Theory of International Trade

With international trade, as with so many other human interactions, people tend first to ask how it 'should' work before getting interested in how it 'actually' works.

The systematic study of international trade emerged in the era of mercantilist economics--- approximately the 16th through 18th centuries in Europe, as crude set of hypothesis about how nations should conduct their trade. It was felt that each nation's self-interest was served by encouraging its exports and discouraging its imports. The mercantilist view began to yield, after the late 18th century, to a free-trade view, a view arguing that a nation's self-interest would both be served best by just letting people buy and sell as they saw fit.

The main hypothesis continued to be one about how trade should be conducted.

Economists studying trade soon found that the issue of what trade policy was best could not be resolved until there was a firmer theory of what made trade flow in the directions it did. On the surface level, the answer might seem obvious: people will trade if they find it privately comfortable, but profitable for whom, for everybody?

If not for everybody, then how do we know that the gains given to some people compensate the losses it brings to others? If one country gains from trade, does it drop its trading influence? These immediate questions illustrate that the answer to what should be cannot be divorced for the task of explaining what was in question though. We cannot know how a nation or an economic group within a nation gains or loses from trade until we know what makes some people find trading profitable, and what goods they will do business on, if given the chance.

To put the point in terms of the recurring concern felt in the United States about trade with Japan: knowing is impossible who would gain or lose, by cutting down the deal with the latter until we know why its is that Japan sells steel, autos, and other merchandise to the United States in exchange for aircraft, grain, and such.

Only when we know why trading proves advantageous and whose profits are tied to trade, can we discern who would be affected by policies restricting it. The basis for trade, so far as supply is concerned, is found in differences in comparative costs. A country may be more efficient than another, as measured by factor inputs per unit of output, in the production of every possible commodity; but so long as it is not equally more efficient in every product, a basis for trade exists.