Economies of scale, imperfect competition, trade among industrially developed countries and between the same industries The main contributor to the new explanation for the causes of trade is the "trade theory of economies of scale", which was developed in the late 1970s and is mainly attributed to the American economist Paul Krugman. This theory is based on economies of scale in the production of enterprises and imperfect competition in the world market to explain the trade between industrial countries and between the same industries, which grew rapidly after the war.
The development of the trade theory of economies of scale [(1)a] is based on two assumptions that differ from previous theories.
(1) There are economies of scale in firm production.
(2) Competition in international markets is imperfect. Specifically, under the conditions of "economies of scale" and "monopolistic competition", the long-run average cost of a firm decreases as output increases, and the firm faces a market demand curve in which the quantity demanded increases as prices fall.
Before the participation in international trade, the enterprise was facing only the domestic demand. Due to the limited domestic market demand, the enterprise cannot produce too much, thus the production cost and product price have to be kept at a high level. If enterprises participate in international trade, the market faced by the product will expand, and domestic demand plus foreign demand, enterprise production can increase. Since production is at the stage of economies of scale, the increase in production instead leads to a lower average cost of the product, thus increasing the competitiveness in the international market. Due to the diversity of industrial products, it is impossible for any country to include all the products of an industry, thus making international division of labor and trade inevitable. However, there is no fixed pattern as to which country concentrates on which product, either by natural (competition) or by agreed division of labor. But this "two-way trade" of industrial products between developed countries is based on economies of scale, rather than comparative advantages arising from differences in technology or resource allocation.
The theory of trade in economies of scale is a doctrine put forward by the famous economist Paul Krugman in his book "Market Structure and Foreign Trade" (1985), co-authored with Helpman Elhanan. The main idea is that increasing returns to scale provide the basis for international trade directly, when the production of a product occurs increasing returns to scale, with the expansion of production scale, the unit product cost decreases and cost advantage, which leads to specialization and export of this product. Economies of Scale (Economies of Scale) refers to the beginning of the expansion of enterprise production, enterprises due to the expansion of the scale of production and economic efficiency to improve.
Theoretical view
The long-term average cost of a firm decreases as production increases, and the firm faces a market demand curve in which the market demand increases as prices fall. Before participating in international trade, the enterprise was facing only the domestic demand. Due to the limited domestic market demand, the enterprise cannot produce too much, thus the production cost and product price have to be kept at a high level. If enterprises participate in international trade, the market faced by the product will expand, and domestic demand plus foreign demand, enterprise production can increase. Since production is at the stage of economies of scale, the increase in production instead lowers the average cost of the product, thus increasing competitiveness in the international market. The economies of scale effect allows countries with even non-differentiated resource endowments to be competitive and gain trade benefits with the advantage of large production scale.
Theoretical value
1) Import of economies of scale into international trade
1) The introduction of economy of scale factors into international trade, marking the transformation of traditional international trade theory to new trade theory
Traditional trade theory believes that the formation of international trade patterns depend on the basic economic characteristics of countries' resource endowments, technology levels and even demand preferences, and countries trade in order to give full play to the comparative interests formed on the basis of international differences in these basic characteristics. However, practice shows that trade among developed industrialized countries, especially trade in capital and technology-intensive products, is not based on differences in these basic economic characteristics. From the development of contemporary international trade, economies of scale, imperfect competition, and product differences have jumped to the forefront as the dominant factors in the development of contemporary international trade. Especially in intra-regional and intra-industry trade, it is indisputable that the role of economies of scale even exceeds the conventional comparative interests. The factor of economy of scale is abstracted as the determinant of international trade, which is of great value in theory, and it marks the transformation of traditional international trade theory to the new contemporary trade theory.
2)It illustrates the phenomenon of intra-industry trade prevalent in contemporary international trade
2)Explains the increasingly common phenomenon of intra-industry trade in contemporary international trade
Since the 1960s, about half or even more of international trade belongs to intra-industry trade or horizontal trade between developed countries, and the proportion of trade between developed and developing countries, inter-industry trade or vertical trade is declining, and this phenomenon can be well illustrated by the doctrine of trade with economies of scale.
Through international trade, manufacturers can face a broader market, the scale of production can be expanded, economies of scale to expand the scale of production after the manufacturer's production costs, product prices decline, the production of the same product and the scale of the same other domestic manufacturers will be eliminated. Therefore, within an industry sector where economies of scale exist, countries will each specialize in the development of certain differential products in that industry sector and then exchange them with each other (i.e., carry out intra-industry trade) to meet each other's diversification needs. The more similar the factor endowments between countries, the more likely they are to produce more of the same types of products, and the greater the volume of intra-industry trade between them. It is with the increasing phenomenon of intra-industry trade that the factor of economies of scale plays an increasingly important role in international trade.
