A paper (pdf) from Professor Elhanan Helpman surveys an exciting recent strand of international trade theory literature. The new approach models choices by individual firms in monopolistically competitive markets and considers the relationships amongst firm productivity, trade costs, and average productivity levels. A particularly striking aspect is the degree to which traditional Ricardian features emerge from models emphasizing heterogeneity within and across industries.
New developments in the world economy have called for new developments in the theory of international trade and foreign directed investment, designed to better understand the shifts in trade and investment patterns and the reorganization of production across national boarders… [T]heoretical refinements have focused on the individual firm, studying its choices in response to its own characteristics, the nature of the industry in which it operates, and the opportunities afforded by foreign trade and investment. Important among these choices are modes of serving foreign markets
and sourcing strategies.
But the theory went beyond the individual firm, studying the implications of firm behavior for the structure of an industry, and, by implication, structural differences across industries. These variations deliver new explanations for trade structure and patterns of FDI, both within and across industries. For example, they identify new sources of comparative advantage, such as the degree of heterogeneity within industries and the quality of contracting institutions.
Heterogeneity plays a key role in this literature in two ways. First, there is heterogeneity as a result of productivity differences across firms within industries, because some firms happen to be luckier than others. Second, there is heterogeneity in organizational form. The two are related, however, because differences in productivity induce different choices for the organization of production and distribution. In this theory, trade and FDI patterns are jointly determined with organizational structures, such as sourcing and integration strategies.