New Trade Theory

New trade theory (NTT) refers to modern economic theory that explains international trade based on economies of scale, network effects, and first-mover advantage. It helps decipher the main reason behind globalization and intensive trading between similar economies. In addition, it paves the way for the government's role in the industrialization of a country.

It opposes the old theory of trade promoting constant returns of scale, fixed technology, and the presence of perfect competition. Instead, it says that a first-mover to establish a company in a trade gets the advantage of being dominant and monopolistic. As a result, a poorer nation may continue struggling in specific industries due to a lack of economies of scale in their companies.

• New trade theory is an economic model given by Paul Krugman to explain international trade and globalization using the economies of scale, network effects, and first-mover advantage.
• It explained the reason for extensive trade between similar countries, developing economies' low industrialization, and giant multinational companies' monopolistic nature.
• The main advantage of this theory lies in the globalization of trade, and the disadvantage lies in the development of monopolistic tendencies of giant corporations globally.
• The main differences between new and old trade theories have been the returns of scale, fixed technology, and perfect competition, which gets supported by the old theory and rejected by the new theory.

The new trade theory of international trade refers to an accumulation of various economic models that focuses mainly on returns of scale, first-mover advantage, and network effects on international trade and globalization. For example, the new trade theory by Paul Krugman has got based on his ideas that analyze trade patterns based on the location of trade activity, for which he received the Nobel Prize in economics in 2008.

Network effects and economies of scale have the potential to be so potent that they could even defeat the more well-known concept of comparative advantage. As a result, some industries might not notice noticeable changes in opportunity costs between the two countries at a particular time. A country, however, may profit from its specialization if it concentrates on a particular industry due to economies of scale and other network advantages.

The new trade theory is a contributing component in explaining the expansion of globalization. It implies that less developed, underdeveloped nations may find it difficult to establish some industries as they enjoy economies of scale like the industrialized world. It is mainly a result of the scale efficiencies existing among mature enterprises and not of any inherent comparative advantage.

Thus, the main factors of new trade theory are the following:

#1 Economies Of Scale

Under this aspect, goods per unit cost gets reduced when they get produced in huge volumes. It gets aided by IT technology, automobiles, and large-scale production machines. Domestic firms do not use it because of low demand, but when the demand for goods from foreign countries gets highly high, economies of scale reduce the cost of production per unit. Every country has a specific industry with such capability and can lower the cost of production by increasing the variety of goods. 

#2 First-Mover Advantage

It attributes to the fact that the earlier a firm gets into producing certain goods, the more economical and strategic benefit it gets over the late entrants. It happens because early entrants' low-cost structures develop into giant firms like NOKIA.

#3 Network Effects

It states that their value increases with increased users of products. An example includes the internet.

Economist Paul Krugman based this theory on certain assumptions. The assumptions of the new trade theory are the following:

• With specializations of firms, they increase their economies of scale.
• Learning by doing has excellent effects on productivity.
• First-mover advantage allows new competitors.
• The government's role in industrialization becomes significant.
• Economies of scale become a key to stopping new entrants and turning firms into monopolies.
• Product differentiation and product specialization become essential in the growth of a firm.

Let us look at new trade theory examples to understand the topic better.

Example # 1

The first example would deal with the giant mobile phone manufacturer NOKIA. It started its mobile manufacturing in Finland. It had its base in the electrical and electronic equipment manufacturing company. NOKIA brand became the first-ever company to foray into manufacturing mobile and related parts in the 1990s. Due to its strong financials, it implemented economies of scale in mobile phone manufacturing. Finland's government also supported its mobile manufacturing venture.

Thus, for almost 15 years, it had a monopoly in mobile phone manufacturing. However, with time, people started using NOKIA to a great extent, making it a valuable mobile company. Hence, government support, economies of scale, network effects, and first-mover made it the undisputed leader of mobile phones for over a decade.

Example # 2 

TESLA is a popular brand in the electric vehicle segment. TESLA had been the early entrant or the first mover into manufacturing electric vehicles (EVs) for the public on a large scale. With time, it transformed from an American EV to a global EV manufacturer. TESLA gained a monopoly in the market by doing the following:

• Being the first mover into EV;
• Getting subsidies from the American government;
• Having economies of scale due to huge funding available; and
• Rising value of its cars, creating network effects, led to monopolistic tendencies in the EV manufacturing sector. 

The new trade and old trade theory has been the pillar of trade theories globally. However, one can observe specific differences between the two, as listed in the table below:

This article has been a guide to what is New Trade Theory by Paul Krugman. We explain its assumptions, examples, advantages & disadvantages and comparison with old trade theory. You can learn more about it from the following articles –

• Cockroach Theory
• Global Trade
• New Economy