New Trade Theory and Me


NEW TRADE THEORY AND ME….I’ve never really paid attention to the breakthroughs in trade theory for which Paul Krugman is most famous as an economist, but Alex Tabarrok explains it this way:

Consider the simplest model [of New Trade Theory]….In this model there are two countries. In each country, consumers have a preference for variety but there is a tradeoff between variety and cost, consumers want variety but since there are economies of scale — a firm’s unit costs fall as it produces more — more variety means higher prices. Preferences for variety push in the direction of more variety, economies of scale push in the direction of less. So suppose that without trade country 1 produces varieties A,B,C and country two produces varieties X,Y,Z. In every other respect the countries are identical so there are no traditional comparative advantage reasons for trade.

Nevertheless, if trade is possible it is welfare enhancing. With trade the scale of production can increase which reduces costs and prices. Notice, however, that something interesting happens. The number of world varieties will decrease even as the number of varieties available to each consumer increases. That is, with trade production will concentrate in say A,B,X,Y so each consumer has increased choice even as world variety declines.

Increasing variety for individuals even as world variety declines is a fundamental fact of globalization.

The reason this caught my eye is that it turns out I’m a disciple of New Trade Theory and I didn’t even know it. Last year I wrote a piece for Mother Jones about media consolidation, and even though it made me feel like a bad liberal I said that I had never been much bothered by it. Why? Because even though the absolute number of news outlets might have declined thanks to globalization, I personally had access to many more news sources than I did 30 years ago. I called this a “paradox,” but apparently it’s actually now conventional trade theory. So, like Monsieur Jourdain, who had been speaking in prose for forty years without knowing it, it looks like I’ve been a Krugmanite for mumblety-mum years without realizing it. I guess I should get out more.

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