international trade system essay

Trade and Globalization

How did international trade and globalization change over time? What is the structure today? And what is its impact?

By: Esteban Ortiz-Ospina , Diana Beltekian and Max Roser

This page was first published in 2014 and last revised in April 2024.

On this topic page, you can find data, visualizations, and research on historical and current patterns of international trade, as well as discussions of their origins and effects.

Other research and writing on trade and globalization on Our World in Data:

• Is globalization an engine of economic development?
• Is trade a major driver of income inequality?

Related topics

Economic Growth

See all our data, visualizations, and writing on economic growth.

Economic Inequality

See all our data, visualizations, and writing on economic inequality.

See all our data, visualizations, and writing on migration.

See all interactive charts on Trade and Globalization ↓

Trade has changed the world economy

Trade has grown remarkably over the last century.

One of the most important developments of the last century has been the integration of national economies into a global economic system. This process of integration, often called globalization, has resulted in a remarkable growth in trade between countries.

The chart here shows the growth of world exports over more than the last two centuries. These estimates are in constant prices (i.e. have been adjusted to account for inflation) and are indexed at 1913 values.

The chart shows an extraordinary growth in international trade over the last couple of centuries: Exports today are more than 40 times larger than in 1913.

You can switch to a logarithmic scale under ‘Settings’. This will help you see that, over the long run, growth has roughly followed an exponential path.

The increase in trade has even outpaced economic growth

The chart above shows how much more trade we have today relative to a century ago. But what about trade relative to total economic output?

Over the last couple of centuries the world economy has experienced sustained positive economic growth , so looking at changes in trade relative to GDP offers another interesting perspective.

The next chart plots the value of traded goods relative to GDP (i.e. the value of merchandise trade as a share of global economic output).

Up to 1870, the sum of worldwide exports accounted for less than 10% of global output. Today, the value of exported goods around the world is around 25%. This shows that over the last hundred years, the growth in trade has even outpaced rapid economic growth.

Trade expanded in two waves

The first "wave of globalization" started in the 19th century, the second one after ww2.

The following visualization presents a compilation of available trade estimates, showing the evolution of world exports and imports as a share of global economic output .

This metric (the ratio of total trade, exports plus imports, to global GDP) is known as the “openness index”. The higher the index, the higher the influence of trade transactions on global economic activity. 1

As we can see, until 1800 there was a long period characterized by persistently low international trade – globally the index never exceeded 10% before 1800. This then changed over the course of the 19th century, when technological advances triggered a period of marked growth in world trade – the so-called “first wave of globalization”.

This first wave came to an end with the beginning of World War I, when the decline of liberalism and the rise of nationalism led to a slump in international trade. In the chart we see a large drop in the interwar period.

After World War II trade started growing again. This new – and ongoing – wave of globalization has seen international trade grow faster than ever before. Today the sum of exports and imports across nations amounts to more than 50% of the value of total global output.

Before the first wave of globalization, trade was driven mostly by colonialism

Over the early modern period, transoceanic flows of goods between empires and colonies accounted for an important part of international trade. The following visualizations provide a comparison of intercontinental trade, in per capita terms, for different countries.

As we can see, intercontinental trade was very dynamic, with volumes varying considerably across time and from empire to empire.

Leonor Freire Costa, Nuno Palma, and Jaime Reis, who compiled and published the original data shown here, argue that trade, also in this period, had a substantial positive impact on the economy. 2

The first wave of globalization was marked by the rise and collapse of intra-European trade

The following visualization shows a detailed overview of Western European exports by destination. Figures correspond to export-to-GDP ratios (i.e. the sum of the value of exports from all Western European countries, divided by the total GDP in this region). You can use “Settings” to switch to a relative view and see the proportional contribution of each region to total Western European exports.

This chart shows that growth in Western European trade throughout the 19th century was largely driven by trade within the region: In the period 1830-1900 intra-European exports went from 1% of GDP to 10% of GDP, and this meant that the relative weight of intra-European exports doubled over the period. However, this process of European integration then collapsed sharply in the interwar period.

After the Second World War trade within Europe rebounded, and from the 1990s onwards exceeded the highest levels of the first wave of globalization. In addition, Western Europe then started to increasingly trade with Asia, the Americas, and to a smaller extent Africa and Oceania.

The next graph, using data from Broadberry and O'Rourke (2010) 3 , shows another perspective on the integration of the global economy and plots the evolution of three indicators measuring integration across different markets – specifically goods, labor, and capital markets.

The indicators in this chart are indexed, so they show changes relative to the levels of integration observed in 1900. This gives us another perspective on how quickly global integration collapsed with the two World Wars. 4

The second wave of globalization was enabled by technology

The worldwide expansion of trade after the Second World War was largely possible because of reductions in transaction costs stemming from technological advances, such as the development of commercial civil aviation, the improvement of productivity in the merchant marines, and the democratization of the telephone as the main mode of communication. The visualization shows how, at the global level, costs across these three variables have been going down since 1930.

Reductions in transaction costs impacted not only the volumes of trade but also the types of exchanges that were possible and profitable.

The first wave of globalization was characterized by inter-industry trade. This means that countries exported goods that were very different from what they imported – England exchanged machines for Australian wool and Indian tea. As transaction costs went down, this changed. In the second wave of globalization, we are seeing a rise in intra -industry trade (i.e. the exchange of broadly similar goods and services is becoming more and more common). France, for example, now both imports and exports machines to and from Germany.

The following visualization, from the UN World Development Report (2009) , plots the fraction of total world trade that is accounted for by intra-industry trade, by type of goods. As we can see, intra-industry trade has been going up for primary, intermediate, and final goods.

This pattern of trade is important because the scope for specialization increases if countries are able to exchange intermediate goods (e.g. auto parts) for related final goods (e.g. cars).

Trade and trade partners by country

Above, we examined the broad global trends over the last two centuries. Let's now examine country-level trends over this long and dynamic period.

This chart plots estimates of the value of trade in goods, relative to total economic activity (i.e. export-to-GDP ratios).

These historical estimates obviously come with a large margin of error (in the measurement section below we discuss the data limitations); yet they offer an interesting perspective.

You can edit the countries and regions selected. Each country tells a different story. 6

In the next chart we plot, country by country, the regional breakdown of exports. India is shown by default, but you can edit the countries and regions shown.

When switching to displaying relative values under ‘Settings’, we see the proportional contribution of purchases from each region. For example, we see that more than a third of Indian exports went to Asian countries in recent decades.

This gives us an interesting perspective on the changing nature of trade partnerships. In India, we see the rising importance of trade with Africa—a pattern that we discuss in more detail below .

Trade around the world today

How much do countries trade, trade openness around the world.

The metric trade as a share of GDP gives us an idea of global integration by capturing all incoming and outgoing transactions of a country.

The charts shows that countries differ a lot in the extent to which they engage in trade. Trade, for example, is much less important to the US economy than for other rich countries.

If you press the play button on the map, you can see changes over time. This reveals that, despite the great variation between countries, there is a common trend: over the last couple of decades trade openness has gone up in most countries.

Exports and imports in real dollars

Expressing the value of trade as a share of GDP tells us the importance of trade in relation to the size of economic activity. Let's now take a look at trade in monetary terms – this tells us the importance of trade in absolute, rather than relative terms.

The chart shows the value of exports (goods plus services) in dollars, country by country.

The main takeaway here is that the trend towards more trade is more pronounced than in the charts showing shares of GDP. This is not surprising: most countries today produce more than a couple of decades ago , and at the same time they trade more of what they produce. 7

What do countries trade?

Trade in goods vs. trade in services.

Trade transactions include goods (tangible products that are physically shipped across borders by road, rail, water, or air) and services (intangible commodities, such as tourism, financial services, and legal advice).

Many traded services make merchandise trade easier or cheaper—for example, shipping services, or insurance and financial services.

Trade in goods has been happening for millennia , while trade in services is a relatively recent phenomenon.

In some countries services are today an important driver of trade: in the UK services account for around half of all exports; and in the Bahamas, almost all exports are services.

In other countries, such as Nigeria and Venezuela, services account for a small share of total exports.

Globally, trade in goods accounts for the majority of trade transactions. But as this chart shows, the share of services in total global exports has slightly increased in recent decades. 8

How are trade partnerships changing?

Bilateral trade is becoming increasingly common.

If we consider all pairs of countries that engage in trade around the world, we find that in the majority of cases, there is a bilateral relationship today: most countries that export goods to a country also import goods from the same country.

The interactive visualization shows this. 9 In the chart, all possible country pairs are partitioned into three categories: the top portion represents the fraction of country pairs that do not trade with one another; the middle portion represents those that trade in both directions (they export to one another); and the bottom portion represents those that trade in one direction only (one country imports from, but does not export to, the other country).

As we can see, bilateral trade is becoming increasingly common (the middle portion has grown substantially). However, many countries still do not trade with each other at all.

South-South trade is becoming increasingly important

The next visualization here shows the share of world merchandise trade that corresponds to exchanges between today's rich countries and the rest of the world.

The 'rich countries' in this chart are: Australia, Austria, Belgium, Canada, Cyprus, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Israel, Italy, Japan, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom and the United States. 'Non-rich countries' are all the other countries in the world.

As we can see, up until the Second World War, the majority of trade transactions involved exchanges between this small group of rich countries. But this has changed quickly over the last couple of decades, and today, trade between non-rich countries is just as important as trade between rich countries.

In the past two decades, China has been a key driver of this dynamic: the UN Human Development Report (2013) estimates that between 1992 and 2011, China's trade with Sub-Saharan Africa rose from $1 billion to more than $140 billion. 10

The majority of preferential trade agreements are between emerging economies

The last few decades have not only seen an increase in the volume of international trade, but also an increase in the number of preferential trade agreements through which exchanges take place. A preferential trade agreement is a trade pact that reduces tariffs between the participating countries for certain products.

The visualization here shows the evolution of the cumulative number of preferential trade agreements in force worldwide, according to the World Trade Organization (WTO). These numbers include notified and non-notified preferential agreements (the source reports that only about two-thirds of the agreements currently in force have been notified to the WTO) and are disaggregated by country groups.

This figure shows the increasingly important role of trade between developing countries (South-South trade), vis-a-vis trade between developed and developing countries (North-South trade). In the late 1970s, North-South agreements accounted for more than half of all agreements – in 2010, they accounted for about one-quarter. Today, the majority of preferential trade agreements are between developing economies.

Trading patterns have been changing quickly in middle-income countries

An important change in the composition of exported goods in these countries has accompanied the increase in trade among emerging economies over the last half century.

The next visualization plots the share of food exports in each country's total exported merchandise. These figures, produced by the World Bank, correspond to the Standard International Trade Classification, in which 'food' includes, among other goods, live animals, beverages, tobacco, coffee, oils, and fats.

Two points stand out. First, the relative importance of food exports has substantially decreased in most countries since the 1960s (although globally, it has gone up slightly more recently). Second, this decrease has been largest in middle-income countries, particularly in Latin America.

Regarding levels, as one would expect, in high-income countries, food still accounts for a much smaller share of merchandise exports than in most low- and middle-income-countries.

Trade generates efficiency gains

The raw correlation between trade and growth.

Over the last couple of centuries, the world economy has experienced sustained positive economic growth , and over the same period, this process of economic growth has been accompanied by even faster growth in global trade .

In a similar way, if we look at country-level data from the last half century we find that there is also a correlation between economic growth and trade: countries with higher rates of GDP growth also tend to have higher rates of growth in trade as a share of output. This basic correlation is shown in the chart here, where we plot the average annual change in real GDP per capita, against growth in trade (average annual change in value of exports as a share of GDP). 11

Is this statistical association between economic output and trade causal?

Among the potential growth-enhancing factors that may come from greater global economic integration are: competition (firms that fail to adopt new technologies and cut costs are more likely to fail and be replaced by more dynamic firms); economies of scale (firms that can export to the world face larger demand, and under the right conditions, they can operate at larger scales where the price per unit of product is lower); learning and innovation (firms that trade gain more experience and exposure to develop and adopt technologies and industry standards from foreign competitors). 12

Are these mechanisms supported by the data? Let's take a look at the available empirical evidence.

Evidence from cross-country differences in trade, growth, and productivity

When it comes to academic studies estimating the impact of trade on GDP growth, the most cited paper is Frankel and Romer (1999). 13

In this study, Frankel and Romer used geography as a proxy for trade to estimate the impact of trade on growth. This is a classic example of the so-called instrumental variables approach . The idea is that a country's geography is fixed, and mainly affects national income through trade. So if we observe that a country's distance from other countries is a powerful predictor of economic growth (after accounting for other characteristics), then the conclusion is drawn that it must be because trade has an effect on economic growth. Following this logic, Frankel and Romer find evidence of a strong impact of trade on economic growth.

Other papers have applied the same approach to richer cross-country data, and they have found similar results. A key example is Alcalá and Ciccone (2004). 14

This body of evidence suggests trade is indeed one of the factors driving national average incomes (GDP per capita) and macroeconomic productivity (GDP per worker) over the long run. 15

Evidence from changes in labor productivity at the firm level

If trade is causally linked to economic growth, we would expect that trade liberalization episodes also lead to firms becoming more productive in the medium and even short run. There is evidence suggesting this is often the case.

Pavcnik (2002) examined the effects of liberalized trade on plant productivity in the case of Chile, during the late 1970s and early 1980s. She found a positive impact on firm productivity in the import-competing sector. She also found evidence of aggregate productivity improvements from the reshuffling of resources and output from less to more efficient producers. 16

Bloom, Draca, and Van Reenen (2016) examined the impact of rising Chinese import competition on European firms over the period 1996-2007 and obtained similar results. They found that innovation increased more in those firms most affected by Chinese imports. They also found evidence of efficiency gains through two related channels: innovation increased and new existing technologies were adopted within firms, and aggregate productivity also increased because employment was reallocated towards more technologically advanced firms. 17

Trade does not only increase efficiency gains

Overall, the available evidence suggests that trade liberalization does improve economic efficiency. This evidence comes from different political and economic contexts and includes both micro and macro measures of efficiency.

This result is important because it shows that there are gains from trade. But of course, efficiency is not the only relevant consideration here. As we discuss in a companion article , the efficiency gains from trade are not generally equally shared by everyone. The evidence from the impact of trade on firm productivity confirms this: "reshuffling workers from less to more efficient producers" means closing down some jobs in some places. Because distributional concerns are real it is important to promote public policies – such as unemployment benefits and other safety-net programs – that help redistribute the gains from trade.

Trade has distributional consequences

The conceptual link between trade and household welfare.

When a country opens up to trade, the demand and supply of goods and services in the economy shift. As a consequence, local markets respond, and prices change. This has an impact on households, both as consumers and as wage earners.

The implication is that trade has an impact on everyone. It's not the case that the effects are restricted to workers from industries in the trade sector; or to consumers who buy imported goods. The effects of trade extend to everyone because markets are interlinked, so imports and exports have knock-on effects on all prices in the economy, including those in non-traded sectors.

Economists usually distinguish between "general equilibrium consumption effects" (i.e. changes in consumption that arise from the fact that trade affects the prices of non-traded goods relative to traded goods) and "general equilibrium income effects" (i.e. changes in wages that arise from the fact that trade has an impact on the demand for specific types of workers, who could be employed in both the traded and non-traded sectors).

Considering all these complex interrelations, it's not surprising that economic theories predict that not everyone will benefit from international trade in the same way. The distribution of the gains from trade depends on what different groups of people consume, and which types of jobs they have, or could have. 18

The link between trade, jobs and wages

Evidence from chinese imports and their impact on factory workers in the us.

The most famous study looking at this question is Autor, Dorn and Hanson (2013): "The China syndrome: Local labor market effects of import competition in the United States". 19

In this paper, Autor and coauthors examined how local labor markets changed in the parts of the country most exposed to Chinese competition. They found that rising exposure increased unemployment, lowered labor force participation, and reduced wages. Additionally, they found that claims for unemployment and healthcare benefits also increased in more trade-exposed labor markets.

The visualization here is one of the key charts from their paper. It's a scatter plot of cross-regional exposure to rising imports, against changes in employment. Each dot is a small region (a 'commuting zone' to be precise). The vertical position of the dots represents the percent change in manufacturing employment for the working-age population, and the horizontal position represents the predicted exposure to rising imports (exposure varies across regions depending on the local weight of different industries).

The trend line in this chart shows a negative relationship: more exposure goes along with less employment. There are large deviations from the trend (there are some low-exposure regions with big negative changes in employment); but the paper provides more sophisticated regressions and robustness checks, and finds that this relationship is statistically significant.

This result is important because it shows that the labor market adjustments were large. Many workers and communities were affected over a long period of time. 20

But it's also important to keep in mind that Autor and colleagues are only giving us a partial perspective on the total effect of trade on employment. In particular, comparing changes in employment at the regional level misses the fact that firms operate in multiple regions and industries at the same time. Indeed, Ildikó Magyari found evidence suggesting the Chinese trade shock provided incentives for US firms to diversify and reorganize production. 21

So companies that outsourced jobs to China often ended up closing some lines of business, but at the same time expanded other lines elsewhere in the US. This means that job losses in some regions subsidized new jobs in other parts of the country.

On the whole, Magyari finds that although Chinese imports may have reduced employment within some establishments, these losses were more than offset by gains in employment within the same firms in other places. This is no consolation to people who lost their jobs. But it is necessary to add this perspective to the simplistic story of "trade with China is bad for US workers".

Evidence from the expansion of trade in India and the impact on poverty reductions

Another important paper in this field is Topalova (2010): "Factor immobility and regional impacts of trade liberalization: Evidence on poverty from India". 22

In this paper, Topalova examines the impact of trade liberalization on poverty across different regions in India, using the sudden and extensive change in India's trade policy in 1991. She finds that rural regions that were more exposed to liberalization experienced a slower decline in poverty and lower consumption growth.

Analyzing the mechanisms underlying this effect, Topalova finds that liberalization had a stronger negative impact among the least geographically mobile at the bottom of the income distribution and in places where labor laws deterred workers from reallocating across sectors.

