By Pascal Lamy, Director-General, World Trade Organisation
In this talk given in Paris last month, Pascal Lamy examines six fallacies concerning international trade.
The first fallacy is: Comparative advantage does not work anymore.
Lamy begins by paying tribute to Paul Krugman’s contribution to international trade theory which was developed at the end of the 1970s and is now known as “new trade theory”. In this theory Krugman looked at the presence of increasing returns to scale which had been ignored in traditional theory, and also the variety of products which trade offers. There is a conflict here between economies of scale which will reduce costs and a desire for variety by consumers which will push costs up. Increasing product variety reduces the opportunity for economies of scale by limiting the potential sales which could be achieved by only having a single product. (There is an interesting article by Broda and Weinstein published by the New York Fed in April 2005 which tries to assign a value to growth in variety in US imports. Read the article here.)
Lamy points out that “while the new trade theory reduces the role played by comparative advantage, it identifies new sources of benefits from trade that were not emphasized or recognized by classical economists. More trade benefits all countries because specialization in production reduces average cost and consumers gain access to a wider variety of products. In contrast, traditional theories of trade assume the variety of goods remains constant even after trade-opening.”
Lamy also looks at the doubts surrounding the proposition that specialization based on comparative advantage results in higher total output, with all countries benefiting from the increased production. He cites a recent paper published by Paul Samuelson from 2004 which showed theoretically how technical progress in a developing country like China had the potential to reduce the gains from trade to a developed country like the United States.
However, he also points out that subsequent research by Bhagwati, Panagariya and Srinivasan contradicted this view. Lamy concludes by saying that “what Samuleson has showed is not that trade along lines of comparative advantage no longer produces gains for countries. Instead, what he has shown is that sometimes, a productivity gain abroad can benefit both trading countries; but at other times, a productivity gain in one country only benefits that country, while permanently reducing the gains from trade that are possible between the two countries.”
But, the important conclusion Lamy makes from this is that “the reduction in benefit does not come from too much trade, but from diminishing trade” and that “the principal of comparative advantage, and more generally, the principle that trade is mutually beneficial, remains valid in the 21st century.”
In his talk Lamy goes on to deal with five other supposed fallacies. These are: It is unhealthy for trade to grow faster and faster compared to output; Current account imbalances are a trade problem and ought to be addressed by trade policies; Trade destroys jobs; Trade leads to a race to the bottom in social standards; and, opening up trade equals deregulation.
Read the whole of this interesting talk here
