International Trade and European Integration

I. Introduction

The Irish economy is one in which, as in Europe in general, industrial activity is unevenly distributed. Some sectors perform - and have developed - better than others. Some have concentrated spatially to a greater extent than others. Yet this uneven development has been the basis for Ireland's recent economic growth. The causes of this unbalanced industrial development include a complex interplay of historical, cultural and institutional factors in addition to traditional comparative advantage. All of these forces operate in the context of an increasingly integrated Europe.

Ireland's economy can be characterised as one which is small and open. A large percentage of Ireland's economic activity takes place in the international sector, through exports and imports. In this paper we will examine different schools of trade theory and their respective explanations of differential industrial development between countries and regions. We will examine to what extent these theories can describe Irish experience to date. We will conclude by drawing out the implications for Irish trade and industrial policy in the future. In general what we show is that �lumpiness’ in the spatial concentration of industry is consistent both with the theories of international trade and the theories of industrial development.

II. Comparative Advantage

According to the traditional Ricardian comparative advantage theory of international trade, countries will specialise in the production and export of those goods in which they have a comparative advantage. Even if Country A can produce, say, both cars and refrigerators better than Country B, as long as A is relatively better (cheaper, more efficient) at producing cars, then A will produce cars and export them to B, and B will produce refrigerators and export them to A. What follows from this is an expectation that when barriers to trade are removed, there will be inter-industry specialisation; the countries involved will begin to specialise in different industries, some countries producing and exporting more cars, and others producing and exporting more refrigerators. Moreover, those that increase their production of cars will, it would be expected, transfer resources out of the refrigerator industry and therefor produce fewer refrigerators. All countries theoretically benefit from the increased productivity brought about this process of specialisation.

Comparative advantage has been at the base of all neoclassical international trade theory (i.e. since the late 19th century). The major innovation in neoclassical theory this century came with the development of the Heckscher-Ohlin-Samuelson (HOS) model. This model has been at the core of neoclassical international trade theory at least up to the end of the 1980s, and it still is the central model in many text books. The HOS model rests heavily on comparative advantage. It states that, with free trade, a country will export the good that uses most intensively the factor of production with which that country is most richly endowed. The rich endowment of the factor makes that factor relatively cheaper, and therefore the production of that good relatively less expensive. With lower relative production costs, this good will be the one that is exported. It is in this latter sense that HOS is based on comparative advantage. The conclusion from HOS is little different from that of simple comparative advantage, namely that, in a free trade context, there will be inter-industry specialisation among countries. What HOS adds is that the reason for this inter-industry specialisation is the difference between countries in endowments of the different factors of production.

The policy implication of these theories is that all countries would be better off if there were no intervention by states in international trade, allowing each country to specialise in its most efficient, least cost industry. However, both the comparative advantage theory and this policy conclusion have come under critical scrutiny. Development economists, for example, have for long held that:

(1) the assumptions upon which comparative advantage theory is based, such as perfect competition and perfect mobility of resources, do not hold, and therefore the theory itself does not hold;

(2) comparative advantage theory is static, and does not allow for dynamic effects, as in the case of planned, created comparative advantage and the important role of leading industries;

(3) the theory does not take into consideration distribution effects, such as the extent to which inter-industry specialisation within an economy may reduce the welfare of those whose livelihood depended on the good whose production is cut back; and,

(4) among relatively less developed countries (LDCs), a dualism can emerge as a result of trade