Economic Rationale of Trade
The potential 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 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. The difficulties in producing a vast array of goods is linked with differences in levels of development.
With trade, competition increases and a rationalization of production often takes place as comparative advantages are being exploited. The outcome of trade liberalization usually involves a specialization of production and the trade of surpluses between partners. Greater economies of scale achieved through specialization result in lower prices and 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 experienced a high level of specialization and geographical clustering.