Page 136 - Global Political Economy_Understanding The International Economic Order

NEW ECONO MIC TH EORIE S
ing by doing, the importance ofR & D, cumulative processes, and
39
technological spillovers. STT challenges the theoretical foundations
ofthe economics profession’s previously unequivocal commitment to
free trade. In fact, the development of STT was stimulated by growing
dissatisfaction with conventional trade theory’s inability to explain
trade patterns and by concern about the increasing trade problems of
the United States, especially with Japan in the 1980s. The application
to trade theory ofnovel methods associated with important theoreti-
cal advances in the field ofindustrial organization provided the means
to develop an alternative to the H-O theory. Mathematical models of
imperfect competition and game theoretic models had been incorpo-
rated into trade theory in the early 1980s by James Brander and Bar-
bara Spencer (1983), theorists ofindustrial organization, and by the
work ofinternational trade theorists Avinash Dixit, Gene Grossman,
and Paul Krugman. 40
The theory ofstrategic trade provides a rationale for nations to use
protectionist measures, for subsidies to particular industries, and for
other forms of industrial policy to provide domestic firms with a deci-
sive advantage in both home and world markets. Favored and pro-
tected firms can take advantage ofincreasing returns, cumulative pro-
cesses, and the positive feedbacks associated with path dependence to
increase their competitiveness in global markets.
The significance ofstrategic trade theory can be appreciated
through consideration of the fundamental differences between perfect
and imperfect competition. In those sectors where there is perfect
competition (i.e., most ofthe economy), the behavior of one small
firm cannot change the rules ofthe game, as it is too small to make
a difference. This means that a small firm could not gain advantage
through strategic behavior. However, ifunit costs in certain industries
continue to fall as output increases, output will expand and the num-
ber offirms in the market will decrease. Economies of scale in an
industry mean that the market will support only one or just a few
large firms; that is, such an industry will become oligopolistic, as hap-
pened in the automobile and computer sectors. Thus, the market will

39
For an important collection ofarticles on imperfect competition and other aspects
ofthese matters, see Gene M. Grossman, ed., Imperfect Competition and International
Trade (Cambridge: MIT Press, 1992).
40
James A. Brander and Barbara J. Spencer, “International R&D Rivalry and Indus-
trial Strategy,” Review of Economic Studies 50, no. 163 (October 1983): 707–22. An
excellent discussion ofthese theoretical developments is in Paul R. Krugman, ed., Stra-
tegic Trade Policy and the New International Economics (Cambridge: MIT Press,
1986).
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