The evidence from India shows that (i) discussions that only look at "winners" in poor countries and "losers" in rich countries miss the point that the gains from trade are unequally distributed within both sets of countries; and (ii) context-specific factors, like worker mobility across sectors and geographic regions, are crucial to understand the impact of trade on incomes.

Evidence from other studies

• Donaldson (2018) uses archival data from colonial India to estimate the impact of India’s vast railroad network. He finds railroads increased trade, and in doing so they increased real incomes (and reduced income volatility). 23
• Porto (2006) looks at the distributional effects of Mercosur on Argentine families, and finds this regional trade agreement led to benefits across the entire income distribution. He finds the effect was progressive: poor households gained more than middle-income households because prior to the reform, trade protection benefitted the rich disproportionately. 24
• Trefler (2004) looks at the Canada-US Free Trade Agreement and finds there was a group who bore "adjustment costs" (displaced workers and struggling plants) and a group who enjoyed "long-run gains" (consumers and efficient plants). 25

The link between trade and the cost of living

The fact that trade negatively affects labor market opportunities for specific groups of people does not necessarily imply that trade has a negative aggregate effect on household welfare. This is because, while trade affects wages and employment, it also affects the prices of consumption goods. So households are affected both as consumers and as wage earners.

Most studies focus on the earnings channel and try to approximate the impact of trade on welfare by looking at how much wages can buy, using as a reference the changing prices of a fixed basket of goods.

This approach is problematic because it fails to consider welfare gains from increased product variety, and obscures complicated distributional issues such as the fact that poor and rich individuals consume different baskets so they benefit differently from changes in relative prices. 26

Ideally, studies looking at the impact of trade on household welfare should rely on fine-grained data on prices, consumption, and earnings. This is the approach followed in Atkin, Faber, and Gonzalez-Navarro (2018): "Retail globalization and household welfare: Evidence from Mexico". 27

Atkin and coauthors use a uniquely rich dataset from Mexico, and find that the arrival of global retail chains led to reductions in the incomes of traditional retail sector workers, but had little impact on average municipality-level incomes or employment; and led to lower costs of living for both rich and poor households.

The chart here shows the estimated distribution of total welfare gains across the household income distribution (the light-gray lines correspond to confidence intervals). These are proportional gains expressed as a percent of initial household income.

As we can see, there is a net positive welfare effect across all income groups; but these improvements in welfare are regressive, in the sense that richer households gain proportionally more (about 7.5 percent gain compared to 5 percent). 28

Evidence from other countries confirms this is not an isolated case – the expenditure channel really seems to be an important and understudied source of household welfare. Giuseppe Berlingieri, Holger Breinlich, Swati Dhingra, for example, investigated the consumer benefits from trade agreements implemented by the EU between 1993 and 2013; and they found that these trade agreements increased the quality of available products, which translated into a cumulative reduction in consumer prices equivalent to savings of €24 billion per year for EU consumers. 29

Implications of trade’s distributional effects

The available evidence shows that, for some groups of people, trade has a negative effect on wages and employment opportunities; at the same time, it has a large positive effect via lower consumer prices and increased product availability.

Two points are worth emphasizing.

For some households, the net effect is positive. But for some households that's not the case. In particular, workers who lose their jobs can be affected for extended periods of time, so the positive effect via lower prices is not enough to compensate them for the reduction in earnings.

On the whole, if we aggregate changes in welfare across households, the net effect is usually positive. But this is hardly a consolation for the worse off.

This highlights a complex reality: There are aggregate gains from trade , but there are also real distributional concerns. Even if trade is not a major driver of income inequalities , it's important to keep in mind that public policies, such as unemployment benefits and other safety-net programs, can and should help redistribute the gains from trade.

Explaining trade patterns: Theory and Evidence

Comparative advantage, theory: what is 'comparative advantage' and why does it matter to understand trade.

In economic theory, the 'economic cost' – or the 'opportunity cost' – of producing a good is the value of everything you need to give up in order to produce that good.

Economic costs include physical inputs (the value of the stuff you use to produce the good), plus forgone opportunities (when you allocate scarce resources to a task, you give up alternative uses of those resources).

A country or a person is said to have a 'comparative advantage' if it can produce something at a lower opportunity cost than its trade partners.

The forgone opportunities of production are key to understanding this concept. It is precisely this that distinguishes absolute advantage from comparative advantage.

To see the difference between comparative and absolute advantage, consider a commercial aviation pilot and a baker. Suppose the pilot is an excellent chef, and she can bake just as well, or even better than the baker. In this case, the pilot has an absolute advantage in both tasks. Yet the baker probably has a comparative advantage in baking, because the opportunity cost of baking is much higher for the pilot.

The freely available economics textbook The Economy: Economics for a Changing World explains this as follows: "A person or country has comparative advantage in the production of a particular good, if the cost of producing an additional unit of that good relative to the cost of producing another good is lower than another person or country’s cost to produce the same two goods."

At the individual level, comparative advantage explains why you might want to delegate tasks to someone else, even if you can do those tasks better and faster than them. This may sound counterintuitive, but it is not: If you are good at many things, it means that investing time in one task has a high opportunity cost, because you are not doing the other amazing things you could be doing with your time and resources. So, at least from an efficiency point of view, you should specialize on what you are best at, and delegate the rest.

The same logic applies to countries. Broadly speaking, the principle of comparative advantage postulates that all nations can gain from trade if each specializes in producing what they are relatively more efficient at producing, and imports the rest: “do what you do best, import the rest”. 30

In countries with a relative abundance of certain factors of production, the theory of comparative advantage predicts that they will export goods that rely heavily upon those factors: a country typically has a comparative advantage in those goods that use its abundant resources. Colombia exports bananas to Europe because it has comparatively abundant tropical weather.

Is there empirical support for comparative-advantage theories of trade?

The empirical evidence suggests that the principle of comparative advantage does help explain trade patterns. Bernhofen and Brown (2004) 31 , for instance, provide evidence using the experience of Japan. Specifically, they exploit Japan’s dramatic nineteenth-century move from a state of near complete isolation to wide trade openness.

The graph here shows the price changes of the key tradable goods after the opening up to trade. It presents a scatter diagram of the net exports in 1869 graphed in relation to the change in prices from 1851–53 to 1869. As we can see, this is consistent with the theory: after opening to trade, the relative prices of major exports such as silk increased (Japan exported what was cheap for them to produce and which was valuable abroad), while the relative price of imports such as sugar declined (they imported what was relatively more difficult for them to produce, but was cheap abroad).

Trade diminishes with distance

The resistance that geography imposes on trade has long been studied in the empirical economics literature – and the main conclusion is that trade intensity is strongly linked to geographic distance.

The visualization, from Eaton and Kortum (2002), graphs 'normalized import shares' against distance. 32 Each dot represents a country pair from a set of 19 OECD countries, and both the vertical and horizontal axes are expressed on logarithmic scales.

The 'normalized import shares' in the vertical axis provide a measure of how much each country imports from different partners (see the paper for details on how this is calculated and normalized), while the distance in the horizontal axis corresponds to the distance between central cities in each country (see the paper and references therein for details on the list of cities). As we can see, there is a strong negative relationship. Trade diminishes with distance. Through econometric modeling, the paper shows that this relationship is not just a correlation driven by other factors: their findings suggest that distance imposes a significant barrier to trade.

The fact that trade diminishes with distance is also corroborated by data on trade intensity within countries. The visualization here shows, through a series of maps, the geographic distribution of French firms that export to France's neighboring countries. The colors reflect the percentage of firms that export to each specific country.

As we can see, the share of firms exporting to each of the corresponding neighbors is the largest close to the border. The authors also show in the paper that this pattern holds for the value of individual-firm exports – trade value decreases with distance to the border.

Institutions

Conducting international trade requires both financial and non-financial institutions to support transactions. Some of these institutions are fairly obvious (e.g. law enforcement); but some are less obvious. For example, the evidence shows that producers in exporting countries often need credit in order to engage in trade.

The scatter plot, from Manova (2013), shows the correlation between levels in private credit (specifically exporters’ private credit as a share of GDP) and exports (average log bilateral exports across destinations and sectors). 34 As can be seen, financially developed economies – those with more dynamic private credit markets – typically outperform exporters with less evolved financial institutions.

Other studies have shown that country-specific institutions, like the knowledge of foreign languages, for instance, are also important to promote foreign relative to domestic trade. 35

Increasing returns to scale

The concept of comparative advantage predicts that if all countries had identical endowments and institutions, there would be little incentive for specialization because the opportunity cost of producing any good would be the same in every country.

So you may wonder: why is it then the case that in the last few years, we have seen such rapid growth in intra-industry trade between rich countries?

The increase in intra-industry between rich countries seems paradoxical under the light of comparative advantage because in recent decades we have seen convergence in key factors, such as human capital , across these countries.

The solution to the paradox is actually not very complicated: Comparative advantage is one, but not the only force driving incentives to specialization and trade.

Several economists, most notably Paul Krugman, have developed theories of trade in which trade is not due to differences between countries, but instead due to "increasing returns to scale" – an economic term used to denote a technology in which producing extra units of a good becomes cheaper if you operate at a larger scale.

The idea is that specialization allows countries to reap greater economies of scale (i.e. to reduce production costs by focusing on producing large quantities of specific products), so trade can be a good idea even if the countries do not differ in endowments, including culture and institutions.

These models of trade, often referred to as “New Trade Theory”, are helpful in explaining why in the last few years we have seen such rapid growth in two-way exchanges of goods within industries between developed nations.

In a much-cited paper, Evenett and Keller (2002) show that both factor endowments and increasing returns help explain production and trade patterns around the world. 36

You can learn more about New Trade Theory, and the empirical support behind it, in Paul Krugman's Nobel lecture .

Measurement and data quality

There are dozens of official sources of data on international trade, and if you compare these different sources, you will find that they do not agree with one another. Even if you focus on what seems to be the same indicator for the same year in the same country, discrepancies are large.

Such differences between sources can also be found in rich countries where statistical agencies tend to follow international reporting guidelines more closely.

There are also large bilateral discrepancies within sources: the value of goods that country A exports to country B can be more than the value of goods that country B imports from country A.

Here we explain how international trade data is collected and processed, and why there are such large discrepancies.

What data is available?

The data hubs from several large international organizations publish and maintain extensive cross-country datasets on international trade. Here's a list of the most important ones:

• World Bank Open Data
• WTO Statistics
• UN Comtrade
• UNCTAD World Integrated Trade Solutions

In addition to these sources, there are also many other academic projects that publish data on international trade. These projects tend to rely on data from one or more of the sources above, and they typically process and merge series in order to improve coverage and consistency. Three important sources are:

• The Correlates of War Project . 37
• The NBER-United Nations Trade Dataset Project .
• The CEPII Bilateral Trade and Gravity Data Project . 38

How large are the discrepancies between sources?

In the visualization here, we compare the data published by several of the sources listed above, country by country, from 1955 to today.

For each country, we exclude trade in services, and we focus only on estimates of the total value of exported goods, expressed as shares of GDP. 39

As this chart clearly shows, different data sources often tell very different stories. If you change the country or region shown you will see that this is true, to varying degrees, across all countries and years.

Constructing this chart was demanding. It required downloading trade data from many different sources, collecting the relevant series, and then standardizing them so that the units of measure and the geographical territories were consistent.

All series, except the two long-run series from CEPII and NBER-UN, were produced from data published by the sources in current US dollars and then converted to GDP shares using a unique source (World Bank).

So, if all series are in the same units (share of national GDP) and they measure the same thing (value of goods exported from one country to the rest of the world), what explains the differences?

Let's dig deeper to understand what's going on.

Why doesn't the data add up?

Differences in guidelines used by countries to record and report trade data.

Broadly speaking, there are two main approaches used to estimate international merchandise trade:

• The first approach relies on estimating trade from customs records , often complementing or correcting figures with data from enterprise surveys and administrative records associated with taxation. The main manual providing guidelines for this approach is the International Merchandise Trade Statistics Manual (IMTS).
• The second approach relies on estimating trade from macroeconomic data , typically National Accounts . The main manual providing guidelines for this approach is the Balance of Payments and International Investment Position Manual (BPM6), which was drafted in parallel with the 2008 System of National Accounts of the United Nations (SNA 2008). The idea behind this approach is to record changes in economic ownership. 40

Under these two approaches, it is common to distinguish between 'traded merchandise' and 'traded goods'. The distinction is often made because goods simply being transported through a country (i.e., goods in transit) are not considered to change a country's stock of material resources and are hence often excluded from the more narrow concept of 'merchandise trade'.

Also, adding to the complexity, countries often rely on measurement protocols developed alongside approaches and concepts that are not perfectly compatible to begin with. In Europe, for example, countries use the 'Compilers guide on European statistics on international trade in goods'.

Measurement error and other inconsistencies

Even when two sources rely on the same broad accounting approach, discrepancies arise because countries fail to adhere perfectly to the protocols.

In theory, for example, the exports of country A to country B should mirror the imports of country B from country A. But in practice this is rarely the case because of differences in valuation. According to the BPM6, imports, and exports should be recorded in the balance of payments accounts on a ' free on board (FOB) basis', which means using prices that include all charges up to placing the goods on board a ship at the port of departure. Yet many countries stick to FOB values only for exports, and use CIF values for imports (CIF stands for 'Cost, Insurance and Freight', and includes the costs of transportation). 41

The chart here gives you an idea of how large import-export asymmetries are. Shown are the differences between the value of goods that each country reports exporting to the US, and the value of goods that the US reports importing from the same countries. For example, for China, the figure in the chart corresponds to the “Value of merchandise imports in the US from China” minus the “Value of merchandise exports from China to the US”.

The differences in the chart here, which are both positive and negative, suggest that there is more going on than differences in FOB vs. CIF values. If all asymmetries were coming from FOB-CIF differences, then we should only see positive values in the chart (recall that, unlike FOB values, CIF values include the cost of transportation, so CIF values are larger).

What else may be going on here?

Another common source of measurement error relates to the inconsistent attribution of trade partners. An example is failure to follow the guidelines on how to treat goods passing through intermediary countries for processing or merchanting purposes. As global production chains become more complex, countries find it increasingly difficult to unambiguously establish the origin and final destination of merchandise, even when rules are established in the manuals. 42

And there are still more potential sources of discrepancies. For example differences in customs and tax regimes, and differences between "general" and "special" trade systems (i.e. differences between statistical territories and actual country borders, which do not often coincide because of things like 'custom free zones'). 43

Even when two sources have identical trade estimates, inconsistencies in published data can arise from differences in exchange rates. If a dataset reports cross-country trade data in US dollars, estimates will vary depending on the exchange rates used. Different exchange rates will lead to conflicting estimates, even if figures in local currency units are consistent.

A checklist for comparing sources

Asymmetries in international trade statistics are large and arise for a variety of reasons. These include conceptual inconsistencies across measurement standards and inconsistencies in the way countries apply agreed-upon protocols. Here's a checklist of issues to keep in mind when comparing sources.

• Differences in underlying records: is trade measured from National Accounts data rather than directly from custom or tax records?
• Differences in import and export valuations: are transactions valued at FOB or CIF prices?
• Inconsistent attribution of trade partners: how is the origin and final destination of merchandise established?
• Difference between 'goods' and 'merchandise': how are re-importing, re-exporting, and intermediary merchanting transactions recorded?
• Exchange rates: how are values converted from local currency units to the currency that allows international comparisons (most often the US-$)?
• Differences between 'general' and 'special' trade system: how is trade recorded for custom-free zones?
• Other issues: Time of recording, confidentiality policies, product classification, deliberate mis-invoicing for illicit purposes.

Many organizations producing trade data have long recognized these factors. Indeed, international organizations often incorporate corrections in an attempt to improve data quality.

The OECD's Balanced International Merchandise Trade Statistics , for example, uses its own approach to correct and reconcile international merchandise trade statistics. 44

The corrections applied in the OECD's 'balanced' series make this the best source for cross-country comparisons. However, this dataset has low coverage across countries, and it only goes back to 2011. This is an important obstacle since the complex adjustments introduced by the OECD imply we can't easily improve coverage by appending data from other sources. At Our World in Data we have chosen to rely on CEPII as the main source for exploring long-run changes in international trade, but we also rely on World Bank and OECD data for up-to-date cross-country comparisons.

There are two key lessons from all of this. The first lesson is that, for most users of trade data out there, there is no obvious way of choosing between sources. And the second lesson is that, because of statistical glitches, researchers and policymakers should always take analyses of trade data with a pinch of salt. For example, in a recent high-profile report , researchers attributed mismatches in bilateral trade data to illicit financial flows through trade mis-invoicing (or trade-based money laundering). As we show here, this interpretation of the data is not appropriate, since mismatches in the data can, and often do arise from measurement inconsistencies rather than malfeasance. 45

Hopefully, the discussion and checklist above can help researchers better interpret and choose between conflicting data sources.

Interactive charts on Trade and Globalization

The openness index, when calculated for the world as a whole, includes double-counting of transactions: When country A sells goods to country B, this shows up in the data both as an import (B imports from A) and as an export (A sells to B).

Indeed, if you compare the chart showing the global trade openness index and the chart showing global merchandise exports as a share of GDP , you find that the former is almost twice as large as the latter.

Why is the global openness index not exactly twice the value reported in the chart plotting global merchandise exports? There a three reasons.

First, the global openness index uses different sources. Second, the global openness index includes trade in goods and services, while merchandise exports include goods but not services. And third, the amount that country A reports exporting to country B does not usually match the amount that B reports importing from A.

We explore this in more detail in our measurement section .

Leonor Freire Costa, Nuno Palma, and Jaime Reis (2015) – The great escape? The contribution of the empire to Portugal's economic growth, 1500–1800 Leonor Freire Costa Nuno Palma Jaime Reis European Review of Economic History, Volume 19, Issue 1, 1 February 2015, Pages 1–22, https://doi.org/10.1093/ereh/heu019

Broadberry and O'Rourke (2010) - The Cambridge Economic History of Modern Europe: Volume 2, 1870 to the Present. Cambridge University Press.

