2.2 Modern Trade Theories

International trade theories evolve to explain complex global commerce patterns. The product life-cycle theory shows how products and production locations shift over time, impacting trade flows and investment decisions between countries at different development stages.

New trade theory introduces economies of scale, product differentiation, and imperfect competition to explain intra-industry trade. These concepts reshape our understanding of specialization, market size effects, and strategic trade policies in the global economy.

Product Life-Cycle and New Trade Theories

Product life-cycle theory in trade

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• Product life-cycle theory stages encompass product evolution from inception to obsolescence:
  • Introduction: new product launched, high costs, limited production
  • Growth: increasing demand, expanded production, export opportunities
  • Maturity: standardized product, price competition, production offshoring
  • Decline: obsolescence, reduced demand, potential discontinuation
• International trade implications reveal dynamic shifts:
  • Production locations move from high-cost to low-cost countries
  • Export patterns evolve from innovator countries to developing nations
• Investment implications guide strategic decisions:
  • Foreign direct investment flows to low-cost production sites
  • Technology transfer occurs as production methods standardize
• Relevance to countries highlights changing competitive advantages:
  • Developed countries initially benefit from innovation leadership
  • Developing countries gain as production shifts for cost efficiency (textile manufacturing)

New trade theory and economies of scale

• Key concepts of new trade theory challenge traditional models:
  • Economies of scale enable cost reduction with increased production
  • Product differentiation creates unique varieties (automobiles)
  • Imperfect competition exists in markets with few large firms
• International trade implications reshape global commerce:
  • Intra-industry trade flourishes between similar economies
  • Countries specialize in product varieties rather than industries
• Market size influences trade patterns:
  • Home market effect favors large domestic markets for exports
  • Larger markets attract more firms and foster industry clusters
• Policy implications suggest strategic interventions:
  • Strategic trade policy supports key industries for national advantage
  • Targeted protectionism may benefit infant industries temporarily

Firm-Specific Advantages and Intra-Industry Trade

Firm-specific advantages in eclectic paradigm

• Eclectic paradigm (OLI framework) explains multinational enterprise activities:
  • Ownership advantages: unique assets or capabilities (patents)
  • Location advantages: benefits of operating in specific countries
  • Internalization advantages: benefits of keeping operations in-house
• Firm-specific advantages create competitive edge:
  • Technological capabilities drive innovation and efficiency
  • Brand reputation builds customer loyalty and premium pricing
  • Management skills optimize resource allocation and strategy
• International business strategies leverage these advantages:
  • Mode of entry decisions balance risk and control (joint ventures)
  • Global value chain positioning optimizes firm activities globally
• Competitive advantage links to broader strategic theories:
  • Resource-based view focuses on unique, valuable firm resources
  • Dynamic capabilities emphasize adapting to changing environments

Importance of intra-industry trade

• Intra-industry trade involves exchanging similar products within industries (automobiles)
• Drivers of intra-industry trade shape modern commerce:
  • Consumer preferences for variety increase product options
  • Economies of scale enable efficient production of different varieties
  • Product differentiation creates unique features within product categories
• Grubel-Lloyd index measures intra-industry trade intensity
• Economic implications highlight benefits:
  • Increased competition spurs innovation and efficiency
  • Efficiency gains result from specialization in product varieties
  • Consumer welfare improves with broader product choices
• Trade patterns reflect economic development:
  • Predominant between developed countries with similar economies
  • Growing in emerging markets as economies diversify and integrate