Economic Rationale of Trade

The economic benefits of international or inter-regional trade are numerous and well known since the seminal work of Adam Smith (1776) and David Ricardo (1817). Without trade, each country must produce a set of basic goods to satisfy the requirements of the national economy. In the above example, four countries are each producing four different goods. National markets tend to be small, impairing the potential economies of scale, which results in higher prices. Product diversity also tends to be limited because of the market size and standards (such as safety or component size) may even be different.

With trade, competition increases and a rationalization of production often takes place as comparative advantages are being exploited. In the above example, the outcome of trade liberalization involves a specialization of production of one good in each country and the trade of other goods between them. Greater economies of scale that are achieved through specialization result in lower prices that results in higher profits. A situation of interdependency is thus created as each trading partner depends on the other for an array of goods. An absolute specialization of the production rarely takes place in reality but some sectors, such as toys and apparels have seen a behavior which is consistent with such a trend.