Trade has always been the basis for forming economic relations. Key trade economic theory (Ricardian model of absolute and comparative advantage) explains that trade offers welfare gains and that countries involved in international trade can gain substantially from cooperation. According to this classical trade theory, countries can build their wealth through trade in the long term. Wealth could be acquired if the country runs a positive balance of trade, that is, if the country’s exports are bigger than imports (the country sells more goods and services to foreigners than it purchases from foreigners).
Modern trade theory focuses on gains from trade achieved through specialization in production, lower prices and market access. However the crucial factor is that through innovation and knowledge spillovers, trade enables productivity rise, which is a basic source of economic growth.
Rising growth of exports in the world and a steady increase in trade as a share of the world economy prove that trade has become ever important. The growth of international trade has been stimulated by the steady decline of trade barriers after World War II. The Ricardian model of international trade introduces the principle of comparative advantage which helps to understand reasons supporting international trade. This model explains for example, how less productive nations can benefit from free trade with their more productive neighbors.4
Adam Smith in his book The Wealth of Nations (1776) stated that the real wealth of a country consists of the goods and services available to its citizens. Smith developed the theory of absolute advantage, which holds that different countries can produce some goods more efficiently than others, thus global efficiency can be increased through free trade. Smith reasoned that if trade were unrestricted, each country would specialize in those products that resulted in a competitive advantage for it, which would be either natural or acquired. A country then could use its specialized production excess to buy more imports than it could have otherwise produced.5
In 1817, David Ricardo expanded Adam Smith’s theory of absolute advantage to develop the theory of comparative advantage. He reasoned that there may still be global efficiency from trade if a country specializes in those products that it can produce more efficiently than other products without regard to absolute advantage.
The Ricardian model of trade was a real breakthrough. Up until then, world resources were considered to be limited and static. As a result, one country’s economic gain was achieved at the expense of another. This situation is called a zero-sum game.
However, David Ricardo proved that international trade is a positive-sum game (win-win situation). Any country can export the goods in which it has the greatest relative productivity and in exchange receive goods which domestically are more expensive to produce. Furthermore, exporting by an industry can increase its productivity as a result of learning-by-doing, economies of scale, or other factors.6 Therefore comparative advantage becomes dynamic and may evolve because of the country’s economic development. It means that countries’ relative advantages are changing over time because of knowledge spillovers, technology transfers or factor accumulation.
Since then other trade theories have appeared, but the theory of comparative advantages is still valid as a simple explanation of a country’s international trade performance.7 A New Trade Theory included the assumptions of economies of scale, product differentiation and imperfect competition into a trade theory. In short, the increasing returns made from the large production of tradable goods make it easier to sell them abroad at competitive prices.8 Gravity theory also adds a spatial context, in which geographical location influences the volume of trade, and distance factor limits the trade.
Nevertheless, how much countries gain depends mainly on the nature of comparative advantage, which is related to sector-level productivity. Countries produce and export a wide variety of goods, which differ greatly by characteristics and by quality. That is why if any country is successful and achieves high export performance for some of these goods, it is most likely a result of its comparative advantage in their production.
