trade Theory (NTT) is the economic critique of international free trade from the perspective of increasing returns to scale and the network effect. Beginning in the 1970s some economists asked whether it might be effective for a nation to shelter infant industries until they had grown to sufficient size to compete internationally.

New trade theory is a methodological alternative to pure trade theory, not a critique of a policy position. New trade theory explains international trade in terms of monopolistic competition, whereas traditional theory assumes perfect competition.

For example, under pure trade theory, two absolutely identical countries (with identical factor endowments) would not gain from trade (especially in the presence of international transport costs). Under new trade theory, however, gains from trade would occur due to increasing returns to scale. This is the classic argument from Adam Smith that specialization is limited by the extent of the market, and that greater specialization results in greater productivity.

The long dominance of Ricardo over Smith – of comparative advantage over increasing returns – was largely due to the belief that the alternative was necessarily a mess. In effect, the theory of international trade followed the perceived line of least mathematical resistance. [Paul Krugman, Rethinking International Trade, p.4]

The wikipedia entry is misleading, because it emphasizes the possibility for protectionism to be welfare-improving under new trade theory, rather than the nature and content of the theory itself. The importance of new trade theory is its examination of how models featuring imperfectly competitive markets both reinforce and alter our traditional views of trade, not the fact that it might breathe new life into the infant industry argument (unless one is not a theorist, but a protectionist hunting for a theory).

Traditional theory is the usual basis for advocating free trade… the new trade theory suggests a more complex view. The potential gains from trade are even larger in a world of increasing returns, and thus, in a way, the case for free trade is all the stronger. On the other hand… new trade models show that it is possible (not certain) that such tools as export subsidies, temporary tariffs, and so on, may shift world specialization in a way favorable to the protecting nation. [Rethinking International Trade, p.3]

Thus, new trade theory provides an explanation for international trade wholly independent of comparative advantage. The Wikipedia entry summary ought to emphasize that Adam Smith’s contributions to international economics complement those of David Ricardo, rather than obsessing over the potential for free trade to be sub-optimal.

[New trade theory is not my specialty. Please note any errors or contrasting interpretations in the comments. Thanks.]

1 thought on “Wikipedia on New Trade Theory

  1. Angel


    You should really edit the wikipedia page, or at least post your comments on the discussion portion. This is going to be way more effective than posting it your (excelent) blog.


Comments are closed.