Competition, Spatial Location of Economic Activity and Financial Issues
Edited by Miroslav N. Jovanović
Chapter 8: Economic Integration and Industry Reallocations: Some Theory with Numbers
Kristian Behrens, Giordano Mion and Gianmarco I.P. Ottaviano* 1 INTRODUCTION ‘New trade theory’ (NTT) developed rapidly from the late 1970s with the aim of explaining a phenomenon that could not adequately be dealt with in the standard perfectly competitive setting: a large share of world trade takes place between countries with relatively similar technologies and factor endowments (Grubel and Lloyd, 1975). Such trade is not driven by differences between countries (as Ricardian and Heckscher–Ohlin theories would predict) but rather, it seems, by their similarity. Various theoretical explanations have been put forward and all of them rely to varying degrees on imperfectly competitive market structures. The first main strand of NTT builds on seminal works by Spence (1976) and Dixit and Stiglitz (1977). It gives rise to a class of models characterised by monopolistic competition, firm-level scale economies, and differentiated products (Krugman, 1979, 1980; Lawrence and Spiller, 1983). In these models, each firm is assumed to produce a single variety in one location only, because of scale economies, and trade occurs because consumers in each locale value variety and purchase a fully diversified consumption bundle. The second main strand of NTT builds on oligopolistic competition to explain how firms’ strategic interdependence may even generate trade in homogeneous goods between identical countries (Markusen, 1981; Brander, 1981; Brander and Krugman, 1983). Countries engage in intra-industry trade because, in the presence of trade costs, firms face a higher demand elasticity abroad and ‘dump’ their product into their export markets. One fundamental aspect distinguishing...
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