Paul Krugman’s article “Is free trade passé?” (1987) espouses the argument that free trade economic theory today is “more in doubt than at any time since the 1817 publication of Ricardo’s Principles of Political Economy” (p. 131, citing Ricardo, 1821). Ricardo was the first to put forth the theory that “[t]he value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that labour” (Ricardo, 1821, p. 1.1). It was his theory that specialization, even to the point of eliminating certain industries in a country, optimized a country’s trade advantage (p. 31.17). As Krugman points out, governments’ strategic trade policy intervention in free trade, through import restrictions or quotas, export subsidies, tariffs, and other trade interventions, have substantively moved international markets away from free trade. As the course module emphasizes, “The Ricardian model of trade…is of limited application to the complexities and realities of modern trade because it provides no insight into the sources of comparative advantage” (Colorado State University-Global Campus, 2014, p. 2). Krugman argues that although free trade may not be passé, the theory has become the reasonable rule of thumb rather than the optimum result, as it is not always the right policy.
Rethinking International Trade Theory
Krugman points out that from the early 1800s to the late 1970s, international economic theory believed that countries only traded to take advantage of their differences. This Heckscher-Ohlin-Samuelson factor endowment theory emphasized income distribution effects that were absent in the Ricardian model (Krugman P. R., 1987):
(Carbaugh, 2013, p. 68). Many international economists had already started to recognize that comparative advantage was not the “whole story, that increasing returns can be an independent
cause of international specialization and trade” (p. 132, citing literature surveys of Helpman, E., & Krugman, P., 1985, and Krugman, P., ed., 1986).
Increasing Returns and Imperfect Competition
New models of international trade, stressing increasing returns and imperfect competition, began to emerge in the 1970s:
These models immediately established the idea that countries specialize and trade, not only because of underlying differences, but also because increasing returns are an independent force leading to geographical concentration of production of each good. Indeed, at a logical level, increasing returns are as fundamental a cause of international trade as comparative advantage. (Krugman P. R., 1987, p. 133).
While this approach supported the existence of trade as opposed to no trade, it began to move away from free trade as the only answer in international economic theory.
Consequently, while government intervention does not always work, it has become more of the norm in current...