Traditional trade theory is based on the framework of perfectly competitive market structure, where perfectly competitive market is the most efficient market and any intervention will only bring about efficiency loss. Therefore traditional trade theory emphasizes the importance of free trade.
The new trade theory, on the other hand, argues that the effectiveness of the market in reality is then questionable. Therefore, two arguments for trade intervention - the profit-shifting theory and the external economy theory - are put forward, on the basis of which a strategic trade policy theory is proposed.
The external economy theory argues that some high-tech industries with technological innovation can bring benefits to other sectors through knowledge spillovers, i.e., they generate beneficial external economies. The government should then support these industries, thus promoting the economic development of the whole society.
Based on the above two theories, the new trade theory puts forward the theory of strategic trade policy, that is, strategic industries that have an important role in promoting the national economy should be supported and subsidized. For example, Japan's seizure of control of the semiconductor industry from the United States in the mid-1980s was the result of the use of strategic policy. Strategic policies had a major influence on the trade policy of the United States in the 1990s and, at the same time, influenced the content of the European Union treaties.
There are two basic elements of strategic trade policy: profit-shifting theory and external economic theory.
Profit shifting theory is the main element of strategic trade policy, which refers to the existence of rents or excess monopoly profits in an oligopolistic competitive international market due to the price of a product above its marginal cost. Through trade interventions on exports or imports, a government can influence the behavior of domestic firms and their foreign competitors and change the pattern of international competition, thus extracting rents from foreign oligopolists or transferring profits to domestic firms for the purpose of increasing domestic net welfare and promoting the development of domestic firms and industries. The profit-shifting theory includes strategic export policies, import policies, and policies that promote exports with import protection. The profit-shifting theory argues that international competition in many markets is oligopolistic in nature due to the constraints of economies of scale at the firm level, and in some markets only one profitable firm is even allowed to enter, and if two firms enter at the same time they both have to lose money, a key feature of such oligopolistic industries is that the price of the product is higher than the marginal cost of product production, and by supporting such industries through government policies A key feature of these oligopolistic industries is that the price of the product is higher than the marginal cost of production, and the country receives a larger share of the "rent" through government policies to support these industries, which are limited in application because of the strict restrictions on the market structure and the nature of the behavior of manufacturers (including the government). Based on internal economies of scale, it is proposed that government intervention in foreign trade can deprive foreign manufacturers of their export profits. Here, government policy plays a "strategic" role in achieving the transfer of excess profits from foreign to domestic markets.
External economies include technical external economies and revenue external economies. Technological externalities refer to the acquisition of technology and knowledge by firms through technology spillovers from other firms in the same or related industries; revenue externalities refer to the market scale effects (including access to convenient and low-cost raw materials, intermediate goods, skilled workers, specialized services, etc.) gained from the agglomeration of firms in the same or related industries, both of which enable firms to increase productivity and reduce costs. The technology externalities and policy interventions are,in R&D input-intensive
industries (generally technology-intensive industries, especially high-technology industries), technology spillovers make it impossible for manufacturers to fully reap the benefits of RD investment, and the resulting lack of private investment prevents these industries from developing to a socially optimal state, thus requiring trade policy support. If the government adopts a policy of protection or subsidy, it will be able to promote the development of these industries and increase national welfare; while foreign governments' support and protection of these sectors may cause the country to lose or reduce these beneficial technology spillovers, so the country must take counter or counter action. Because these technology-intensive industries, including high-technology industries, are strategic to national interests, active government intervention policies are strategic to the international competition of domestic industries. The revenue external economy and policy intervention is that the size of a country's industry reflects the size of the market scale effect (equivalent to industrial agglomeration effect) obtained by manufacturers, and manufacturers in countries with large industry size will have higher revenue external economy, thus manufacturers in countries with small industry size are at a disadvantage in international competition. If a country is in the early stage of development and small-scale industries belong to strategic industries, the government can support the expansion of production of manufacturers in these industries through protective and supportive trade policies to increase the market scale effect and the revenue external economy of manufacturers, thus promoting these industries to enhance international competitiveness more quickly.
