Traditional Model: Theory

Mercantilism viewed trade as a zero-sum game in which a trade surplus of one country is offset by a trade dejicit of another country, In contrast, Adam Smith viewed trade as a positive-sum game in which all trading partners can benefit if countries specialize in the production of goods in which they have absolute advuntages. Ricardo extended absolute advantage theory to comparative advantage theory. According to Ricardo, even if a country does not have an absolute advantage in any good, this country and other countries would still benqfit from international trade. However, Ricardo did not satisfactorily explain why comparative advantages are different between countries. Heckscher and Ohlin explained that comparative advantage arises from differences in factor endowments. This theory appears to be virtually self-evident. However, Leontief found a paradoxical result. Some economists have developed ulternative theories because the Heckscher-Ohlin model did not work well in the real world. These theories include product cycle, country similarity, and trade based on economies of scale. All ofthe theories discussed in this chapter are useful in understanding many of today's industrial and trade policies. They are also helpful in understanding and evaluating the debate over competitiveness in Chapter 2.