Introduction

My opening quotation, taken from a Festschrift for E. H. Chamberlin, is almost as close in time to us as it is to Chamberlin's pioneering Theory of Monopolistic Competition (1933). Yet it belongs to a bygone era. The theory of monopolistic competition has had a huge impact on modern trade theory, and no serious student of the subject can afford to neglect its many applications. Nor is any student likely to be allowed to neglect them. It is even rumoured that there are universities where the graduate trade curriculum covers nothing but monopolistic competition!

One development above all others is responsible for this shift: the publication in 1977 of Avinash Dixit and Joe Stiglitz's paper which introduced an elegant, parsimonious and tractable formalisation of the Chamberlinian model. Dixit and Stiglitz themselves (hereafter, ‘DS’) applied their innovation only to the classic issue in industrial organisation of whether monopolistically competitive industries would yield an optimal level of product diversity. But within a few years, a sizeable literature had already developed applying their approach to international trade. The DS approach provided a framework for modelling some distinctive features of contemporary international trade, especially trade in manufactured goods between developed countries, which traditional competitive models failed to capture. Above all, it allowed consideration of the implications of increasing returns to scale and product differentiation in general equilibrium.

Introduction

Discussion of industrial policy often refers to the importance of maintaining a ‘manufacturing base’, and suggests that there may be some level of activity below which contraction of manufacturing may be difficult to reverse. In simple economic models it is difficult to make sense of this line of reasoning. An adverse shock to industry in one country may cause exit or relocation of firms, but, if the shock is reversed, then those remaining earn a higher return than in the original equilibrium. Entry will occur, and the equilibrium will revert to the initial position.

There are several circumstances in which this need not be the case. One is when there are sunk costs associated with entry and exit (as in the ‘beachhead’ models of Baldwin and Krugman (1989) and Dixit (1989)). It may take a large shock to attract new entrants (importers, in the literature referred to), but once they have paid their fixed costs they are difficult to dislodge. Another circumstance is when there are positive ‘linkages’ between firms in the industry, these linkages causing profits to be an increasing, rather than decreasing, function of the number of firms in the location. With such linkages there is a high degree of interdependence between the location decisions of different firms, and this creates the possibility of agglomeration of activity. An adverse shock may then destroy one centre of activity and cause others to form, in which case, even if the shock is reversed, its effects may not be.

This volume has two interrelated purposes: to present a selection of important contemporary work in international trade theory at the beginning of the 1990s, and to honor Ronald Jones, one of the leading post-war figures in international economics. Although Jones is still as active and innovative a researcher as ever, his sixtieth birthday in 1991 provided an opportunity to assess and honor his contributions. With this in mind, a conference was organized at the University of Pennsylvania in November 1990, at which drafts of the papers in this volume were presented. The result, we hope, is a collection of papers which shows both the continuing influence of Jones's work and the increasing diversity and maturity of international trade theory.

Chapter 2, by Wilfred Ethier, attempts to assess Ronald Jones's contributions to international trade theory, while the remainder of the book contains representative work from the frontier of the field. The remainder of the present chapter introduces the subsequent contributions and attempts to place them in context. We have arranged them so that they form a natural progression, starting in Part II with the spatial and historical context of international trade and moving through positive and normative issues in static models of trade (in Parts III and IV respectively) to work on dynamics and growth in Part V.

In chapter 3 Paul Krugman continues his recent work on geography and trade. Whereas previously he developed a theory of industrial specialization based on agglomeration effects in production and a regional dispersion of demand, here he builds a theory of industrial specialization based on agglomeration and transportation “hubs.” The main idea is that transport costs differ across pairs of countries and regions.

Introduction

In a world with internationally mobile factors of production, commercial policy is intimately bound up with the questions of whether and to what extent factor flows should be restricted. This is true even in a small open economy which cannot influence the world prices at which goods and factors are traded: non-interference with all international transactions is the first-best policy but constraints on the implementation of this policy on one category of transactions will in general imply non-zero levels of optimal second-best regulation of the other category. In a large economy which can influence its terms of goods and factor trade, the interdependence between restrictions on trade and international factor flows is even more pronounced. The first-best policy package may now call for a subsidy to some transactions rather than a tax; and constraints on policy choice may have surprising implications for the optimal values of those instruments whose values may be altered.

All these issues have been extensively considered in the literature and especially in the writings of Ronald Jones. However, the general principles underlying optimal policy choice when both goods and factors are internationally mobile seem to defy convenient synthesis. A major reason for this must be the concentration in much of the literature on the Heckscher–Ohlin case. As is well known, this framework introduces an indeterminacy in the pattern of specialization and the results obtained appear to be very sensitive to detailed assumptions about the structure of production. Two exceptions to the general concentration on the Heckscher–Ohlin case may be mentioned.