Integration in the goods markets is measured here through the 'trade openness index', which is defined by the sum of exports and imports as a share of GDP. In our interactive chart you can explore trends in trade openness over this period for a selection of European countries.

Broadberry and O'Rourke (2010) - The Cambridge Economic History of Modern Europe: Volume 2, 1870 to the Present. Cambridge University Press. The graph depicts the “evolution of three indicators measuring integration in commodity, labor, and capital markets over the long run. Commodity market integration is measured by computing the ratio of exports to GDP. Labor market integration is measured by dividing the migratory turnover by population. Financial integration is measured using Feldstein–Horioka estimators of current account disconnectedness.”

We also have the same chart but showing imports .

We also have the same chart, but showing imports .

This interactive chart shows trade in services as a share of GDP across countries and regions.

This chart was inspired by a chart from Helpman, E., Melitz, M., & Rubinstein, Y. (2007). Estimating trade flows: Trading partners and trading volumes (No. w12927). National Bureau of Economic Research.

We also have the same data, but as a stacked-area chart .

There are different ways of capturing this correlation. I focus here on all countries with data over the period 1945-2014. You can find a similar chart using different data sources and time periods in Ventura, J. (2005). A global view of economic growth. Handbook of economic growth, 1, 1419-1497. Online here .

The textbook The Economy: Economics for a Changing World explains this in more detail.

Frankel, J. A., & Romer, D. H. (1999). Does trade cause growth? American Economic Review, 89(3), 379-399.

Alcalá, F., & Ciccone, A. (2004). Trade and productivity . The Quarterly Journal of Economics, 119(2), 613-646.

There are many papers that try to answer this specific question with macro data. For an overview of papers and methods see: Durlauf, S. N., Johnson, P. A., & Temple, J. R. (2005). Growth econometrics. Handbook of economic growth, 1, 555-677.

Pavcnik, N. (2002). Trade liberalization, exit, and productivity improvements: Evidence from Chilean plants . The Review of Economic Studies, 69(1), 245-276.

Bloom, N., Draca, M., & Van Reenen, J. (2016). Trade induced technical change? The impact of Chinese imports on innovation, IT and productivity. The Review of Economic Studies, 83(1), 87-117. Available online here .

You can read more about these economic concepts, and the related predictions from economic theory, in Chapter 18 of the textbook The Economy: Economics for a Changing World .

David, H., Dorn, D., & Hanson, G. H. (2013). The China syndrome: Local labor market effects of import competition in the United States . American Economic Review, 103(6), 2121-68.

It's important to mention here that the economist Jonathan Rothwell wrote a paper suggesting these findings are the result of a statistical illusion. Rothwell's critique received some attention from the media , but Autor and coauthors provided a reply , which I think successfully refutes this claim.

Magyari, I. (2017). Firm Reorganization, Chinese Imports, and US Manufacturing Employment . US Census Bureau, Center for Economic Studies.

Topalova, P. (2010). Factor immobility and regional impacts of trade liberalization: Evidence on poverty from India . American Economic Journal: Applied Economics, 2(4), 1-41.

Donaldson, D. (2018). Railroads of the Raj: Estimating the impact of transportation infrastructure . American Economic Review, 108(4-5), 899-934.

Porto, G (2006). Using Survey Data to Assess the Distributional Effects of Trade Policy. Journal of International Economics 70 (2006) 140–160.

Trefler, D. (2004). The long and short of the Canada-US free trade agreement . American Economic Review, 94(4), 870-895.

See: (i) Feenstra, R. C., & Weinstein, D. E. (2017). Globalization, markups, and US welfare . Journal of Political Economy, 125(4), 1040-1074. (ii) Fajgelbaum, P. D., & Khandelwal, A. K. (2016). Measuring the unequal gains from trade . The Quarterly Journal of Economics, 131(3), 1113-1180.

Atkin, David, Benjamin Faber, and Marco Gonzalez-Navarro. "Retail globalization and household welfare: Evidence from Mexico." Journal of Political Economy 126.1 (2018): 1-73.

In the paper, Atkin and coauthors explore the reasons for this and find that the regressive nature of the distribution is mainly due to richer households placing higher weight on the product variety and shopping amenities on offer at these new foreign stores.

Berlingieri, G., Breinlich, H., & Dhingra, S. (2018). The Impact of Trade Agreements on Consumer Welfare—Evidence from the EU Common External Trade Policy. Journal of the European Economic Association.

Nobel laureate Paul Samuelson (1969) was once challenged by the mathematician Stanislaw Ulam: "Name me one proposition in all of the social sciences which is both true and non-trivial." It was several years later than he thought of the correct response: comparative advantage. "That it is logically true need not be argued before a mathematician; that is is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them."

(NB. This is an excerpt from https://www.wto.org/english/res_e/reser_e/cadv_e.htm)

Bernhofen, D., & Brown, J. (2004). A Direct Test of the Theory of Comparative Advantage: The Case of Japan. Journal of Political Economy, 112(1), 48-67. doi:1. Retrieved from http://www.jstor.org/stable/10.1086/379944 doi:1

Eaton, J., & Kortum, S. (2002). Technology, geography, and trade. Econometrica, 70(5), 1741-1779.

Crozet, M., & Koenig, P. (2010). Structural Gravity Equations with Intensive and Extensive Margins. The Canadian Journal of Economics / Revue Canadienne D'Economique, 43(1), 41-62. Retrieved from http://www.jstor.org/stable/40389555

Manova, Kalina. "Credit constraints, heterogeneous firms, and international trade." The Review of Economic Studies 80.2 (2013): 711-744.

Melitz, J. (2008). Language and foreign trade. European Economic Review, 52(4), 667-699.

Evenett, S. J., & Keller, W. (2002). On theories explaining the success of the gravity equation . Journal of Political Economy, 110(2), 281-316.

For more information on how the COW trade datasets were constructed see: (i) Barbieri, Katherine, and Omar M. G. Omar Keshk. 2016. Correlates of War Project Trade Data Set Codebook, Version 4.0. Available at http://correlatesofwar.org and (ii) Barbieri, Katherine, Omar M. G. Keshk, and Brian Pollins. 2009. TRADING DATA: Evaluating our Assumptions and Coding Rules. Conflict Management and Peace Science, 26(5): 471–491.

Further information on CEPII's methodology can be found in their working paper .

The chart includes series labeled by the sources as 'merchandise trade' and 'goods trade'. As we explain below, part of the asymmetries in trade data comes from the fact that, although 'merchandise' and 'goods' are equivalent in the dictionary, these two terms often measure related but different things.

For example, if there is no change in ownership (e.g. a firm exports goods to its factory in another country for processing, and then re-imports the processed goods) the manual says that statistical agencies should only record the net difference in value. You can find more details about this in an OECD Statistics Briefing .

This issue is actually also a source of disagreement between National Accounts data and customs data. You can read more about it in this report: Harrison, Anne (2013) FOB/CIF Issue in Merchandise Trade/Transport of Goods in BPM6 and the 2008 SNA, Twenty-Fifth Meeting of the IMF Committee on Balance of Payments Statistics, Washington, D.C .

Precisely because of the difficulty that arises when trying to establish the origin and final destination of merchandise, some sources distinguish between national and dyadic (i.e. 'directed') trade estimates.

For more details about general and special trade see the Eurostat glossary .

The OECD approach consists of four steps, which they describe as follows: "First, data are collected and organized, and imports are converted to FOB prices to match the valuation of exports. Secondly, data are adjusted for several specific large problems known to drive asymmetries. Presently these include “modular” adjustments for unallocated and confidential trade; for exports by Hong Kong, China; for Swiss non-monetary gold; and for clear-cut cases of product misclassifications. The list of modules is expected to grow over time. In the third step, adjusted data are balanced using a “Symmetry Index” that weights exports and imports. As the final step, the data are also converted to Classification of Products by Activity (CPA) products to better align with National Accounts statistics, such as in national Supply-Use tables." You can read more about it here . In addition to the OECD, other sources also use corrections. The IMF's DOTS dataset, for example, uses a 6 percent rule for converting import valuations (in CIF) into export values (in FOB). More information can be found in the IMF's (2018) working paper on 'New Estimates for Direction of Trade Statistics'.

For more details on this see Forstater, M. (2018) Illicit Financial Flows, Trade Misinvoicing, and Multinational Tax Avoidance: The Same or Different? , CGD Policy Paper 123.

Cite this work

Our articles and data visualizations rely on work from many different people and organizations. When citing this topic page, please also cite the underlying data sources. This topic page can be cited as:

BibTeX citation

Reuse this work freely

All visualizations, data, and code produced by Our World in Data are completely open access under the Creative Commons BY license . You have the permission to use, distribute, and reproduce these in any medium, provided the source and authors are credited.

The data produced by third parties and made available by Our World in Data is subject to the license terms from the original third-party authors. We will always indicate the original source of the data in our documentation, so you should always check the license of any such third-party data before use and redistribution.

All of our charts can be embedded in any site.

Our World in Data is free and accessible for everyone.

Help us do this work by making a donation.

Programs submenu

Regions submenu, topics submenu, postponed: a complete impasse—gaza: the human toll, is it me or the economic system changing chinese attitudes toward inequality: a big data china event, the u.s. vision for ai safety: a conversation with elizabeth kelly, director of the u.s. ai safety institute, new frontiers in uflpa enforcement: a fireside chat with dhs secretary alejandro mayorkas.

• Abshire-Inamori Leadership Academy
• Aerospace Security Project
• Africa Program
• Americas Program
• Arleigh A. Burke Chair in Strategy
• Asia Maritime Transparency Initiative
• Asia Program
• Australia Chair
• Brzezinski Chair in Global Security and Geostrategy
• Brzezinski Institute on Geostrategy
• Chair in U.S.-India Policy Studies
• China Power Project
• Chinese Business and Economics
• Defending Democratic Institutions
• Defense-Industrial Initiatives Group
• Defense 360
• Defense Budget Analysis
• Diversity and Leadership in International Affairs Project
• Economics Program
• Emeritus Chair in Strategy
• Energy Security and Climate Change Program
• Europe, Russia, and Eurasia Program
• Freeman Chair in China Studies
• Futures Lab
• Geoeconomic Council of Advisers
• Global Food and Water Security Program
• Global Health Policy Center
• Hess Center for New Frontiers
• Human Rights Initiative
• Humanitarian Agenda
• Intelligence, National Security, and Technology Program
• International Security Program
• Japan Chair
• Kissinger Chair
• Korea Chair
• Langone Chair in American Leadership
• Middle East Program
• Missile Defense Project
• Project on Critical Minerals Security
• Project on Fragility and Mobility
• Project on Nuclear Issues
• Project on Prosperity and Development
• Project on Trade and Technology
• Renewing American Innovation Project
• Scholl Chair in International Business
• Smart Women, Smart Power
• Southeast Asia Program
• Stephenson Ocean Security Project
• Strategic Technologies Program
• Wadhwani Center for AI and Advanced Technologies
• Warfare, Irregular Threats, and Terrorism Program
• All Regions
• Australia, New Zealand & Pacific
• Middle East
• Russia and Eurasia
• American Innovation
• Civic Education
• Climate Change
• Cybersecurity
• Defense Budget and Acquisition
• Defense and Security
• Energy and Sustainability
• Food Security
• Gender and International Security
• Geopolitics
• Global Health
• Human Rights
• Humanitarian Assistance
• Intelligence
• International Development
• Maritime Issues and Oceans
• Missile Defense
• Nuclear Issues
• Transnational Threats
• Water Security

The Future of the International System

Photo: KENA BETANCUR/AFP via Getty Images

Table of Contents

Report by James Andrew Lewis , Heather A. Conley, Ayse Kaya, and David G. Victor

Published August 26, 2021

Available Downloads

• Download the Full Report 1074kb

Messy Multilateralism, Networked Technology, and Pioneering Innovation

• Messy Multilateralism: Selective and Haphazard Cooperation in the New Global Economy (Ayse Kaya)
• The Role of Cyber and Emerging Technologies and its Impact on the International System (James Lewis)
• Rethinking Global Climate Strategy and Global Order (David G. Victor)

Introduction

Heather a. conley.

The great American baseball player and “philosopher,” Yogi Berra, famously said that if you come to a fork in the road, you should take it. Today, the international system stands at Berra’s fork and is heeding his advice by taking two roads simultaneously. The first road is the well-trodden one: the international community continues to practice multilateral diplomacy and follow the post-1945 international patterns of cooperation—but with fewer productive results. The second is an as-yet unchartered path of new patterns of behavior marked by technological competition and coercion, the revitalization and modernization of industrial policies, and a radical rethink of the role of governance and diplomacy. 

The terrain of this new road is explored with the help of three authors: Ayse Kaya, associate professor of political science, Swarthmore College; James A. Lewis, senior vice president, CSIS; and David Victor, professor, School of Global Policy and Strategy, University of California at San Diego. Each author was asked to write a short, imaginative essay that examined the three issues that will significantly shape the future international system: 1) global trade and inequality (Kaya), 2) the role of cyber and emerging technologies (Lewis), and 3) climate change and the global energy transition (Victor). The authors were tasked to answer what they believed the future nature of competition and conflict would be in their respective topic and what they considered the role or limitations of the nation state in addressing those challenges. Who will hold power in this new international system, and who may lose preferential status? What are the consequences of failure or resilience of national governments to address these global challenges?

The international system has been advancing toward this fork in the road for the past 30 years, accelerated in recent years by a rapid decline in multilateralism as the United States returned to its historical state of retrenchment and as China challenges the U.S.-led global order and its presence in the Indo-Pacific. This structural shift of heightened Sino-American confrontation, very different from the bipolarity of the Cold War era, occurs at a time when trans-national challenges—climate change, technological innovation, a global pandemic, as well as ethnic, racial, and political tensions—confront all nations and spur calls for collective action. In this transitory period, fluid trans-, sub-state, and private sector coalitions have emerged to fill regional power vacuums. Increasingly, cross-regional alignments such as the proposed “alliance of democracies,” the emergence of cities and private companies as independent foreign policy actors, and greater fusion between the public and private sectors are also features of this structural shift. 

There is no Google map or Waze app to navigate this new road, and the travelers of it seem “too tired, too divided, and without victors to negotiate the kind of new, U.S.-led order that was hashed out at the end of World War II,” as Professor Kaya notes in her piece, “Messy Multilateralism: Selective and Haphazard Cooperation in the New Global Economy . ” Messy is an apt description of the international system today and of global economic relations in general, wherein a powerful political backlash against globalization and rising social inequality have fueled demands for policy changes. Kaya draws on the fork in the road analogy to describe two paths for future global economic and trade relations as priorities shift away from multilateralism and toward national industrial policies and protection of supply chains. The first of these roads, “take control,” foresees a future global economic order that has states seeking to regulate more rigorously while they look inward to shield domestic industries. In contrast, the second road encourages some positive reforms to the current international economic system, such as collective debt relief and emergency lending during economic crises, to help temper the worst instincts of the “take control” path. While suggesting that there are positive signs that a reform of the existing international economic system is possible, Kaya concludes with a sobering note by suggesting that the most likely way forward is a piecemeal renegotiation of the current multilateral economic system; in the meantime, a scaling back of international commitments and foreign economic policies based on individual domestic needs seems inevitable.

Just as cooperative patterns related to global trade are in flux, the role of new digitally networked technologies has also fundamentally shifted power in the international system, according to Jim Lewis in his essay, “The Role of Cyber and Emerging Technologies and its Impact on the International System.” As Lewis argues, most countries with cyber capabilities use them to pursue their national objectives (espionage and surveillance), but for those countries that utilize cyber as a coercive tool—mainly Russia and China—cyber is now a “central arena for inter-state conflict.” Within a framework of global technological competition, “countries that are strong in creating new technologies have advantages,” and fortunately, for now, most “innovator nations” are Western democracies. But they confront forceful competitors. Lewis suggests that “new groups with processes” are needed “to accelerate growth, ensure technological parity, and protect democratic values.” While governments must ensure a framework for cooperation, the actual work will be done in the private sector. If Western nations can develop such processes, technological trends in power relations will shift in their favor.

David Victor’s essay, “Rethinking Global Climate Strategy and Global Order,” integrates Kaya’s concept of messy multilateralism as well as Lewis’ point on the need for new processes and interactions between governments and the private sector. Victor notes that 30 years of climate diplomacy has resulted in three global treaties but an increase in global emissions. When it comes to climate policy, a “radical rethinking of the role of governance and diplomacy” is needed. He observes, for example, that decarbonization success comes from “a series of revolutions that will begin within localized sectors and markets and then, with the right incentives, spread widely.” These technological revolutions are pursued by risk-taking and innovative technology pioneers that focus on niche technologies. As these technologies begin to show promise, pioneering clubs of countries may be formed, which can more rapidly spread successful climate technologies. While these climate networks are neither business nor government controlled, for profound technology change to occur, they will require public investment, business models that reward innovation, and “joint searches between business and government to test out new ideas and learn what works.”

What all three essayists convey is the need for something different in international governance. Old strategic doctrines and methods both restrain new thinking and are increasingly ineffectual—as climate diplomacy has demonstrated. In David Victor’s words, a “radicalized theory of change” may be required to break out of the old multilateralism and into the new. This radicalization emanates from a sense of global urgency and civic activism and will be enormously uncomfortable for elites trying to manage the international system as they always have. But to be successful in the new international system, these authors suggest that it is likely that we will renegotiate traditional multilateral approaches, a reality that reflects changing domestic political requirements and greater integration of other important stakeholders. 

Should these domestic requirements in part be fulfilled with a robust research and development base to support future technological innovation—which in turn fuels greater shared economic prosperity and incentivizes innovator nations to further develop more promising technologies which improve livelihoods globally —we might begin to see positive change in the international system and a new international approach. This is the promise, but it will be messy getting there. As Yogi Berra would say about the future, “It’s pretty far, but it doesn’t seem like it.”

Heather A. Conley is senior vice president for Europe, Eurasia, and the Arctic and director of the Europe, Russia, and Eurasia Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. 

