Economic Rationale of Trade

Economic Rationale of Trade

The difficulties in producing a vast array of goods are linked with differences in levels of development. The potential economic benefits of international or inter-regional trade are numerous and well known since the seminal work of Adam Smith (1776) and David Ricardo (1817). Without trade, each country must produce a set of essential goods to satisfy the requirements of the national economy. In the above example, four countries having similar endowments (e.g. population, size, resources) are each producing four different goods. National markets tend to be small, impairing potential economies of scale, which results in higher prices for the end consumer. Product diversity also tends to be limited because of the market size and standards (such as safety or component size) may even be different.

With trade, competition increases, and rationalization of production often takes place as comparative advantages are being exploited. The outcome of trade liberalization usually involves a specialization of production and the trade of surpluses between partners. Greater economies of scale achieved through specialization result in lower prices and higher profits. Therefore, even if the output remains the same, each country is better off because the same quantity of goods is available at a lower price. This increases the purchasing power and could allow the same level of income to consume a larger quantity of goods. A situation of interdependency is thus created as each trading partner depends on the other for an array of goods.

Although economic theory underlines that all actors involved in international trade benefit, they do not necessarily benefit to the same extent. The main reason is that specialization results in a focus on different economic sectors that may now have the same added value. Different added values lead to different economic outcomes and opportunities. As a result, trade liberalization can be associated with a growth in inequalities even if all actors see a net rise in income. Still, an absolute specialization of the production rarely takes place and economies commonly keep a wide range of economic activities even if they are open to trade. Some sectors, such as toys and apparel, have experienced a high level of specialization and geographical clustering.