The journal article “Is Free Trade Passé?” (Krugman, 1987) makes the case that the traditional free trade approach to international economics is more in doubt today than at any time since publication of Ricardo’s On the Principles of Political Economy and Taxation (1821) that originally espoused the philosophy of free trade. Krugman (1987) argues that comparative advantage based on constant returns and perfect competition models have given way of late to import restrictions, exports subsidies, and other government intrusions on international trade. This paper examines the positions that challenge the assumptions of constant returns and perfect competition, and the implications for classical trade optimism that free trade is always a good thing, and for trade policy and practice.
Increasing Returns and Imperfect Competition
Krugman (1979) and others like him, including Lancaster (Lancaster, 1980), and Dixit and Norman (1980), have challenged their own teachings in international trade theory based on perfect competition and constant returns: while the traditional approach was based on a trade balance, the new approach based on imperfect competition and increasing returns actually supports a trade benefit or gain by one side over the other (Krugman, Is free trade passé?, 1987). In his earlier work, “Increasing retums, monopolistic competition, and international trade,” Krugman (1979) argues that monopolistic competition results in increasing returns to scale. Drawing on Chamberlin’s model of monopolistic competition (1962), Krugman (1979) concludes that trade “need not be a result of international differences in technology or factor endowments…trade may simply be a way of extending the market and allowing exploitation of scale economies” (p. 479). Dixit and Norman (1980) address the issue that gains in monopolistic trade are potential rather than necessarily realized in the context of scale economies and imperfect competition: “There are potential [emphasis in original] gains from trade in the presence of economies of scale, but with imperfect markets there is no assurance that these gains will be reaped in practice” (p. 294).
Others have also challenged the free trade assumptions. Wan (2000) addresses the challenge to constant returns to scale in the classical free trade assumptions with variable returns to scale. Opposing the perfect competition model, Wan develops a model of economies and technology that allows for “positive, constant or negative economies of scale (2000, p. 64). Sorger (1996) also addresses imperfect competition, suggesting that the world economy is made up of markets with perfect competition, but also markets with imperfect competition as in monopsony or monopoly. Similarly, Zegeye and Rosenblum (2000) challenge the assumptions of constant returns to scale and perfect competition in measuring productivity, suggesting that economies of scale and intermediate price markups have more impact in the structure of world...