Messy Multilateralism: Selective and Haphazard Cooperation in the New Global Economy

What trends will drive the future shape of the global economic order or the economic openness among countries governed by multilateral institutions? Under increasing pressure since the 2008 global financial crisis, the international economic system has been shaped by three overarching trends. These three trends will increasingly produce messy multilateralism with two realms of interaction between states, markets, and rules governing the global economy: (1) a “take control” sphere and (2) a “multilateral cooperation as we know it” with new cooperative struggles.

Background Trends

First, growing discontent with economic globalization will intensify, particularly following the global pandemic, as it has become painfully clear that global economic integration has left the  bottom classes in rich economies underserved . Second, while one could dispute the extent to which heightened economic insecurity (as opposed to nativist anti-immigration attitudes) has fueled it, populism—featuring a backlash against elites and foreign influences—has been on the rise, especially in rich economies. Third, intertwined with these developments is that U.S.-China tensions have become more visible—at first awkwardly in the Obama administration’s “Pivot to Asia” and then as a fully-fledged rivalry during the Trump administration. These tensions will likely persist during the Biden administration.

These developments suggest that the global economic order is at an inflection point. While disintegration and full reversal on economic integration and multilateral institutions are unlikely, the order is going to be marked by states’ changing priorities (e.g., industrial policies and diversified supply chains), which will lead to messy multilateralism containing selective and haphazard cooperation.

Messy Multilateralism and Its Realms

One can think of messy multilateralism as containing two major realms, or spheres. Realm 1, the “ take control” sphere, will feature states’ continued attempts to wrestle back control from global economic integration and international rules over what they consider and claim to be sensitive industries and markets. Covid-19 has had a significant impact in this area. Realm 1 is thus about restoring domestic primacy from preexisting international rules of integration for the major economies, as well as regulating and reining in markets (particularly digital markets and platforms). To be sure, this realm does not mean the absence of multilateralism or cooperation, but rather a negotiated multilateralism that rolls back previous dictates of the global economy. Hence, it will be the realm of change—either because multilateral rules are being renegotiated or because there will be a hiatus from the existing rules.

Global economic order is at an inflection point. The order is going to be marked by states’ changing priorities (e.g., industrial policies and diversified supply chains), which will lead to messy multilateralism containing selective and haphazard cooperation.

Realm 2 is the “multilateral cooperation as we know it” sphere, where states will continue to strive for cooperation under the rubric of existing multilateral institutions adorned with collaborative rhetoric. Even in this zone, however, struggles over cooperation will rise to the forefront.

These realms emerge from and impact the extant trends, suggesting that although the multilateral order will continue to prove sticky, states’ changing priorities will nonetheless reshape it to produce a “messy multilateralism” consisting of selective and haphazard cooperation.

Realm 1: Take Control

The Trump administration targeted the multilateral system by highlighting its weaknesses and blaming it for its ills. The Biden administration seeks to restore and reform the multilateral economic system and end longstanding disputes. For example, the Biden administration ended the U.S. resistance to appointing the former Nigerian finance minister, Ngozi Okonjo-Iweala, as the new director-general of the World Trade Organization (WTO). The end of the Trump administration, however, did not change one of the underlying long-term drivers of populist and hostile rhetoric against international organizations that makes it difficult for American leaders to holistically support multilateral economic integration.

Although the multilateral order will continue to prove sticky, states’ changing priorities will nonetheless reshape it to produce a “messy multilateralism” consisting of selective and haphazard cooperation.

Particularly, U.S. cheerleading for economic globalization has become difficult as distributional consequences of economic globalization in the country have come to the forefront, benefiting primarily high-income groups. Although there are many reasons for the widening income gap within the United States (including technology privileging higher-skilled workers and weakened labor institutions ), the impact of international trade—with China in particular—has created a non-negligible, “ China trade shock ,” which has been credited with fueling the rise of populist political candidates. Demonstrating greater political will for economic multilateralism and taming distributional effects of economic openness can partially alleviate structural constraints. Yet the reality remains: the United States must renegotiate economic openness to attenuate domestic inequalities and tame the rise of China.

As a result, aspects of the Trump administration’s policies toward the global economic order will persist under Biden. Although the Biden administration endorsed the preferred head for the WTO, for example, it continued the American refusal to consider any new nominees for appointment to the institution’s appellate body, which reviews the cases referred from the panels in the institution’s dispute settlement mechanism (DSM). The Biden administration appears to agree with its predecessor that the DSM— contrary to what the numbers suggest —has not worked for the United States and is too deferential to international rules over national priorities.

Additionally, a growing U.S.-China rivalry also has repercussions for the international trading system. The Biden administration, in one example, affirmed goods from Hong Kong labeled as “Made in China” despite protestations from Hong Kong. The Biden administration has also continued to maintain the U.S. policy position of China as a non-market economy (NME) in trade remedy cases, which has been a U.S. position since the 1980s. China’s 2001 accession to the WTO enhanced the importance of this issue as China claimed its WTO accession required the NME status to be changed by 2016 and launched a case against the United States and the European Union. The case ended up being suspended upon China’s request in 2019 when the Chinese realized they were unlikely to be victorious. NME status assumes heavy state intervention in the Chinese economy and eases the Department of Commerce’s imposing of anti-dumping duties on Chinese imports (dumping by China means products are sold at a lower cost than the cost of production or lower than in the Chinese market). From the U.S. perspective, NME status is necessary to maintain fair trade for U.S. producers, but from the Chinese perspective—and those relying on Chinese goods for their own production in the United States—it distorts multilateral trading. 

The United States must renegotiate economic openness to attenuate domestic inequalities and tame the rise of China.

Some continuation of Trump-era policies within the Biden administration can also be expected on the foreign direct investment (FDI) front. The Trump administration fully utilized an interagency committee, the Committee on Foreign Investment in the United States (CFIUS), which screens investment deals with national security implications by expanding the definitional flexibility in what constitutes national security, giving the committee greater power. The Trump administration bolstered this committee’s purview by requiring deals in 27 “critical technologies,” such as biotechnology or semiconductors, to be reported to the committee. This revision was directly linked to concerns about Chinese investments in these sectors. Since CFIUS investigations are generally not made public, it is difficult to detail how much the strengthened body has impacted Chinese investments. Yet the interagency’s bolstered position will remain, thanks to bipartisan support for heightened vigilance on foreign investments in the United States. 

Further boosting the “take control” sphere is Covid-19, which has underscored that all economies can be vulnerable to dependencies in various critical sectors and supply chains, such as the manufacture of personal protective equipment (PPE) and semiconductors. Critics of the Washington Consensus—development policies centered around liberalization and privatization of markets and their deregulation—have long argued that not all sectors are best left to the vagaries of interdependence and globalization, but Covid-19 intensified these concerns. Supply chain vulnerabilities and reliance on other countries for critical equipment rose to prominence during Covid-19, highlighting questions such as “who makes and exports medical equipment?” In 2018, China supplied over 40 percent of the world’s personal protective equipment (PPE), for instance. Once the crisis deepened, the question turned to restrictions on exports of medicine and vaccines. Both the Biden and Trump administrations have invoked the Defense Production Act in order to accelerate vaccine production in the United States. While the invocation has aimed to ease supply chain restrictions within the United States, critics have argued that it has caused supply problems elsewhere in the world. Overall, Covid-19 is a reminder that one can end up on the wrong side of Adam Smith’s powerful idea of division of labor, especially in a world where nationalistic instincts can easily impede global cooperation. Hence, it is best to take back control.

To be sure, states should be expected to bolster their efforts to rein in the markets for reasons that predate Covid-19. Particularly, there is a pressing imperative to ensure mobile capital returns greater societal benefit at a time of increasing social dissensus and deferred infrastructural maintenance in rich economies. Statutory corporate tax rates have been in decline since the 1980s , and the growing monopoly power of large technology companies accentuates gross disparities in the economic system. In this light, the Biden administration and the European Union recently announced their intentions to seek more tax revenue from capital and to channel it toward repairing infrastructure and post-Covid economic recovery, respectively.

The current moment offers an opportunity to tax capital more rigorously: states can move more firmly toward global rules on capital and business. Yet, some states will resist global standards because they undercut their own economic model, and the temptation to not coordinate will persist, with some countries moving quickly to take advantage of global capital, especially in the post-Covid-19 world. Simply, not everyone will be on board with scaling up regulation of global capital, which means states will be jostling among themselves to attract capital yet again. The temptation to not cooperate may be particularly appealing because the post-Covid-19 world will witness supply chain relocations and diversification as companies reconsider their production locations during the pandemic. To take control, however, states need to utilize this opportune moment cooperatively. In this respect, Realm 1 also offers an opportunity to fill the voids of international regulation. Hence, in this sphere, one might not just witness a retreat from multilateral rules but also a renegotiation of existing rules or the making of new ones when the control of markets are concerned.

Realm 2: International Cooperation as We Know It 

Realm 2 is marked by the status quo and states continuing cooperation over critical economic matters as they have done in the past. As global markets have become more integrated, global crises have become more frequent. In this context, the benefits of multilateral cooperation for facilitating financial and economic stability have only become more obvious. 

Even amid rivalries and oscillations in U.S. multilateralism, these institutions have been able to rely on their existing apparatus to function and lend funds because they do not only consist of state representatives but also international bureaucrats with an interest in the perpetuation of these institutions. Figure 1 below shows International Monetary Fund (IMF) lending since the 1980s, displaying remarkable levels of lending during the Covid-19 pandemic. The World Bank also reported to have made $160 billion available, with about 30 percent of these funds as grants or on concessional terms. Meanwhile, newcomers to development finance, particularly the Asian Infrastructure Investment Bank, have also revamped their lending lines to provide funds for the Covid-19 pandemic. 

Even with growing U.S.-China rivalry taken into consideration, international financial institutions will continue as central platforms. Undoubtedly, existing institutions are beset with problems that undermine their sturdiness. For instance, IMF conditionality has been controversial, and the institution is widely perceived as working more at the behest of its advanced economy member states—particularly the United States and the European Union, with the greatest voting power—than its developing country members. This has led to the build-up of foreign exchange reserves (as bulwarks against crises instead of borrowing from the IMF), particularly in Asia, as well as regional monetary cooperation. A new addition to these regional mechanisms is the BRICS’ (Brazil, Russia, India, China, and South Africa) Contingent Reserve Arrangements (CRA). These arrangements are, however, not ready to replace the IMF. In the case of the CRA, to access some of the funds, countries need to have a loan arrangement with the IMF, for example. 

The IMF has also been partially effective in its reform efforts. While incremental on the surface, reforms since 2008 reinvested some of the emerging economies’ energies back into the institution. In one example, the staff and the Executive Board utilized flexible rules to include Chinese currency in the basket of currencies that constitute the institution’s own unit of account, the Special Drawing Right (SDR). This has satisfied China’s long-term desire while also getting the country officials to recommit to IMF-preferred policies. Just as it is important not to exaggerate the institution’s changes, it is also crucial not to overlook them since they have given the institutions some renewed strength.

The next test for international financial institutions will be coordination on debt relief, as many lower-income economies are burdened with crushing levels of debt. The fact that Covid-19 funds from multiple multilateral economic institutions have been dispensed without tight coordination among different lenders (the Bretton Woods institutions attempted at some coordination ) raises particular concerns about debt in a fragmented multilateral lending system. Moreover, the rise of bilateral lending by China , which is not wholly transparent, compounds these concerns. Advanced countries are saddled with their own debt problem exacerbating the debt dynamics, and only one state, the United States, has the “exorbitant privilege” of issuing the world’s reserve currency. Even in Realm 2, multilateralism may look messier than usual, but this realm shows that the multilateral system will retain a number of its cooperative characteristics.

Note: The figure shows total outstanding IMF credit in the institution’s own unit of accounting (Special Drawing Right, SDR). GRA stands for General Resources Account, and PRGT denotes the Poverty Reduction and Growth Trust, which is reserved for low-income countries. The gray-shaded areas show the 2008 global crisis and the start of the Covid-19 pandemic.

Source: Author’s calculations from IMF, “IMF DATA,” online database, https://www.imf.org/en/Data .

Effective multilateral cooperation in Realm 2 can tame the self-help tendencies of Realm 1 and even offer common solutions to undesirable dimensions of economic globalization. This is unlikely to be a linear process, however. The world seems too tired, too divided, and without victors to negotiate the kind of new, U.S.-led order that was hashed out at the end of World War II. The current U.S. policy consensus, for example, appears in favor of reorienting U.S. foreign economic policy to be adjusted to work for the U.S. “ middle class ,” which calls for making trade “fair” for the public in conjunction with a national competitiveness strategy. This reorientation implies the United States needs to simultaneously renegotiate the existing order while also trying to scale back on its commitments, with the aim of having foreign policy more robustly serve domestic goals. Therein might lie the contradiction: U.S. leaders may find it difficult to both simultaneously reduce commitments while also renegotiating the economic system. Indeed, Realm 1’s potential for self-help inclinations can only be attenuated if the system has strong political leadership and a creative vision. But perhaps political vision and energies can be channeled to incrementally renegotiate that order, as the discussions on global capital taxation suggest. Unfortunately for this kind of focused or tidy multilateralism, the world will become more familiar with a United States that returns to multilateralism in a piecemeal and selective fashion as both the United States and its European partners look inward to overcome their domestic woes and outward to tame an ambitious Chinese global economic agenda. 

U.S. leaders may find it difficult to both simultaneously reduce commitments while also renegotiating the economic system.

Ayse Kaya is Associate Professor of Political Science at Swarthmore College.

The author thanks Mark Kuperberg, Jonathan Kay, and Matthew Salah for insightful comments on this piece.

The Role of Cyber and Emerging Technologies and its Impact on the International System

James Lewis

New technologies create economic and military power. This has been true for more than a century. The immediate focus is on digital, networked technologies. The centrality of digital network technologies to human activity puts a spotlight on their relevance for national security and highlights the importance of cyber operations. 

Cyberspace is a new and not always well-understood domain. The powerful influence of outdated strategic doctrine constrains new thinking that could help the United States and other democracies better defend their position in an era of strategic competition. The nature of cyber operations is significantly different from kinetic action, rendering some precedents from international affairs less useful. And while the private sector plays a key role in supplying software and services and expects to play a similarly key role in international cyber policy, it has an incomplete grasp of the requirements for a durable international strategy. All of these factors complicate democracies’ development of effective policies.

Cyber does not fundamentally change trends in international power. These trends are the decreased utility of post-1945 institutions and rules, the decline in Western global influence (particularly in Europe), and the emergence of new powers. The growing number of countries with cyber capabilities see them as another tool to pursue their national objectives. For most, this means espionage and surveillance, but for a few, cyber operations are a tool of coercion. Unfortunately for western democracies, the leading coercive actors are Russia, China, and in some instances, Iran (although its actions are mainly against its neighbors). This is not “grey zone conflict”—a nineteenth-century notion which implies some middle ground between war and peace. Cyber is not a grey zone but a central arena for inter-state conflict.

Russia is the source of the most dangerous coercive actions. Its intent is to weaken democratic opponents and create political unrest among allies, and it builds on its expertise and history of political interference. It has a well-developed doctrine for coercive cyber techniques. Russia has had some success and shows no sign of abandoning its long, occasionally covert campaign against the North Atlantic Treaty Organization (NATO) members. The failure of the West to react in any meaningful way has only encouraged the Russians and increased their influence.

China, while it has studied Russia’s coercive cyber operations, emphasizes cyber espionage as a key part of its national strategy. This important change highlights how the contours of interstate conflict have changed from Cold War-style military contests. This is not conventional political-military espionage, but spying aimed to provide China with commercial advantages and technological leadership, and ultimately a dominant global position. It, too, has had remarkable success; cyber espionage, combined with predatory commercial and trade practices and heavy government spending (often in contravention of China’s World Trade Organization (WTO) commitments), has made China the second most powerful economy in the world. China is strong in some technologies, such as autonomous vehicles, genetic engineering, and quantum encryption, but it lags across the board and Xi Jinping’s quest for tighter political control may slow its ability to innovate.

Cyber is not a grey zone but a central arena for inter-state conflict.

China's economic success and Russian aggression are one way technology has fundamentally shifted the balance of power. China and Russia are not dominant, but they hope to exploit the fraying of the post-1945 international order to advance their interests, undercut the democratic narrative, and reassert sovereign rights over universal values. Chinese leaders are firm in their belief that the United States and Europe are in irreversible decline and that Western policies are a form of containment. The Kremlin also believes the West is in decline due to their decadence (democratic values) and polarization (which their policies foment), but Russian leaders require contestation with the West to preserve the regime. Chinese leaders prefer Western acquiescence but are prepared for increased contestation. 

Cyber technologies enable coercive action and espionage. They also enable a struggle for control of the global political narrative and international operating system that shapes international power. Both Russia and China realize this, but both have had difficulty in articulating a compelling alternative narrative externally while maintaining complete control internally. Russia utilizes information as a weapon but does so as a defensive measure. Information is not a weapon, but it is a threat to internal political stability, especially to governments that lack mechanisms for accommodating dissent and political change. Both countries have their own constraining domestic political and economic dynamics and should not be viewed as unstoppable giants. But they have chosen conflict, albeit in unconventional forms, and cyber is the premier point of engagement.

Cyber actions and informational conflict take place in the context of a larger technological competition. Countries that are strong in creating new technologies have advantages, but there are only a handful of such countries, with China and Russia among them. Most “innovator nations” are Western democracies, but they now face forceful competitors. While many technologies are commercially available (so those who cannot make can buy), the leaders in innovation will always have a long-term advantage, and this favors the West.

In this contest, Europe and the United States have been handicapped by their own politics. In the 1990s, the United States cut investment in crucial public goods like science, technology, engineering, and mathematics (STEM) education and fundamental research. This weakened its innovation ecosystem. The European Union’s governance shortcomings and internal tensions between member states on industrial policy hampered the European Union's ability to create and capitalize on new technologies. One result of this was Europe’s failure to take advantage of the digital technology revolution that began in the 1990s. While the current leadership in Brussels is taking steps to remedy this, it faces a difficult task—especially since the departure of the United Kingdom means the loss of the European Union’s only major cyber power and of one of the world’s premier centers for technological innovation.

