What is "New" New Trade Theory?

Fellow, RIETI


The realm of international trade theory has entered a new stage in the 21st century, with active use of firm-level data and a next-generation trade theory that could be termed "New" New Trade Theory (note) bursting into the mainstream. This paper will briefly introduce the "New" New Trade Theory, touching on research conducted by the Research Institute of Economy, Trade and Industry (RIETI).

Background to "New" New Trade Theory

Exports account for a large proportion of gross domestic production in Japan and other countries around the world, but it has come to light in recent years that only a small minority of firms actually engages in export. According to Bernard et al. (2007), a mere 4% of the 5.5 million firms operating in the U.S. in 2000 were exporting firms, and the top 10% of these exporting firms accounted for 96% of the U.S.' total exports by value. Exporters also have a higher productivity than non-exporters.

However, neither old nor new trade theories were able to explain the fact that exporting firms comprise only a very few highly productive companies. A scenario in which Company A in a given industry exports while Company B in the same industry does not a scenario hypothesized by traditional trade theories or New Trade Theory. Both the trade theories of Ricardo and Heckscher-Ohlin and New Trade Theory (at least within an industry) presume representative firms equal in productivity (i.e., firms qualitatively the same).

Emergence of "New" New Trade Theory

In light of the fact that firms of varying levels of productivity do exist, however, Melitz (2003) constructed a model in which only a few highly productive firms are engaged in export. The underlying idea in Melitz (2003) is that only highly productive firms are able to make sufficient profits to cover the large fixed costs required for export operations. Helpman et al. (2004) expanded the Melitz (2003) model into one in which the productivity of exporting firms is lower than that of firms engaged in local production overseas (FDI). The theory in Helpman et al. (2004) is also based on the idea that only productive firms can cover the enormous fixed costs (local factory construction, etc.) entailed in local production overseas. These "Melitz-type models" constituted the theoretical foundations for empirical research based in particular on firm-level data.

Table 1 offers a summary of the points discussed above.

Table 1 : Trade Theory Comparison
Major trade theoryMain targetAssumption regarding firms
(within each industry)
"Small minority of firms with higher productivity engaging in export"
19th century -
Traditional trade theory
Interindustry tradeHomogeneous productivity across firmsUnexplainable
1980 -
New trade theory
Intra-industry trade
2000 -
"New" new trade theory
Firm-level exports / FDIHeterogeneous productivity across firmsExplainable

Policy Implications of "New" New Trade Theory

Melitz (2003) indicated the new source of trade gains. When lowered trade barriers stimulate competition on a global scale, low-productivity firms that had been protected theretofore by the trade barriers are forced to withdraw from the market, replaced by the increased production volume of high-productivity firms. As a consequence, the average productivity of a country on the whole rises. This rise in average productivity means a rise in people's real income; people become wealthier through the natural selection of firms on a global scale. It can be understood from Melitz (2003) that heavy protection given to a domestic industry can inhibit the functioning of natural selection and block a rise in productivity.

In Japan, there are particular concerns about heavy government protection possibly hampering a rise in agricultural productivity. In other words, agriculture might not be able to enjoy the benefits of rising productivity achieved through competition on a global scale and the natural selection pointed out in Melitz (2003). Boosting Japan's food self-sufficiency logically necessitates raising its agricultural productivity. It is worth nothing that hindering a rise in productivity through subsidies and trade restrictions could weaken the country's food self-sufficiency.

RIETI's Study Group on International Trade and Companies

Carrying out empirical research on "New" New Trade Theory often requires firm-level data. RIETI has long used firm-level data available from the Ministry of Economy, Trade and Industry and offers research forums tailored to "New" New Trade Theory. In particular, its Study Group on International Trade and Companies has published numerous papers that attempt to verify and develop "New" New Trade Theory. An overview of these efforts has been compiled by Ryuhei Wakasugi, Professor at Kyoto University and Research Counselor at RIETI, in "A True Picture of Internationalizing Japanese Companies" (Research Digest). Research on "New" New Trade Theory conducted by this Study Group utilizing data on individual Japanese firms has also been presented at international research meetings of the Centre for Economic Policy Research (CEPR), joint RIETI-CEPR international workshops, and meetings of the American Economic Association, etc.

Future Outlook

RIETI's Study Group on International Trade and Companies is currently engaged in research on topics more directly connected with policy, such as the relationship between the internationalization of firms and employment within Japan. The findings of these research efforts are expected to provide useful information in the area of policy.

June 8, 2010
  • The appellation "'New' New Trade Theory" is not one in general use - "the firm heterogeneity model" has greater currency - but the more readily comprehensible term "'New' New Trade Theory" is used in this paper.
  • Bernard, Andrew B., J. Bradford Jensen, Stephen J. Redding and Peter K. Schott (2007). "Firms in International Trade." Journal of Economic Perspectives, Vol. 21, No.3, pp. 105-130.
  • Helpman, Elhanan, Marc J. Melitz and Stephen Ross Yeaple (2004). "Export Versus FDI with Heterogeneous Firms." American Economic Review, Vol.94, No.1, pp.300-316.
  • Melitz, Marc J. (2003). "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity." Econometrica, Vol.71, No.6, pp. 1695-1725.

June 8, 2010

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