3) Explains the fundamental reasons for the formation of contemporary international trade patterns
Traditional trade theory holds that the difference in relative factor endowments of two countries determines the difference in relative factor rewards of two countries, which in turn directly leads to the difference in relative commodity prices of two countries and trade, thus forming international trade, and the difference in relative factor endowments is the fundamental reason for the formation of trade. If there is no difference in relative factor endowments between the two countries, trade between the two countries will not occur. However, from the development of contemporary trade, trade between developed industrialized countries, especially trade in capital- and technology-intensive products, is not based on differences in factor endowments.
The doctrine of trade with economies of scale can explain another fundamental reason for the formation of international trade. As long as the factor of economies of scale exists, even two countries with exactly the same level of technology and resource conditions can equally specialize in division of labor and trade. Because of the existence of economies of scale, the difference in relative commodity prices between two countries cannot be derived directly from the difference in factor prices. Other things being equal, the difference in economies of scale between the two countries leads to differences in production costs, which also affect the prices of commodities. The mechanism by which differences in relative prices of commodities are determined is that differences in relative factor endowments determine differences in relative factor prices, and differences in relative factor prices and differences in economies of scale between countries (specifically, differences in output levels) jointly determine differences in relative prices of commodities. Thus, relative factor endowment differences are equivalent to relative factor price differences, but both are no longer equivalent to relative commodity price differences. It is the combination of differences in relative factor endowments and differences in economies of scale between countries that is the root cause of trade formation. It can also be argued that trade can occur even if there are no differences in factor endowments between two countries due to differences in economies of scale. This explains the conundrum of the existence of substantial trade between developed countries faced by traditional trade theory.
Once a country starts mass production in an industry with the goal of obtaining economies of scale, even if the scale advantage at the beginning of the start-up is weak, this advantage will snowball as production expands, eventually leading to specialized production and mutual trade. Much trade (especially between countries with similar resources and technologies) is the product of this specialized division of labor based on economies of scale, rather than the result of a specialized division of labor based on comparative interests. For example, the minimum economies of scale in aircraft manufacturing are large. It is estimated that Boeing in the United States must invest $3 billion before selling a 777 jet, selling 300 to level costs and revenues, such high fixed costs require huge economies of scale, while world demand or world market capacity can only support three such oligopolistic companies. It can be seen that the world market can only accommodate a handful of manufacturers that have reached an effective scale, and the resulting few manufacturers will be able to fully satisfy the needs of the world market, and in order to make these manufacturers serve the world market, international trade is inevitable.
4) Revised the view on factor price effects
4) Revision of the traditional international trade theory on the factor price effect
The Heckscher-Ohlin-Samuelson model (H-O-S theorem) states that under certain strict assumptions (including incomplete specialization and the absence of factor intensity reversal), international trade will equalize not only commodity prices but also factor prices. But from the economics of scale, if there are incremental returns to scale, even with the above strict assumptions, factor price equalization generally does not occur. This is because, under the conditions of economies of scale, the prices of production factors depend on both the size of the scale of production and several factors necessary for the H-O-S theorem to hold.
Thus, after satisfying certain strict conditions necessary for the H-O-S theorem to hold, trade will not equalize international differences in factor prices if countries do not produce on the same economic scale. This is especially true today, when economies of scale are expanding the basis for international specialization. As can be seen, the economics of scale doctrine draws a new conclusion in the analysis about factor price effects in international trade.
5) Reveals another important source of contemporary trade interests
Traditional international trade theory assumes that countries' trade interests are mainly nurtured by international differences in factor endowments. The economics of scale theory, on the other hand, suggests that incremental returns to scale are another important source of trade benefits. The existence of incremental returns to scale implies that even two countries with similar economic circumstances can profit from trade, and that this new type of trade benefit can exist independently of any benefit.
International experience also shows that industries in which a country lacks economies of scale or has only incremental returns to scale domestically can gain incremental gains in international scale when trade is conducted, with faster and better development of domestic manufacturing and certain services, and greater consumer welfare. As mentioned earlier, if two countries trade in automobiles, each country produces one million for domestic consumption, and if trade is carried out, the two markets form an integration with a total of two million vehicles, such a market is beneficial to both manufacturers and consumers. Some economists point out that for some small Western European countries, economies of scale are the main source of their profits from regional trade integration and are no less important than conventional comparative interests. Even for large countries, the factor of economies of scale is equally important. It has been argued that when the absolute size of the trading parties is not equal, large countries are able to obtain more trade benefits derived from incremental returns to scale.