Europe has a strong research and engineering base, but a predilection for regulation can interfere with innovation and growth. Innovation is half the story; the other is entrepreneurship. Entrepreneurs turn research into product, but this requires an acceptance of risk not always found in European business culture. The result is that China has not displaced the United States technologically; it has displaced Europe.

This is not in the interest of the United States since it changes the international order in ways that are adverse for U.S. interests because a strong Europe is essential for American strategic interests. While Europe's confidence in the United States has been shaken—leading to more calls for “strategic autonomy”—and while its concern over its place in the digital world has led to similar calls for technological sovereignty, rebuilding a transatlantic partnership in digital technology is in the interest of both the United States and Europe. The formation of such a partnership remains ill-defined. The Biden administration has begun to change this, but it faces other issues, such as a lack of common transatlantic understanding of data protection, competitiveness policy, and content regulation.

One problem for the United States is that while it is likely the world’s leader in cyber espionage capabilities, it is espionage in service of what was, until recently, an erratic national strategy. The best intelligence in the world did not compensate for this. Additionally, while the United States still leads the world in technological innovation (although not by as much in the past), it is recovering from two decades of misdirected resources. Had even a fraction of the trillions of dollars spent in Iraq and Afghanistan been devoted to technology and innovation, the United States would be in a much stronger position in any global technology race. A lack of strategic focus in these new domains means that, in colloquial terms, the United States has been “punching below its weight” on the global stage.

Technology competition comes at a moment when today’s technological environment is being rapidly reshaped by cloud computing, artificial intelligence, and 5G (soon 6G) networks. There is a movement toward a hybrid environment where virtual and physical blend seamlessly. The nations that lead in this will have increased military and economic advantage. These current technologies will be followed by some hybrid realties applications, genetic engineering, and widespread automation. Technological change will remake business and societies by changing incentives and costs. This does not mean, however, that there will be mass unemployment. People will find new ways to create value. This has been true since the dawn of automation, and it will probably involve creating intangible goods and services. The fact that the creation of value and new jobs does not involve a linear, easily predictable process probably explains much of the anxiety and uncertainty over the next technological transition.

Compensating for the inevitable shifts in power created by digital technologies (combined with other factors) requires the United States to develop new ways to work with allies in Japan, Australia, and Europe to develop the commercial and military applications of emerging technologies such as quantum, biotech, and artificial intelligence. This cannot be an anti-China coalition but rather a new group with processes to accelerate growth, ensure technological parity, and protect democratic values. The central dilemma is that while governments must ensure a framework for cooperation, the actual work will be done in the private sector. If Western nations can develop such processes, it will shift the technological trends in power relations in their favor.

James A. Lewis is a senior vice president and director of the Strategic Technologies Program at CSIS.

Rethinking Global Climate Strategy and Global Order

David g. victor.

2021 marks the 30th anniversary of the start of UN-sponsored talks to address climate change. Over that period, climate diplomacy has become a nearly continuous activity that has produced three treaties: the UN Framework Convention on Climate Change (UNFCCC), the Kyoto Protocol, and the Paris Agreement. These agreements work by global consensus, which helps explain why the effect of this diplomacy on reducing actual warming is hard to discern. Global emissions have risen nearly every year since diplomacy began. The global temperature, already having warmed 1.2ºC since pre-industrial times, is set to blow through the widely discussed goal of stopping warming at 2ºC. 

Stopping warming requires cutting emissions of carbon dioxide (CO 2 ) and other warming pollutants nearly to zero. For advanced economies, this is expensive and hard to initiate because it implicates the competitiveness of modern industrial economies and could cause catastrophic harm to incumbent industries that are well organized politically. The need to help pay some of the costs of emissions control for developing nations is another obstacle to international cooperation through diplomatic negotiations. Overcoming such obstacles requires a radical rethinking of the role of governance and diplomacy. It requires active efforts to create new industries—and thus create new political interests—and it requires new thinking about which countries and industrial sectors will lead and follow. In a world where advanced market economies, led reliably by the United States, could set the pace for governance, it is possible to imagine that effective international arrangements might arise through institutionalized global diplomacy. But in the modern world, with fragmented control and ephemeral leadership, something different is needed. 

New Organizing Principles for Climate Governance: Niches and Clubs

Elimination of emissions or decarbonization of the economy requires technological revolutions in each of the emitting industries. But revolutions are rarely planned by consensus committees. Instead, they emerge in niches where pioneers see an advantage from change. Technologies advance in these niches, and the firms that back them gain political power in tandem with market share. In turn, those synergistic technological and political forces make it easier for new entrants to rewrite market rules to their advantage and, in time, crush polluting incumbents. This is a costly and risky sport and thus must initially occur in arenas that will tolerate or invite the changes. Pioneers bear the cost of first movement, but they also gain the reward by demonstrating and leading new business models that create confidence and erode political opposition elsewhere. Put differently, the leadership of pioneering action makes followership in the rest of the global market easier—and through the globalization of manufacturing and deployment of technology, this dynamic of leadership and followership can play out on a planetary scale. In climate change, it is followership that really matters, for most global emissions and growth in global emissions come from places that are far from the technological and political frontier. 

This niche-focused, pioneering approach to radical technological change is already playing out— although not fast enough nor as pervasively as needed for global transformation. For example, cheap solar power today is the result of niches created by pioneers , such as in Germany, where its bold, unilateral Energiewende policy and its precursors drove down costs through a rapid expansion in procurement. Now the rest of the world is enjoying a solar revolution that was initially funded by German taxpayers and electricity ratepayers. In time, the dominant position in solar manufacturing shifted to China, which is making solar panels at much lower prices—a benefit of globalization that is helping to accelerate the solar revolution across the planet. Revolutions in electricity storage (batteries), hydrogen production (electrolyzers), electric vehicles, clean steel, clean cement, and carbon capture and storage (CCS) are at various stages in the revolution—all emerging in niches. 

Pioneers bear the cost of first movement, but they also gain the reward by demonstrating and leading new business models that create confidence and erode political opposition elsewhere.

By this logic, the role of global diplomacy, tethered to global consensus, is relatively minor. At best, global diplomacy provides cover, justification, and legitimacy for niche policy investments that must occur rather than global planning. But the real work will happen in more focused settings, such as in distinct “clubs” of governments and industries in the sectors and the markets that are willing to go first—whether out of fear of being seen as a laggard or the hope of outsized opportunity that comes from going first.

Today, Europe is at the center of most of these “climate clubs.” One example of how a climate club has formed is the North Sea Northern Lights project—a huge system backed by Norway, the European Union, and three energy companies—that demonstrates how to use carbon capture and storage (CCS) technologies to cut industrial CO2 pollution in the North Sea.

Example of a Club for Carbon Capture and Storage: The North Sea Northern Lights project

CCS technologies could play a central role in deep decarbonization but making this approach economical hinges on achieving large-scale deployment—the capacity to apply CCS to huge volumes of emissions. Industrial hubs could play a central role in this process because many different highly concentrated industrial CO 2 sources—steel and cement plants, refineries, and power plants, for example—could be aggregated, and then the hubs could utilize a common infrastructure to move and inject the CO 2 safely underground.

There have been many ideas for industrial CO 2 hubs, but most of those ideas are little more than breezy speculation and some chalk lines drawn on maps. One of the few industrial hub CO 2 projects to advance is “Northern Lights”—a network of ships that will carry liquefied CO 2 from industrial sites around the North Sea to a common point in southern Norway and then injected underground at an offshore location. The project, a first of a kind, is not economical at current costs for emitting CO 2 and current regulations. Rather, it is a bet on a future where such projects will become economical once technologies improve and real firms have experience managing these systems. Because of its high risk, the project requires a public-private partnership with huge financial backstops from government. Following a vote of the Norwegian Parliament in December 2020, the project has reliable financial backing from Norway and is also making use of EU funding. The three industrial firms at the center of the project—Equinor, Shell, and Total—all have extensive experience with related projects and see experience earned through Northern Lights as a way to help create industries for a low-carbon future. 

The project reveals why working in small clubs is so important. The complex coordination needed to design and implement an industrial project is greatly facilitated by restricting membership to a small group of highly motivated firms with one clear lead (Equinor). What is most important is that the political arrangements needed to secure funding and implicit regulatory support for the project are easier to hammer out with fewer players—with the government of Norway in the lead. And because the matter was debated openly (and supported) in the Norwegian parliament, the policy support essential to moving the project forward was highly credible. 

Winners and Losers in the Decarbonization Revolution

Already it is possible to identify the characteristics of the likely winners and losers in the international system from this technological view of climate governance and politics. In terms of industries, the winners are certain to be electric power and industries that expand the utilization of electric power—from heat pumps to grid control systems designed to accommodate large amounts of clean renewable power. Almost every technical study of deep decarbonization arrives at the conclusion that decarbonization requires electrification. Compared to today, the world’s electric grids seem poised to supply two to three times the volume of electricity in a decarbonized world. The future of decarbonization is steeped in uncertainty, but the one thing that is virtually certain is that a clean future will be an electric one. After electricity, however, it is much harder to see exactly which industries are assured a prominent place in a decarbonized future. 

Looking to governments, the winners are likely to be nations that are skilled at opening, protecting, and expanding the niches where radical new low-carbon technologies will emerge—a task that, in effect, is climate industrial policy. Not all governments are good at doing this, for it requires the capacity to intervene heavily in the market yet not to pour state capital and other resources into white elephants in the desert. With awareness of the need for deep decarbonization, the flower of industrial policy is blooming again—albeit with little attention, for the most part, to where and how governments direct and maintain these skills. 

The future of decarbonization is steeped in uncertainty, but the one thing that is virtually certain is that a clean future will be an electric one.

The winners in low-carbon revolutions won’t be “industries” or “governments,” but combinations of the two as neither the private sector nor the state have the sole capacity needed to create the conditions needed for low-carbon technologies to thrive. Those conditions, many studies suggest, include: keeping the costs of capital low first and foremost, which means creating certainty for investors, such as assuring policy stability, while adopting business models that are insulated against risk. The energy systems of a carbon-free economy will probably have very low operating costs (e.g., little need to purchase coal or oil) in exchange for high fixed assets that will be affordable only if their costs are amortized over long time horizons. A growing number of studies show that deep decarbonization might be surprisingly inexpensive for society—free, perhaps—and essentially all of these studies hinge on the assumption of cheap capital that is adroitly deployed and well amortized. A second condition is skill in identifying promising new technologies. Often these technologies arise in networks that neither business nor government controls on its own—for example, electric vehicles that depend on global supply chains for materials and batteries, distinct supply chains for the vehicles themselves, and charging networks available at the same pace that customers need them. A third condition is continued profound technological change, which depends partly on investment in the public good of new knowledge, partly on firms with business models that reward innovation, and partly on joint searches between business and government to test out new ideas and learn what works. 

It is a useful exercise to ask which marriages of business and government will thrive under these conditions. There are many sector-government partnerships in Europe and in other places as well—from the electric utilities and suppliers in the California market to the state-based nuclear power agency in Abu Dhabi, where access to inexpensive capital has led to the construction of the first nuclear complex in the Arab world. One of the challenges in the United States will be that federal politics has become so polarized that it is increasingly difficult for the federal government to provide the kind of policy stability needed for success with deep decarbonization. In such settings, success in the real world may be found in domains within the country—state and local levels, often working with highly regulated firms and industries—rather than nationally. Most of the computer models used to assess the speed and cost of deep decarbonization are essentially unaware of how these conditions will condition the real-world deployment of capital and technology. 

For strategists who are thinking about how these kinds of conditions affect international governance, at least two broad implications will follow. One is that there will be large heterogeneity in the national response to deep decarbonization, not just because of variation in preferences but also because of variation in the marriages of these industry-government pairs. Successful systems for international governance will need to create space for the successful marriages to transform the world, rather than connecting the whole planet via consensus to the worst marriages around the planet. 

Second, successful decarbonization industrial policy will be indistinguishable from nationalistic industrial policy. Both involve deep intervention in the economy, propping up of national champions, and prodigious use of border measures (and other policies) to nurture infant industries. Down one path, the world’s suites of technologies are transformed, and climate change gets better. Down the nationalistic path, there is extensive onshoring of production lines but little of the synergistic technological advance needed to solve the planetary challenge of warming. The first path creates national benefits and international cooperation; the second path creates nationalism and erodes cooperation, similar to a “security dilemma” found in arms control where a country that seeks to bolster defense and produce more security often triggers a counter-buildup by others, eroding security. A decarbonization policy dilemma seems likely to unfold with similar logic.

The Consequences of Being Slow

Decarbonization success must come from a series of revolutions that will begin within localized sectors and markets and then, with the right incentives, spread widely. These processes will take time to gestate and may look like “muddling through” by actors who do not feel a sense of urgency. This is due to the fact that pervasive revolutions aren’t planned and orchestrated by central committees with command of every filigree in the global economy. Rather, they emerge from the filigrees. 

One result will be growing impatience. The interest groups concerned with climate are likely to become even more radicalized, which, frankly, has been the source of most climate policy and investment action thus far. When activists send letters about the need for climate action, firms forward them to the corporate social responsibility department. When activists chain or superglue themselves to the front door of the headquarters, the CEO pays attention. 

Decarbonization success must come from a series of revolutions that will begin within localized sectors and markets and then, with the right incentives, spread widely.

Responses to radicalized actions work not like an elegant carbon tax that tinkers with incentives to decarbonize at the margin. Rather, radicalization is a big sledgehammer that can be reckless in application, create catastrophic brand risks, and yield other severe consequences. The good news in this radicalization is that such forces will inspire more firms and governments to invest massively in finding solutions. This radicalized theory of change, which sits uncomfortably for elites, needs a lot more attention. Occupying the policy center of the road in these debates, as many analysts and leaders like to do, seems likely to generate a lot of policy roadkill.

Tragically, the slowness of these revolutions means that we are in for significant global warming. What will we do if climate change exceeds control? Technologies could be readied—with modest effort—to manage solar radiation and cool the planet, also known as geoengineering. The side effects are unknown and probably unknowable without deployment. The collective action problems, however, are easy to see: a big nation could do this on its own and thus transform the problem of difficult mutual transformation to restrain emissions into a problem of mutual restraint. In desperation, restraints may be hard to make fast.

David G. Victor is a professor of innovation and public policy at the School of Global Policy and Strategy at UC San Diego.

This report is made possible by the Ministry of Foreign Affairs of Norway.

This report is produced by the Center for Strategic and International Studies (CSIS), a private, tax- exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2021 by the Center for Strategic and International Studies. All rights reserved.

James Andrew Lewis

Programs & projects.

