Chapter 8 International trade: magic and black magic
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Chapter 8 focuses on winners and losers from balanced international trade. Traditional thinking is called static analysis, because it assumes that technology, the labor supply, the capital stock, and the quality of all products are fixed. In addition, it assumes that all firms are perfectly efficient. Dynamic analysis allows all the above to change, especially in response to increased foreign competition. International trade is an example of specialization, whereby output increases tremendously when people (or countries) specialize in what they do best. However, specialization creates much interdependence, i.e., we all depend on others to buy what we produce and to produce what we buy. This can cause extreme hardships when a person or a town is highly specialized and suddenly no one wants what they produce. An important idea in static analysis is the Stolper-Samuelson theorem, which concludes that international trade will increase the relative incomes of the resources that are used intensively to produce exports. Conversely, trade decreases the relative incomes of the resources that are used intensively to produce goods that are imported. It is usually assumed that the losers are worse off in an absolute sense, but this need not be true. They might actually be better off from trade, but feel left behind because others have gained much more. The dynamic gains from trade are primarily tied up with the effect of foreign competition on domestic firms. There is evidence at the microeconomic level (individual firms and industries) that this induces home firms to become more efficient, to accept a lower profit markup, and to innovate more. In addition, overall average productivity in a country increases when trade causes inefficient home firms to contract or shut down, while efficient firms expand. It is possible that the dynamic gains from trade dominate any static losses via the Stolper-Samuelson theorem, but we do not know.

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