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24 June 2013
Trade Liberalization vs. Protectionism
Trade / Trade Theories

The current paradigm classical neo-liberal economics proposes free trade and allows state intervention only to “liberalize markets and lower distortions” (Wade 1990, 23).  Consequently, most trade models oppose protectionism by nature. The simplest and probably most influential trade model is Ricardo’s comparative advantage.  “[C]ountries will export goods that their labor produces relatively efficiently and import goods that their labor produces relatively inefficiently” (Krugman Obstfeld 2003, 34).  Another important trade theory is Samuelson and Jones’ specific factors model that adds information concerning income distribution.  “[F]actors specific to export sectors in each country gain from trade, while factors specific to import-competing sectors lose. Mobile factors that can work in either sector may either gain or lose” (2003, 60).  Additionally, the Heckscher-Ohlin model clarifies resources and trade: countries will export goods which are intensive in the factors with which they are supplied abundantly. The Krugman-Obstfeld standard trade model

derives a world relative supply curve from production possibilities and a world relative demand curve from preferences.  The price of exports relative to imports, a country’s terms of trade, is determined by the intersection of the world relative supply and demand curves.  Other things equal, a rise in a country’s terms of trade increases its welfare.  Conversely, a decline in a country’s terms of trade will leave the country worse off” (Krugman, Obstfeld, 2003, 113).

Another pro-trade argument is economies of scale, meaning that the more is produced, the lower the unit price.  This can create imperfect competition domestically but will lead to monopolistic competition internationally and consumers will be able to purchase a higher variety of goods at lower prices.  External economies are economies of scale at the level of the industry instead of the company (2003, 155).

Yet another free trade proposition is called counter-tariffs argument, which maintains that tariffs raise the domestic price by less than the tariff rate.  Whereas domestic producers of a good gain because the tariff raises the prices, consumers lose.  The government gains because it gets the tariff payment.  Adding all those gains together, in comparison to free trade, there is an efficiency or deadweight loss (2003, 206). 

For an excellent summary of trade models, see Krugman, P.R.;  Obstfeld, M.  2003.  International Economics: Theory and Policy: Sixth Edition. Boston, San Franciso, New York:  Addison Wesley.

Wade, R.  1990.  Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization.  Princeton: Princeton University Press. 23(13)

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