• Search Menu

Sign in through your institution

• Browse content in Arts and Humanities
• Browse content in Archaeology
• Anglo-Saxon and Medieval Archaeology
• Archaeological Methodology and Techniques
• Archaeology by Region
• Archaeology of Religion
• Archaeology of Trade and Exchange
• Biblical Archaeology
• Contemporary and Public Archaeology
• Environmental Archaeology
• Historical Archaeology
• History and Theory of Archaeology
• Industrial Archaeology
• Landscape Archaeology
• Mortuary Archaeology
• Prehistoric Archaeology
• Underwater Archaeology
• Urban Archaeology
• Zooarchaeology
• Browse content in Architecture
• Architectural Structure and Design
• History of Architecture
• Residential and Domestic Buildings
• Theory of Architecture
• Browse content in Art
• Art Subjects and Themes
• History of Art
• Industrial and Commercial Art
• Theory of Art
• Biographical Studies
• Byzantine Studies
• Browse content in Classical Studies
• Classical History
• Classical Philosophy
• Classical Mythology
• Classical Literature
• Classical Reception
• Classical Art and Architecture
• Classical Oratory and Rhetoric
• Greek and Roman Papyrology
• Greek and Roman Epigraphy
• Greek and Roman Law
• Greek and Roman Archaeology
• Late Antiquity
• Religion in the Ancient World
• Social History
• Digital Humanities
• Browse content in History
• Colonialism and Imperialism
• Diplomatic History
• Environmental History
• Genealogy, Heraldry, Names, and Honours
• Genocide and Ethnic Cleansing
• Historical Geography
• History by Period
• History of Emotions
• History of Agriculture
• History of Education
• History of Gender and Sexuality
• Industrial History
• Intellectual History
• International History
• Labour History
• Legal and Constitutional History
• Local and Family History
• Maritime History
• Military History
• National Liberation and Post-Colonialism
• Oral History
• Political History
• Public History
• Regional and National History
• Revolutions and Rebellions
• Slavery and Abolition of Slavery
• Social and Cultural History
• Theory, Methods, and Historiography
• Urban History
• World History
• Browse content in Language Teaching and Learning
• Language Learning (Specific Skills)
• Language Teaching Theory and Methods
• Browse content in Linguistics
• Applied Linguistics
• Cognitive Linguistics
• Computational Linguistics
• Forensic Linguistics
• Grammar, Syntax and Morphology
• Historical and Diachronic Linguistics
• History of English
• Language Evolution
• Language Reference
• Language Acquisition
• Language Variation
• Language Families
• Lexicography
• Linguistic Anthropology
• Linguistic Theories
• Linguistic Typology
• Phonetics and Phonology
• Psycholinguistics
• Sociolinguistics
• Translation and Interpretation
• Writing Systems
• Browse content in Literature
• Bibliography
• Children's Literature Studies
• Literary Studies (Romanticism)
• Literary Studies (American)
• Literary Studies (Asian)
• Literary Studies (European)
• Literary Studies (Eco-criticism)
• Literary Studies (Modernism)
• Literary Studies - World
• Literary Studies (1500 to 1800)
• Literary Studies (19th Century)
• Literary Studies (20th Century onwards)
• Literary Studies (African American Literature)
• Literary Studies (British and Irish)
• Literary Studies (Early and Medieval)
• Literary Studies (Fiction, Novelists, and Prose Writers)
• Literary Studies (Gender Studies)
• Literary Studies (Graphic Novels)
• Literary Studies (History of the Book)
• Literary Studies (Plays and Playwrights)
• Literary Studies (Poetry and Poets)
• Literary Studies (Postcolonial Literature)
• Literary Studies (Queer Studies)
• Literary Studies (Science Fiction)
• Literary Studies (Travel Literature)
• Literary Studies (War Literature)
• Literary Studies (Women's Writing)
• Literary Theory and Cultural Studies
• Mythology and Folklore
• Shakespeare Studies and Criticism
• Browse content in Media Studies
• Browse content in Music
• Applied Music
• Dance and Music
• Ethics in Music
• Ethnomusicology
• Gender and Sexuality in Music
• Medicine and Music
• Music Cultures
• Music and Media
• Music and Religion
• Music and Culture
• Music Education and Pedagogy
• Music Theory and Analysis
• Musical Scores, Lyrics, and Libretti
• Musical Structures, Styles, and Techniques
• Musicology and Music History
• Performance Practice and Studies
• Race and Ethnicity in Music
• Sound Studies
• Browse content in Performing Arts
• Browse content in Philosophy
• Aesthetics and Philosophy of Art
• Epistemology
• Feminist Philosophy
• History of Western Philosophy
• Metaphysics
• Moral Philosophy
• Non-Western Philosophy
• Philosophy of Language
• Philosophy of Mind
• Philosophy of Perception
• Philosophy of Science
• Philosophy of Action
• Philosophy of Law
• Philosophy of Religion
• Philosophy of Mathematics and Logic
• Practical Ethics
• Social and Political Philosophy
• Browse content in Religion
• Biblical Studies
• Christianity
• East Asian Religions
• History of Religion
• Judaism and Jewish Studies
• Qumran Studies
• Religion and Education
• Religion and Health
• Religion and Politics
• Religion and Science
• Religion and Law
• Religion and Art, Literature, and Music
• Religious Studies
• Browse content in Society and Culture
• Cookery, Food, and Drink
• Cultural Studies
• Customs and Traditions
• Ethical Issues and Debates
• Hobbies, Games, Arts and Crafts
• Natural world, Country Life, and Pets
• Popular Beliefs and Controversial Knowledge
• Sports and Outdoor Recreation
• Technology and Society
• Travel and Holiday
• Visual Culture
• Browse content in Law
• Arbitration
• Browse content in Company and Commercial Law
• Commercial Law
• Company Law
• Browse content in Comparative Law
• Systems of Law
• Competition Law
• Browse content in Constitutional and Administrative Law
• Government Powers
• Judicial Review
• Local Government Law
• Military and Defence Law
• Parliamentary and Legislative Practice
• Construction Law
• Contract Law
• Browse content in Criminal Law
• Criminal Procedure
• Criminal Evidence Law
• Sentencing and Punishment
• Employment and Labour Law
• Environment and Energy Law
• Browse content in Financial Law
• Banking Law
• Insolvency Law
• History of Law
• Human Rights and Immigration
• Intellectual Property Law
• Browse content in International Law
• Private International Law and Conflict of Laws
• Public International Law
• IT and Communications Law
• Jurisprudence and Philosophy of Law
• Law and Politics
• Law and Society
• Browse content in Legal System and Practice
• Courts and Procedure
• Legal Skills and Practice
• Primary Sources of Law
• Regulation of Legal Profession
• Medical and Healthcare Law
• Browse content in Policing
• Criminal Investigation and Detection
• Police and Security Services
• Police Procedure and Law
• Police Regional Planning
• Browse content in Property Law
• Personal Property Law
• Study and Revision
• Terrorism and National Security Law
• Browse content in Trusts Law
• Wills and Probate or Succession
• Browse content in Medicine and Health
• Browse content in Allied Health Professions
• Arts Therapies
• Clinical Science
• Dietetics and Nutrition
• Occupational Therapy
• Operating Department Practice
• Physiotherapy
• Radiography
• Speech and Language Therapy
• Browse content in Anaesthetics
• General Anaesthesia
• Neuroanaesthesia
• Clinical Neuroscience
• Browse content in Clinical Medicine
• Acute Medicine
• Cardiovascular Medicine
• Clinical Genetics
• Clinical Pharmacology and Therapeutics
• Dermatology
• Endocrinology and Diabetes
• Gastroenterology
• Genito-urinary Medicine
• Geriatric Medicine
• Infectious Diseases
• Medical Toxicology
• Medical Oncology
• Pain Medicine
• Palliative Medicine
• Rehabilitation Medicine
• Respiratory Medicine and Pulmonology
• Rheumatology
• Sleep Medicine
• Sports and Exercise Medicine
• Community Medical Services
• Critical Care
• Emergency Medicine
• Forensic Medicine
• Haematology
• History of Medicine
• Browse content in Medical Skills
• Clinical Skills
• Communication Skills
• Nursing Skills
• Surgical Skills
• Browse content in Medical Dentistry
• Oral and Maxillofacial Surgery
• Paediatric Dentistry
• Restorative Dentistry and Orthodontics
• Surgical Dentistry
• Medical Ethics
• Medical Statistics and Methodology
• Browse content in Neurology
• Clinical Neurophysiology
• Neuropathology
• Nursing Studies
• Browse content in Obstetrics and Gynaecology
• Gynaecology
• Occupational Medicine
• Ophthalmology
• Otolaryngology (ENT)
• Browse content in Paediatrics
• Neonatology
• Browse content in Pathology
• Chemical Pathology
• Clinical Cytogenetics and Molecular Genetics
• Histopathology
• Medical Microbiology and Virology
• Patient Education and Information
• Browse content in Pharmacology
• Psychopharmacology
• Browse content in Popular Health
• Caring for Others
• Complementary and Alternative Medicine
• Self-help and Personal Development
• Browse content in Preclinical Medicine
• Cell Biology
• Molecular Biology and Genetics
• Reproduction, Growth and Development
• Primary Care
• Professional Development in Medicine
• Browse content in Psychiatry
• Addiction Medicine
• Child and Adolescent Psychiatry
• Forensic Psychiatry
• Learning Disabilities
• Old Age Psychiatry
• Psychotherapy
• Browse content in Public Health and Epidemiology
• Epidemiology
• Public Health
• Browse content in Radiology
• Clinical Radiology
• Interventional Radiology
• Nuclear Medicine
• Radiation Oncology
• Reproductive Medicine
• Browse content in Surgery
• Cardiothoracic Surgery
• Gastro-intestinal and Colorectal Surgery
• General Surgery
• Neurosurgery
• Paediatric Surgery
• Peri-operative Care
• Plastic and Reconstructive Surgery
• Surgical Oncology
• Transplant Surgery
• Trauma and Orthopaedic Surgery
• Vascular Surgery
• Browse content in Science and Mathematics
• Browse content in Biological Sciences
• Aquatic Biology
• Biochemistry
• Bioinformatics and Computational Biology
• Developmental Biology
• Ecology and Conservation
• Evolutionary Biology
• Genetics and Genomics
• Microbiology
• Molecular and Cell Biology
• Natural History
• Plant Sciences and Forestry
• Research Methods in Life Sciences
• Structural Biology
• Systems Biology
• Zoology and Animal Sciences
• Browse content in Chemistry
• Analytical Chemistry
• Computational Chemistry
• Crystallography
• Environmental Chemistry
• Industrial Chemistry
• Inorganic Chemistry
• Materials Chemistry
• Medicinal Chemistry
• Mineralogy and Gems
• Organic Chemistry
• Physical Chemistry
• Polymer Chemistry
• Study and Communication Skills in Chemistry
• Theoretical Chemistry
• Browse content in Computer Science
• Artificial Intelligence
• Computer Architecture and Logic Design
• Game Studies
• Human-Computer Interaction
• Mathematical Theory of Computation
• Programming Languages
• Software Engineering
• Systems Analysis and Design
• Virtual Reality
• Browse content in Computing
• Business Applications
• Computer Security
• Computer Games
• Computer Networking and Communications
• Digital Lifestyle
• Graphical and Digital Media Applications
• Operating Systems
• Browse content in Earth Sciences and Geography
• Atmospheric Sciences
• Environmental Geography
• Geology and the Lithosphere
• Maps and Map-making
• Meteorology and Climatology
• Oceanography and Hydrology
• Palaeontology
• Physical Geography and Topography
• Regional Geography
• Soil Science
• Urban Geography
• Browse content in Engineering and Technology
• Agriculture and Farming
• Biological Engineering
• Civil Engineering, Surveying, and Building
• Electronics and Communications Engineering
• Energy Technology
• Engineering (General)
• Environmental Science, Engineering, and Technology
• History of Engineering and Technology
• Mechanical Engineering and Materials
• Technology of Industrial Chemistry
• Transport Technology and Trades
• Browse content in Environmental Science
• Applied Ecology (Environmental Science)
• Conservation of the Environment (Environmental Science)
• Environmental Sustainability
• Environmentalist Thought and Ideology (Environmental Science)
• Management of Land and Natural Resources (Environmental Science)
• Natural Disasters (Environmental Science)
• Nuclear Issues (Environmental Science)
• Pollution and Threats to the Environment (Environmental Science)
• Social Impact of Environmental Issues (Environmental Science)
• History of Science and Technology
• Browse content in Materials Science
• Ceramics and Glasses
• Composite Materials
• Metals, Alloying, and Corrosion
• Nanotechnology
• Browse content in Mathematics
• Applied Mathematics
• Biomathematics and Statistics
• History of Mathematics
• Mathematical Education
• Mathematical Finance
• Mathematical Analysis
• Numerical and Computational Mathematics
• Probability and Statistics
• Pure Mathematics
• Browse content in Neuroscience
• Cognition and Behavioural Neuroscience
• Development of the Nervous System
• Disorders of the Nervous System
• History of Neuroscience
• Invertebrate Neurobiology
• Molecular and Cellular Systems
• Neuroendocrinology and Autonomic Nervous System
• Neuroscientific Techniques
• Sensory and Motor Systems
• Browse content in Physics
• Astronomy and Astrophysics
• Atomic, Molecular, and Optical Physics
• Biological and Medical Physics
• Classical Mechanics
• Computational Physics
• Condensed Matter Physics
• Electromagnetism, Optics, and Acoustics
• History of Physics
• Mathematical and Statistical Physics
• Measurement Science
• Nuclear Physics
• Particles and Fields
• Plasma Physics
• Quantum Physics
• Relativity and Gravitation
• Semiconductor and Mesoscopic Physics
• Browse content in Psychology
• Affective Sciences
• Clinical Psychology
• Cognitive Psychology
• Cognitive Neuroscience
• Criminal and Forensic Psychology
• Developmental Psychology
• Educational Psychology
• Evolutionary Psychology
• Health Psychology
• History and Systems in Psychology
• Music Psychology
• Neuropsychology
• Organizational Psychology
• Psychological Assessment and Testing
• Psychology of Human-Technology Interaction
• Psychology Professional Development and Training
• Research Methods in Psychology
• Social Psychology
• Browse content in Social Sciences
• Browse content in Anthropology
• Anthropology of Religion
• Human Evolution
• Medical Anthropology
• Physical Anthropology
• Regional Anthropology
• Social and Cultural Anthropology
• Theory and Practice of Anthropology
• Browse content in Business and Management
• Business Ethics
• Business Strategy
• Business History
• Business and Technology
• Business and Government
• Business and the Environment
• Comparative Management
• Corporate Governance
• Corporate Social Responsibility
• Entrepreneurship
• Health Management
• Human Resource Management
• Industrial and Employment Relations
• Industry Studies
• Information and Communication Technologies
• International Business
• Knowledge Management
• Management and Management Techniques
• Operations Management
• Organizational Theory and Behaviour
• Pensions and Pension Management
• Public and Nonprofit Management
• Strategic Management
• Supply Chain Management
• Browse content in Criminology and Criminal Justice
• Criminal Justice
• Criminology
• Forms of Crime
• International and Comparative Criminology
• Youth Violence and Juvenile Justice
• Development Studies
• Browse content in Economics
• Agricultural, Environmental, and Natural Resource Economics
• Asian Economics
• Behavioural Finance
• Behavioural Economics and Neuroeconomics
• Econometrics and Mathematical Economics
• Economic History
• Economic Systems
• Economic Methodology
• Economic Development and Growth
• Financial Markets
• Financial Institutions and Services
• General Economics and Teaching
• Health, Education, and Welfare
• History of Economic Thought
• International Economics
• Labour and Demographic Economics
• Law and Economics
• Macroeconomics and Monetary Economics
• Microeconomics
• Public Economics
• Urban, Rural, and Regional Economics
• Welfare Economics
• Browse content in Education
• Adult Education and Continuous Learning
• Care and Counselling of Students
• Early Childhood and Elementary Education
• Educational Equipment and Technology
• Educational Strategies and Policy
• Higher and Further Education
• Organization and Management of Education
• Philosophy and Theory of Education
• Schools Studies
• Secondary Education
• Teaching of a Specific Subject
• Teaching of Specific Groups and Special Educational Needs
• Teaching Skills and Techniques
• Browse content in Environment
• Applied Ecology (Social Science)
• Climate Change
• Conservation of the Environment (Social Science)
• Environmentalist Thought and Ideology (Social Science)
• Natural Disasters (Environment)
• Social Impact of Environmental Issues (Social Science)
• Browse content in Human Geography
• Cultural Geography
• Economic Geography
• Political Geography
• Browse content in Interdisciplinary Studies
• Communication Studies
• Museums, Libraries, and Information Sciences
• Browse content in Politics
• African Politics
• Asian Politics
• Chinese Politics
• Comparative Politics
• Conflict Politics
• Elections and Electoral Studies
• Environmental Politics
• Ethnic Politics
• European Union
• Foreign Policy
• Gender and Politics
• Human Rights and Politics
• Indian Politics
• International Relations
• International Organization (Politics)
• International Political Economy
• Irish Politics
• Latin American Politics
• Middle Eastern Politics
• Political Behaviour
• Political Economy
• Political Institutions
• Political Methodology
• Political Communication
• Political Philosophy
• Political Sociology
• Political Theory
• Politics and Law
• Politics of Development
• Public Policy
• Public Administration
• Qualitative Political Methodology
• Quantitative Political Methodology
• Regional Political Studies
• Russian Politics
• Security Studies
• State and Local Government
• UK Politics
• US Politics
• Browse content in Regional and Area Studies
• African Studies
• Asian Studies
• East Asian Studies
• Japanese Studies
• Latin American Studies
• Middle Eastern Studies
• Native American Studies
• Scottish Studies
• Browse content in Research and Information
• Research Methods
• Browse content in Social Work
• Addictions and Substance Misuse
• Adoption and Fostering
• Care of the Elderly
• Child and Adolescent Social Work
• Couple and Family Social Work
• Direct Practice and Clinical Social Work
• Emergency Services
• Human Behaviour and the Social Environment
• International and Global Issues in Social Work
• Mental and Behavioural Health
• Social Justice and Human Rights
• Social Policy and Advocacy
• Social Work and Crime and Justice
• Social Work Macro Practice
• Social Work Practice Settings
• Social Work Research and Evidence-based Practice
• Welfare and Benefit Systems
• Browse content in Sociology
• Childhood Studies
• Community Development
• Comparative and Historical Sociology
• Economic Sociology
• Gender and Sexuality
• Gerontology and Ageing
• Health, Illness, and Medicine
• Marriage and the Family
• Migration Studies
• Occupations, Professions, and Work
• Organizations
• Population and Demography
• Race and Ethnicity
• Social Theory
• Social Movements and Social Change
• Social Research and Statistics
• Social Stratification, Inequality, and Mobility
• Sociology of Religion
• Sociology of Education
• Sport and Leisure
• Urban and Rural Studies
• Browse content in Warfare and Defence
• Defence Strategy, Planning, and Research
• Land Forces and Warfare
• Military Administration
• Military Life and Institutions
• Naval Forces and Warfare
• Other Warfare and Defence Issues
• Peace Studies and Conflict Resolution
• Weapons and Equipment

• < Previous chapter
• Next chapter >

2 The International Trading System and Its Future

Rachel McCulloch is Rosen Family Professor of International Finance in the Department of Economics and the International Business School at Brandeis University. Prior to joining the Brandeis faculty in 1987, she taught at the University of Chicago, Harvard University, and the University of Wisconsin-Madison. In 2004–2005, she was the AGIP Professor of International Economics at the Bologna Center of the Johns Hopkins School of Advanced International Studies. She currently serves on the Academic Advisory Council of the Federal Reserve Bank of Boston and the Advisory Committee of the Peterson Institute for International Economics, Washington, D.C. She has also been a consultant to the Asian Development Bank and the World Bank and a member of the Technology Assessment Advisory Council of the U.S. Congressional Office of Technology Assessment (1979–1987), the President’s Commission on Industrial Competitiveness (1984–1985), and the Committee on International Relations Studies with the People’s Republic of China (1984–1992). She holds a Ph.D. in economics from the University of Chicago.

• Published: 18 September 2012
• Cite Icon Cite
• Permissions Icon Permissions

This article discusses the international trading system. Section 1 begins by describing the evolution and structure of the General Agreement on Tariffs and Trade/World Trade Organization (GATT/WTO) system. Section 2 deals with the tension between the fundamental GATT/WTO principle of most-favored-nation treatment, that is, nondiscrimination among trading partners, and the trend toward discriminatory trading arrangements, including the proliferation of regional agreements, as well as new versions of special and differential treatment of low-income countries. Section 3 focuses on participation of developing countries in the system and the effort to use special treatment to promote development objectives. Section 4 discusses the pressure to use the enforcement power of the GATT/WTO system to achieve member compliance with social norms in the areas of environment and labor. Section 5 assesses some significant challenges that currently face the international trading system. Section 6 concludes by considering possible directions of the system's evolution in response to these challenges.

Personal account

• Sign in with email/username & password
• Get email alerts
• Save searches
• Purchase content
• Activate your purchase/trial code
• Add your ORCID iD

Institutional access

Sign in with a library card.

• Sign in with username/password
• Recommend to your librarian
• Institutional account management
• Get help with access

Access to content on Oxford Academic is often provided through institutional subscriptions and purchases. If you are a member of an institution with an active account, you may be able to access content in one of the following ways:

IP based access

Typically, access is provided across an institutional network to a range of IP addresses. This authentication occurs automatically, and it is not possible to sign out of an IP authenticated account.

