I started this series on international trade with the story of the castaways Eva and Ricardo. You may remember (if not, or you haven't read it go to that blog post here) that Eva was better at fishing and baking than was Ricardo. Economists would say that she had an absolute advantage over Ricardo in both endeavors. But we saw that whenever Ricardo gave up time to catch one fish he was able to use that time to bake two loaves of bread, while Eva could bake one loaf of bread when she gave up the time to catch one additional fish. Economists would say that Ricardo had a comparative advantage in baking bread. Recognizing this, Ricardo specialized in baking and Eva in fishing, they traded with each other fish for bread and both were better off for it.
But surely this can't be the only reason why international trade takes place because we often see that countries trade goods within the same industry with each other, and not just those goods for which they may have a comparative advantage. For instance, look at automobiles. The United States imports, and also exports cars and trucks, and even exports vehicles to the some of the same countries from which it imports them. For example, the United States imports a lot of vehicles from Germany, but Germany is also the third largest market for United States autos. Yes, you can see Jeeps and Ford Mustangs parked on the streets and in parking lots in Germany. Of course, there are not as many United States auto company cars in Germany as there are German cars on American roads. But the point is that comparative advantage can't explain this kind of trade in similar goods between countries.
Nor can the other explanation for international trade we offered in the "global trade is good, why the blue collar blues" blog post explain trade in similar products between countries. Remember the argument was that as markets get larger businesses per unit costs of production can fall. Global trade makes markets larger and per unit costs fall leading to a decline in prices. Economists call this phenomena economies of scale. This is a gain from trade in addition to the gain from comparative advantage. But it doesn't really explain trade in similar products between countries, not directly at least.
But here's the rub. Economies of scale provide a push for corporations to become very large in order to take advantage of the lower costs of production. And large corporations accumulate market power within their home country market, the power to set prices with little restraint from competitors. They can use this power to gain the greatest profit for the company and its stock holders at the expense of the domestic buyers of the products.
The larger the company relative to the market, the more market power. This is a breakdown in competition and one remedy for it is an increase in the size of the market relative to the company. And that is exactly what happens when tariffs come down and international trade expands. Previously protected domestic companies now face more competition. They have less market power and less ability to manipulate prices at the expense of the buyers of the products. They need to match the international competition, or they will lose sales in their home market and not be able to capture sales in foreign markets. So they compete. They lower prices, increase product quality, try to make their products distinctive and seek their own niche in the global market place; and we see foreign products competing with domestic products in our home market. This increased competition is an additional gain from global trade.
To sum up the gains from global trade to all countries engaged in it, we have gains from (1) comparative advantage (and some international trade can be explained by comparative advantage (think coffee and petroleum, for example, or even fish from Iceland and Greenland) (2) larger markets leading to large scale production leading to lower costs of production, and (3) the increased competition that results in less market power of very large corporations and a larger variety of products offered to consumers.
Now, just by looking around and seeing all the foreign products in our market places should be an indication that the gains from trade are most likely very large. Do we have any good hard numbers to support that notion, and do we have any numbers to indicate just how large the gains really are?
And don't forget that in the "blue collar blues" blog post we recognized that while trade may be good in raising real incomes, some of us, especially workers in industries that compete with imports can be hurt. They can lose their job, become unemployed and be forced to accept far lower wages than they were previously earning.
In a subsequent blog post we will try to uncover some numbers that document how large the gains from global trade for the United States may be, and the extent that American wages may have been hurt by global trade.