Choose this option to get remote access when outside your institution. Shibboleth/Open Athens technology is used to provide single sign-on between your institution’s website and Oxford Academic.

• Click Sign in through your institution.
• Select your institution from the list provided, which will take you to your institution's website to sign in.
• When on the institution site, please use the credentials provided by your institution. Do not use an Oxford Academic personal account.
• Following successful sign in, you will be returned to Oxford Academic.

If your institution is not listed or you cannot sign in to your institution’s website, please contact your librarian or administrator.

Enter your library card number to sign in. If you cannot sign in, please contact your librarian.

Society Members

Society member access to a journal is achieved in one of the following ways:

Sign in through society site

Many societies offer single sign-on between the society website and Oxford Academic. If you see ‘Sign in through society site’ in the sign in pane within a journal:

• Click Sign in through society site.
• When on the society site, please use the credentials provided by that society. Do not use an Oxford Academic personal account.

If you do not have a society account or have forgotten your username or password, please contact your society.

Sign in using a personal account

Some societies use Oxford Academic personal accounts to provide access to their members. See below.

A personal account can be used to get email alerts, save searches, purchase content, and activate subscriptions.

Some societies use Oxford Academic personal accounts to provide access to their members.

Viewing your signed in accounts

Click the account icon in the top right to:

• View your signed in personal account and access account management features.
• View the institutional accounts that are providing access.

Signed in but can't access content

Oxford Academic is home to a wide variety of products. The institutional subscription may not cover the content that you are trying to access. If you believe you should have access to that content, please contact your librarian.

For librarians and administrators, your personal account also provides access to institutional account management. Here you will find options to view and activate subscriptions, manage institutional settings and access options, access usage statistics, and more.

Our books are available by subscription or purchase to libraries and institutions.

• About Oxford Academic
• Publish journals with us
• University press partners
• What we publish
• New features  
• Open access
• Rights and permissions
• Accessibility
• Advertising
• Media enquiries
• Oxford University Press
• Oxford Languages
• University of Oxford

Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide

• Copyright © 2024 Oxford University Press
• Cookie settings
• Cookie policy
• Privacy policy
• Legal notice

This Feature Is Available To Subscribers Only

Sign In or Create an Account

This PDF is available to Subscribers Only

For full access to this pdf, sign in to an existing account, or purchase an annual subscription.

• Advanced Search

Browse Theses

January 2020

• University of Oregon
• Committee Members:
• United States

Through trade policy actions, decades of global trade liberalization have resulted in lower formal trade barriers. However, there remain significant barriers to trade that fall outside the realm of traditional policy tools. This dissertation analyzes two under-studied non-tariff trade barriers: natural disasters and rules of origin. While there are fundamental differences in how these trade barriers arise, both natural disasters and rules of origin have meaningful implications for the functioning of global trade systems, the formation of global value chains, and consumer welfare. The three essays in this dissertation provide evidence that these under-studied trade barriers have a significant impact on trade flows. In Chapter II, I find that rules of origin liberalization can restore preferential market access and improve firm-level export growth in least-developed countries (LDCs). In Chapter III, I find evidence that hurricanes reduce trade volumes from US ports, and that the effect is highly persistent. Finally, in Chapter IV, using detailed data on international shipments, I show that hurricane activity around US ports-of-exit affects aggregate exports through price indices, and as a result, affects average consumer welfare. In the case of rules of origin, the results highlight the crucial role that non-tariff barriers play in the formation of trade agreements. In the case of natural disasters, the findings presented in this dissertation highlight the importance of designing policy aimed at addressing unexpected shocks to global trade.

Save to Binder

• Publication Years 2020 - 2020
• Publication counts 1
• Citation count 0
• Available for Download 0
• Downloads (cumulative) 0
• Downloads (12 months) 0
• Downloads (6 weeks) 0
• Average Downloads per Article 0
• Average Citation per Article 0
• Publication Years
• Publication counts 0

Index Terms

Applied computing

Enterprise computing

Law, social and behavioral sciences

Recommendations

Essays in international trade and russian trade policy, essays on international trade and policy, three essays on international trade and productivity, export citations.

• Please download or close your previous search result export first before starting a new bulk export. Preview is not available. By clicking download, a status dialog will open to start the export process. The process may take a few minutes but once it finishes a file will be downloadable from your browser. You may continue to browse the DL while the export process is in progress. Download
• Download citation
• Copy citation

We are preparing your search results for download ...

We will inform you here when the file is ready.

Your file of search results citations is now ready.

Your search export query has expired. Please try again.

• Lifestyles & Social Issues
• Philosophy & Religion
• Politics, Law & Government
• World History
• Health & Medicine
• Browse Biographies
• Birds, Reptiles & Other Vertebrates
• Bugs, Mollusks & Other Invertebrates
• Environment
• Fossils & Geologic Time
• Geography & Travel
• Entertainment & Pop Culture
• Sports & Recreation
• Visual Arts

• Introduction

Historical overview

• The theory of international trade
• State interference in international trade
• Contemporary trade policies
• Patterns of trade

international trade

international trade , economic transactions that are made between countries. Among the items commonly traded are consumer goods, such as television sets and clothing; capital goods, such as machinery; and raw materials and food. Other transactions involve services, such as travel services and payments for foreign patents ( see service industry ). International trade transactions are facilitated by international financial payments, in which the private banking system and the central banks of the trading nations play important roles.

International trade and the accompanying financial transactions are generally conducted for the purpose of providing a nation with commodities it lacks in exchange for those that it produces in abundance; such transactions, functioning with other economic policies, tend to improve a nation’s standard of living . Much of the modern history of international relations concerns efforts to promote freer trade between nations. This article provides a historical overview of the structure of international trade and of the leading institutions that were developed to promote such trade.

The barter of goods or services among different peoples is an age-old practice, probably as old as human history. International trade, however, refers specifically to an exchange between members of different nations , and accounts and explanations of such trade begin (despite fragmentary earlier discussion) only with the rise of the modern nation-state at the close of the European Middle Ages. As political thinkers and philosophers began to examine the nature and function of the nation, trade with other countries became a particular topic of their inquiry. It is, accordingly, no surprise to find one of the earliest attempts to describe the function of international trade within that highly nationalistic body of thought now known as mercantilism .

Mercantilism

Mercantilist analysis, which reached the peak of its influence upon European thought in the 16th and 17th centuries, focused directly upon the welfare of the nation. It insisted that the acquisition of wealth, particularly wealth in the form of gold , was of paramount importance for national policy. Mercantilists took the virtues of gold almost as an article of faith; consequently, they never sought to explain adequately why the pursuit of gold deserved such a high priority in their economic plans.

Mercantilism was based on the conviction that national interests are inevitably in conflict—that one nation can increase its trade only at the expense of other nations. Thus, governments were led to impose price and wage controls, foster national industries, promote exports of finished goods and imports of raw materials, while at the same time limiting the exports of raw materials and the imports of finished goods. The state endeavoured to provide its citizens with a monopoly of the resources and trade outlets of its colonies.

The trade policy dictated by mercantilist philosophy was accordingly simple: encourage exports, discourage imports, and take the proceeds of the resulting export surplus in gold. Mercantilists’ ideas often were intellectually shallow, and indeed their trade policy may have been little more than a rationalization of the interests of a rising merchant class that wanted wider markets—hence the emphasis on expanding exports—coupled with protection against competition in the form of imported goods.

A typical illustration of the mercantilist spirit is the English Navigation Act of 1651, which reserved for the home country the right to trade with its colonies and prohibited the import of goods of non-European origin unless transported in ships flying the English flag. This law lingered until 1849. A similar policy was followed in France.

A strong reaction against mercantilist attitudes began to take shape toward the middle of the 18th century. In France, the economists known as Physiocrats demanded liberty of production and trade . In England, economist Adam Smith demonstrated in his book The Wealth of Nations (1776) the advantages of removing trade restrictions. Economists and businessmen voiced their opposition to excessively high and often prohibitive customs duties and urged the negotiation of trade agreements with foreign powers. This change in attitudes led to the signing of a number of agreements embodying the new liberal ideas about trade, among them the Anglo-French Treaty of 1786, which ended what had been an economic war between the two countries.

After Adam Smith, the basic tenets of mercantilism were no longer considered defensible. This did not, however, mean that nations abandoned all mercantilist policies. Restrictive economic policies were now justified by the claim that, up to a certain point, the government should keep foreign merchandise off the domestic market in order to shelter national production from outside competition. To this end, customs levies were introduced in increasing number, replacing outright bans on imports, which became less and less frequent.

In the middle of the 19th century, a protective customs policy effectively sheltered many national economies from outside competition. The French tariff of 1860, for example, charged extremely high rates on British products: 60 percent on pig iron; 40 to 50 percent on machinery; and 600 to 800 percent on woolen blankets. Transport costs between the two countries provided further protection.

A triumph for liberal ideas was the Anglo-French trade agreement of 1860 , which provided that French protective duties were to be reduced to a maximum of 25 percent within five years, with free entry of all French products except wines into Britain. This agreement was followed by other European trade pacts.

Resurgence of protectionism

A reaction in favour of protection spread throughout the Western world in the latter part of the 19th century. Germany adopted a systematically protectionist policy and was soon followed by most other nations. Shortly after 1860, during the Civil War , the United States raised its duties sharply; the McKinley Tariff Act of 1890 was ultraprotectionist. The United Kingdom was the only country to remain faithful to the principles of free trade .

But the protectionism of the last quarter of the 19th century was mild by comparison with the mercantilist policies that had been common in the 17th century and were to be revived between the two world wars. Extensive economic liberty prevailed by 1913. Quantitative restrictions were unheard of, and customs duties were low and stable. Currencies were freely convertible into gold, which in effect was a common international money . Balance-of-payments problems were few. People who wished to settle and work in a country could go where they wished with few restrictions; they could open businesses, enter trade, or export capital freely. Equal opportunity to compete was the general rule, the sole exception being the existence of limited customs preferences between certain countries, most usually between a home country and its colonies. Trade was freer throughout the Western world in 1913 than it was in Europe in 1970.

Want to create or adapt books like this? Learn more about how Pressbooks supports open publishing practices.

2.1 What Is International Trade Theory?

Learning objectives.

• Understand international trade.
• Compare and contrast different trade theories.
• Determine which international trade theory is most relevant today and how it continues to evolve.

What Is International Trade?

International trade theories are simply different theories to explain international trade. Trade is the concept of exchanging goods and services between two people or entities. International trade is then the concept of this exchange between people or entities in two different countries.

People or entities trade because they believe that they benefit from the exchange. They may need or want the goods or services. While at the surface, this many sound very simple, there is a great deal of theory, policy, and business strategy that constitutes international trade.

In this section, you’ll learn about the different trade theories that have evolved over the past century and which are most relevant today. Additionally, you’ll explore the factors that impact international trade and how businesses and governments use these factors to their respective benefits to promote their interests.

What Are the Different International Trade Theories?

People have engaged in trade for thousands of years. Ancient history provides us with rich examples such as the Silk Road—the land and water trade routes that covered more than four thousand miles and connected the Mediterranean with Asia.

Wikimedia Commons – public domain.

“Around 5,200 years ago, Uruk, in southern Mesopotamia, was probably the first city the world had ever seen, housing more than 50,000 people within its six miles of wall. Uruk, its agriculture made prosperous by sophisticated irrigation canals, was home to the first class of middlemen, trade intermediaries…A cooperative trade network…set the pattern that would endure for the next 6,000 years” (Ridley, 2010).

In more recent centuries, economists have focused on trying to understand and explain these trade patterns. Chapter 1 “Introduction” , Section 1.4 “The Globalization Debate” discussed how Thomas Friedman’s flat-world approach segments history into three stages: Globalization 1.0 from 1492 to 1800, 2.0 from 1800 to 2000, and 3.0 from 2000 to the present. In Globalization 1.0, nations dominated global expansion. In Globalization 2.0, multinational companies ascended and pushed global development. Today, technology drives Globalization 3.0.

To better understand how modern global trade has evolved, it’s important to understand how countries traded with one another historically. Over time, economists have developed theories to explain the mechanisms of global trade. The main historical theories are called classical and are from the perspective of a country, or country-based. By the mid-twentieth century, the theories began to shift to explain trade from a firm, rather than a country, perspective. These theories are referred to as modern and are firm-based or company-based. Both of these categories, classical and modern, consist of several international theories.

Classical or Country-Based Trade Theories

Mercantilism.

Developed in the sixteenth century, mercantilism was one of the earliest efforts to develop an economic theory. This theory stated that a country’s wealth was determined by the amount of its gold and silver holdings. In it’s simplest sense, mercantilists believed that a country should increase its holdings of gold and silver by promoting exports and discouraging imports. In other words, if people in other countries buy more from you (exports) than they sell to you (imports), then they have to pay you the difference in gold and silver. The objective of each country was to have a trade surplus , or a situation where the value of exports are greater than the value of imports, and to avoid a trade deficit , or a situation where the value of imports is greater than the value of exports.

A closer look at world history from the 1500s to the late 1800s helps explain why mercantilism flourished. The 1500s marked the rise of new nation-states, whose rulers wanted to strengthen their nations by building larger armies and national institutions. By increasing exports and trade, these rulers were able to amass more gold and wealth for their countries. One way that many of these new nations promoted exports was to impose restrictions on imports. This strategy is called protectionism and is still used today.

Nations expanded their wealth by using their colonies around the world in an effort to control more trade and amass more riches. The British colonial empire was one of the more successful examples; it sought to increase its wealth by using raw materials from places ranging from what are now the Americas and India. France, the Netherlands, Portugal, and Spain were also successful in building large colonial empires that generated extensive wealth for their governing nations.

Although mercantilism is one of the oldest trade theories, it remains part of modern thinking. Countries such as Japan, China, Singapore, Taiwan, and even Germany still favor exports and discourage imports through a form of neo-mercantilism in which the countries promote a combination of protectionist policies and restrictions and domestic-industry subsidies. Nearly every country, at one point or another, has implemented some form of protectionist policy to guard key industries in its economy. While export-oriented companies usually support protectionist policies that favor their industries or firms, other companies and consumers are hurt by protectionism. Taxpayers pay for government subsidies of select exports in the form of higher taxes. Import restrictions lead to higher prices for consumers, who pay more for foreign-made goods or services. Free-trade advocates highlight how free trade benefits all members of the global community, while mercantilism’s protectionist policies only benefit select industries, at the expense of both consumers and other companies, within and outside of the industry.

Absolute Advantage

In 1776, Adam Smith questioned the leading mercantile theory of the time in The Wealth of Nations (Smith, 1776). Smith offered a new trade theory called absolute advantage , which focused on the ability of a country to produce a good more efficiently than another nation. Smith reasoned that trade between countries shouldn’t be regulated or restricted by government policy or intervention. He stated that trade should flow naturally according to market forces. In a hypothetical two-country world, if Country A could produce a good cheaper or faster (or both) than Country B, then Country A had the advantage and could focus on specializing on producing that good. Similarly, if Country B was better at producing another good, it could focus on specialization as well. By specialization, countries would generate efficiencies, because their labor force would become more skilled by doing the same tasks. Production would also become more efficient, because there would be an incentive to create faster and better production methods to increase the specialization.

Smith’s theory reasoned that with increased efficiencies, people in both countries would benefit and trade should be encouraged. His theory stated that a nation’s wealth shouldn’t be judged by how much gold and silver it had but rather by the living standards of its people.

Comparative Advantage

The challenge to the absolute advantage theory was that some countries may be better at producing both goods and, therefore, have an advantage in many areas. In contrast, another country may not have any useful absolute advantages. To answer this challenge, David Ricardo, an English economist, introduced the theory of comparative advantage in 1817. Ricardo reasoned that even if Country A had the absolute advantage in the production of both products, specialization and trade could still occur between two countries.

Comparative advantage occurs when a country cannot produce a product more efficiently than the other country; however, it can produce that product better and more efficiently than it does other goods. The difference between these two theories is subtle. Comparative advantage focuses on the relative productivity differences, whereas absolute advantage looks at the absolute productivity.

Let’s look at a simplified hypothetical example to illustrate the subtle difference between these principles. Miranda is a Wall Street lawyer who charges $500 per hour for her legal services. It turns out that Miranda can also type faster than the administrative assistants in her office, who are paid $40 per hour. Even though Miranda clearly has the absolute advantage in both skill sets, should she do both jobs? No. For every hour Miranda decides to type instead of do legal work, she would be giving up $460 in income. Her productivity and income will be highest if she specializes in the higher-paid legal services and hires the most qualified administrative assistant, who can type fast, although a little slower than Miranda. By having both Miranda and her assistant concentrate on their respective tasks, their overall productivity as a team is higher. This is comparative advantage. A person or a country will specialize in doing what they do relatively better. In reality, the world economy is more complex and consists of more than two countries and products. Barriers to trade may exist, and goods must be transported, stored, and distributed. However, this simplistic example demonstrates the basis of the comparative advantage theory.

Heckscher-Ohlin Theory (Factor Proportions Theory)

The theories of Smith and Ricardo didn’t help countries determine which products would give a country an advantage. Both theories assumed that free and open markets would lead countries and producers to determine which goods they could produce more efficiently. In the early 1900s, two Swedish economists, Eli Heckscher and Bertil Ohlin, focused their attention on how a country could gain comparative advantage by producing products that utilized factors that were in abundance in the country. Their theory is based on a country’s production factors—land, labor, and capital, which provide the funds for investment in plants and equipment. They determined that the cost of any factor or resource was a function of supply and demand. Factors that were in great supply relative to demand would be cheaper; factors in great demand relative to supply would be more expensive. Their theory, also called the factor proportions theory , stated that countries would produce and export goods that required resources or factors that were in great supply and, therefore, cheaper production factors. In contrast, countries would import goods that required resources that were in short supply, but higher demand.

For example, China and India are home to cheap, large pools of labor. Hence these countries have become the optimal locations for labor-intensive industries like textiles and garments.

Leontief Paradox

In the early 1950s, Russian-born American economist Wassily W. Leontief studied the US economy closely and noted that the United States was abundant in capital and, therefore, should export more capital-intensive goods. However, his research using actual data showed the opposite: the United States was importing more capital-intensive goods. According to the factor proportions theory, the United States should have been importing labor-intensive goods, but instead it was actually exporting them. His analysis became known as the Leontief Paradox because it was the reverse of what was expected by the factor proportions theory. In subsequent years, economists have noted historically at that point in time, labor in the United States was both available in steady supply and more productive than in many other countries; hence it made sense to export labor-intensive goods. Over the decades, many economists have used theories and data to explain and minimize the impact of the paradox. However, what remains clear is that international trade is complex and is impacted by numerous and often-changing factors. Trade cannot be explained neatly by one single theory, and more importantly, our understanding of international trade theories continues to evolve.

Modern or Firm-Based Trade Theories

In contrast to classical, country-based trade theories, the category of modern, firm-based theories emerged after World War II and was developed in large part by business school professors, not economists. The firm-based theories evolved with the growth of the multinational company (MNC). The country-based theories couldn’t adequately address the expansion of either MNCs or intraindustry trade , which refers to trade between two countries of goods produced in the same industry. For example, Japan exports Toyota vehicles to Germany and imports Mercedes-Benz automobiles from Germany.

Unlike the country-based theories, firm-based theories incorporate other product and service factors, including brand and customer loyalty, technology, and quality, into the understanding of trade flows.

Country Similarity Theory

Swedish economist Steffan Linder developed the country similarity theory in 1961, as he tried to explain the concept of intraindustry trade. Linder’s theory proposed that consumers in countries that are in the same or similar stage of development would have similar preferences. In this firm-based theory, Linder suggested that companies first produce for domestic consumption. When they explore exporting, the companies often find that markets that look similar to their domestic one, in terms of customer preferences, offer the most potential for success. Linder’s country similarity theory then states that most trade in manufactured goods will be between countries with similar per capita incomes, and intraindustry trade will be common. This theory is often most useful in understanding trade in goods where brand names and product reputations are important factors in the buyers’ decision-making and purchasing processes.

Product Life Cycle Theory

Raymond Vernon, a Harvard Business School professor, developed the product life cycle theory in the 1960s. The theory, originating in the field of marketing, stated that a product life cycle has three distinct stages: (1) new product, (2) maturing product, and (3) standardized product. The theory assumed that production of the new product will occur completely in the home country of its innovation. In the 1960s this was a useful theory to explain the manufacturing success of the United States. US manufacturing was the globally dominant producer in many industries after World War II.

It has also been used to describe how the personal computer (PC) went through its product cycle. The PC was a new product in the 1970s and developed into a mature product during the 1980s and 1990s. Today, the PC is in the standardized product stage, and the majority of manufacturing and production process is done in low-cost countries in Asia and Mexico.

The product life cycle theory has been less able to explain current trade patterns where innovation and manufacturing occur around the world. For example, global companies even conduct research and development in developing markets where highly skilled labor and facilities are usually cheaper. Even though research and development is typically associated with the first or new product stage and therefore completed in the home country, these developing or emerging-market countries, such as India and China, offer both highly skilled labor and new research facilities at a substantial cost advantage for global firms.

Global Strategic Rivalry Theory

Global strategic rivalry theory emerged in the 1980s and was based on the work of economists Paul Krugman and Kelvin Lancaster. Their theory focused on MNCs and their efforts to gain a competitive advantage against other global firms in their industry. Firms will encounter global competition in their industries and in order to prosper, they must develop competitive advantages. The critical ways that firms can obtain a sustainable competitive advantage are called the barriers to entry for that industry. The barriers to entry refer to the obstacles a new firm may face when trying to enter into an industry or new market. The barriers to entry that corporations may seek to optimize include:

• research and development,
• the ownership of intellectual property rights,
• economies of scale,
• unique business processes or methods as well as extensive experience in the industry, and
• the control of resources or favorable access to raw materials.

Porter’s National Competitive Advantage Theory

In the continuing evolution of international trade theories, Michael Porter of Harvard Business School developed a new model to explain national competitive advantage in 1990. Porter’s theory stated that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. His theory focused on explaining why some nations are more competitive in certain industries. To explain his theory, Porter identified four determinants that he linked together. The four determinants are (1) local market resources and capabilities, (2) local market demand conditions, (3) local suppliers and complementary industries, and (4) local firm characteristics.

• Local market resources and capabilities (factor conditions). Porter recognized the value of the factor proportions theory, which considers a nation’s resources (e.g., natural resources and available labor) as key factors in determining what products a country will import or export. Porter added to these basic factors a new list of advanced factors, which he defined as skilled labor, investments in education, technology, and infrastructure. He perceived these advanced factors as providing a country with a sustainable competitive advantage.
• Local market demand conditions. Porter believed that a sophisticated home market is critical to ensuring ongoing innovation, thereby creating a sustainable competitive advantage. Companies whose domestic markets are sophisticated, trendsetting, and demanding forces continuous innovation and the development of new products and technologies. Many sources credit the demanding US consumer with forcing US software companies to continuously innovate, thus creating a sustainable competitive advantage in software products and services.
• Local suppliers and complementary industries. To remain competitive, large global firms benefit from having strong, efficient supporting and related industries to provide the inputs required by the industry. Certain industries cluster geographically, which provides efficiencies and productivity.
• Local firm characteristics. Local firm characteristics include firm strategy, industry structure, and industry rivalry. Local strategy affects a firm’s competitiveness. A healthy level of rivalry between local firms will spur innovation and competitiveness.

In addition to the four determinants of the diamond, Porter also noted that government and chance play a part in the national competitiveness of industries. Governments can, by their actions and policies, increase the competitiveness of firms and occasionally entire industries.

Porter’s theory, along with the other modern, firm-based theories, offers an interesting interpretation of international trade trends. Nevertheless, they remain relatively new and minimally tested theories.

Which Trade Theory Is Dominant Today?

The theories covered in this chapter are simply that—theories. While they have helped economists, governments, and businesses better understand international trade and how to promote, regulate, and manage it, these theories are occasionally contradicted by real-world events. Countries don’t have absolute advantages in many areas of production or services and, in fact, the factors of production aren’t neatly distributed between countries. Some countries have a disproportionate benefit of some factors. The United States has ample arable land that can be used for a wide range of agricultural products. It also has extensive access to capital. While it’s labor pool may not be the cheapest, it is among the best educated in the world. These advantages in the factors of production have helped the United States become the largest and richest economy in the world. Nevertheless, the United States also imports a vast amount of goods and services, as US consumers use their wealth to purchase what they need and want—much of which is now manufactured in other countries that have sought to create their own comparative advantages through cheap labor, land, or production costs.

As a result, it’s not clear that any one theory is dominant around the world. This section has sought to highlight the basics of international trade theory to enable you to understand the realities that face global businesses. In practice, governments and companies use a combination of these theories to both interpret trends and develop strategy. Just as these theories have evolved over the past five hundred years, they will continue to change and adapt as new factors impact international trade.

Key Takeaways

• Trade is the concept of exchanging goods and services between two people or entities. International trade is the concept of this exchange between people or entities in two different countries. While a simplistic definition, the factors that impact trade are complex, and economists throughout the centuries have attempted to interpret trends and factors through the evolution of trade theories.
• There are two main categories of international trade—classical, country-based and modern, firm-based.
• Porter’s theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. He identified four key determinants: (1) local market resources and capabilities (factor conditions), (2) local market demand conditions, (3) local suppliers and complementary industries, and (4) local firm characteristics.

(AACSB: Reflective Thinking, Analytical Skills)

• What is international trade?
• Summarize the classical, country-based international trade theories. What are the differences between these theories, and how did the theories evolve?
• What are the modern, firm-based international trade theories?
• Describe how a business may use the trade theories to develop its business strategies. Use Porter’s four determinants in your explanation.

Ridley, M., “Humans: Why They Triumphed,” Wall Street Journal , May 22, 2010, accessed December 20, 2010, http://online.wsj.com/article/SB10001424052748703691804575254533386933138.html .

Smith, A., An Inquiry into the Nature and Causes of the Wealth of Nations (London: W. Strahan and T. Cadell, 1776). Recent versions have been edited by scholars and economists.

International Business Copyright © 2017 by [Author removed at request of original publisher] is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.

Share This Book

Social Sciences

© 2024 Inquiries Journal/Student Pulse LLC . All rights reserved. ISSN: 2153-5760.

Disclaimer: content on this website is for informational purposes only. It is not intended to provide medical or other professional advice. Moreover, the views expressed here do not necessarily represent the views of Inquiries Journal or Student Pulse, its owners, staff, contributors, or affiliates.

Home | Current Issue | Blog | Archives | About The Journal | Submissions Terms of Use :: Privacy Policy :: Contact

Need an Account?

Forgot password? Reset your password »

International (Global) Trade: Definition, Benefits, Criticisms

• Search Search Please fill out this field.
• International Trade

Imports and Exports

Comparative advantage.

• Other Benefits

Free Trade vs. Protectionism

• International Trade FAQs

The Bottom Line

Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas' experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.

• International (Global) Trade: Definition, Benefits, Criticisms CURRENT ARTICLE
• What are Tariffs?
• Tariffs and Trade Barriers
• How Would a Trade War Affect You?
• Who Has the Highest Tariffs?
• Protectionism
• The Plaza Accord
• Currency Wars
• Factors Driving the USD
• Emerging Markets: The Parts of Russia's GDP
• How OPEC (and Non-OPEC) Production Affects Oil Prices
• BRICS: Acronym for Brazil, Russia, India, China, and South Africa
• The Economy of Canada
• How Currency Fluctuations Affect the Economy
• Devaluation
• Manipulation
• Revaluation
• What is Fiat Money?
• Yuan vs. Renminbi: What's the Difference?
• What Causes a Currency Crisis?
• South Korea's Ties to Crypto
• El Salvador Breaks Ground on Crypto
• Sweden Takes First Steps on Crypto
• Is Africa the Next Big Crypto Market?
• What is a Commodity?
• Tradable Commodities
• Commodities Index
• 10 Countries With The Most Natural Resources
• What Causes Oil Prices to Fluctuate?
• What is a Crypto Commodity?

International trade is the purchase and sale of goods and services by companies in different countries. Consumer goods, raw materials, food, and machinery all are bought and sold in the international marketplace.

International trade allows countries to expand their markets and access goods and services that otherwise may not have been available domestically. As a result of international trade, the market is more competitive. This can ultimately result in more competitive pricing and cheaper products. Some countries engage in national treatment of imported goods, treating them as equivalent to those same products produced domestically.

Key Takeaways

• International trade gives consumers and countries the opportunity to be exposed to goods and services that are not available in their own countries, or that are more expensive domestically.
• The importance of international trade was recognized early on by political economists such as Adam Smith and David Ricardo.
• Critics argue that international trade can be harmful for smaller nations, putting them at a disadvantage on the world stage.

Understanding International Trade

If you can walk into a supermarket and find Costa Rican bananas, Brazilian coffee, and a bottle of South African wine, you're experiencing the impacts of international trade.

International trade was key to the rise of the global economy . In the global economy, supply and demand—and thus prices—both impact and are impacted by global events.

Political change in Asia, for example, could result in an increase in the cost of labor. This could increase the manufacturing costs for an American sneaker company that is based in Malaysia, which would then result in an increase in the price charged for a pair of sneakers that an American consumer might purchase at their local mall.

A product that is sold to the global market is called an export , and a product that is bought from the global market is an import . Imports and exports are accounted for in the current account section of a country's balance of payments.

Different countries are endowed with different assets and natural resources, such as land, labor, capital, and technology. Global trade allows wealthy countries to use their resources more efficiently.

This also allows some countries to produce the same good more efficiently; in other words, more quickly and at a lower cost. Therefore, they may sell it more cheaply than other countries might. If a country cannot efficiently produce an item, it can obtain it by trading with another country that can. This is known as specialization .

England and Portugal have historically been used—as far back as in Adam Smith's "The Wealth of Nations" — to illustrate how two countries can mutually benefit by specializing and trading according to their own comparative advantages. In such examples, Portugal is said to have plentiful vineyards and can make wine at a low cost, while England is able to more cheaply manufacture cloth given its pastures are full of sheep.

According to the theory of comparative advantage , each country would eventually recognize these facts and stop attempting to make the product that was more costly to generate domestically in favor of engaging in trade. Indeed, over time, England would likely stop producing wine, and Portugal stop manufacturing cloth. Both countries would realize that it was to their advantage to redirect their efforts at producing what they were relatively better at domestically and, instead, to trade with each other in order to acquire the other.

These two countries realized that they could produce more by focusing on those products for which they have a comparative advantage. In such a case, the Portuguese would begin to produce only wine, and the English only cloth.

Each country could then create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country could access both products at lower costs. We can see then that for both countries, the opportunity cost of producing both products is greater than the cost of specializing.

Comparative advantage can contrast with absolute advantage . Absolute advantage leads to unambiguous gains from specialization and trade only in cases wherein each producer has an absolute advantage in producing some good.

If a producer lacked any absolute advantage, then they would never export anything. But we do see that countries without any clear absolute advantage do gain from trade because they have a comparative advantage.

According to international trade theory, even if a country has an absolute advantage over another, it can still benefit from specialization.

Origins of Comparative Advantage

The theory of comparative advantage has been attributed to the English political economist  David Ricardo . Comparative advantage is discussed in Ricardo's book " On the Principles of Political Economy and Taxation," published in 1817, although it has been suggested that Ricardo's mentor, James Mill, likely originated the analysis and slipped it into Ricardo's book on the sly.

Comparative advantage, as we have shown above, famously showed how England and Portugal both benefit by specializing and trading according to their comparative advantages. In this case, Portugal was able to make wine at a low cost, while England was able to cheaply manufacture cloth. Ricardo predicted that each country would eventually recognize these facts and stop attempting to make the product that was more costly to generate.

A more contemporary example of comparative advantage is China’s comparative advantage over the United States in the form of cheap labor. Throughout much of the 20th century, Chinese workers produced simple consumer goods at a much lower opportunity cost.

The comparative advantage for the U.S. is in specialized, capital-intensive labor. American workers produce sophisticated goods or investment opportunities at lower opportunity costs. Specializing and trading along these lines benefit each country. However, it should be noted that Chinese manufactures are now able to produce goods that span all levels of the value chain, including high quality, higher cost products.

The theory of comparative advantage helps to explain why protectionism has been traditionally unsuccessful. If a country removes itself from an international trade agreement, or if a government imposes tariffs, it may produce an immediate local benefit in the form of new jobs; however, this is rarely a long-term solution to a trade problem.

Eventually, that country will grow to be at a disadvantage relative to its neighbors, countries that were already better able to produce these items at a lower opportunity cost.

The U.S. international trade deficit in March 2024 was $69.4 billion, meaning imports exceed exports.

Criticisms of Comparative Advantage

Why doesn't the world have open trading between countries? When there is free trade, why do some countries remain poor at the expense of others? There are many reasons, but the most influential is something that economists call  rent seeking . Rent seeking occurs when one group organizes and lobbies the government to protect its interests.

Say, for example, the producers of American shoes understand and agree with the free-trade argument but also know that cheaper foreign shoes would negatively impact their narrow interests. Even if laborers would be most productive by switching from making shoes to making computers, nobody in the shoe industry wants to lose their job or see profits decrease in the short run.

This desire could lead the shoemakers to lobby for special tax breaks for their products or extra duties (or even outright bans) on foreign footwear. Appeals to save American jobs and preserve a time-honored American craft abound—even though, in the long run, American laborers would be relatively less productive and American consumers relatively poorer as a result of such protectionist tactics.

Other Possible Benefits of Trading Globally 

International trade not only results in increased efficiency but also allows countries to participate in a global economy, encouraging the opportunity for foreign direct investment (FDI). In theory, economies can thus grow more efficiently and become competitive economic participants more easily.

For the receiving government, FDI is a means by which foreign currency and expertise can enter the country . It raises employment levels and, theoretically, leads to a growth in the gross domestic product (GDP). For the investor, FDI offers company expansion and growth, which means higher revenues.

As with all theories, there are opposing views. International trade has two contrasting views regarding the level of control placed on trade between countries.

Free trade is the simpler of the two theories. This approach is also sometimes referred to as laissez-faire economics. With a laissez-faire approach, there are no restrictions on trade. The main idea is that supply and demand factors, operating on a global scale, will ensure that production happens efficiently. Therefore, nothing must be done to protect or promote trade and growth because market forces will do this automatically.

Protectionism holds that regulation of international trade is important to ensure that markets function properly. Advocates of this theory believe that market inefficiencies may hamper the benefits of international trade, and they aim to guide the market accordingly.

Protectionism exists in many different forms, but the most common are tariffs , subsidies , and quotas . These strategies attempt to correct any inefficiency in the international market.

As international trade opens up the opportunity for specialization, and thus more efficient use of resources, it has the potential to maximize a country's capacity to produce and acquire goods. Opponents of global free trade have argued, however, that international trade still allows for inefficiencies that leave developing nations compromised. What is certain is that the global economy is in a state of continual change. Thus, as it develops, so too must its participants.

What Are the Benefits of International Trade for a Business?

The benefits of international trade for a business are a larger potential customer base, meaning more profits and revenues, possibly less competition in a foreign market that hasn't been accessed as yet, diversification, and possible benefits through foreign exchange rates.

What Creates the Need for International Trade?

International trade arises from the differences in certain areas of each nation. Typically, differences in technology, education, demand, government policies, labor laws, natural resources, wages, and financing opportunities spur international trade.

What Are Common Barriers to International Trade?

The barriers to international trade are policies that governments implement to prevent international trade and protect domestic markets. These include subsidies, tariffs, quotas, import and export licenses, and standardization.

The world economies have become more intertwined through globalization and international trade is a major part of most economies. It provides consumers with a variety of options and increases competition so that businesses must produce cost-efficient and high-quality goods, benefiting these consumers.

Nations also benefit through international trade, focusing on producing the goods they have a comparative advantage in. Though some countries limit international trade through tariffs and quotas to protect domestic businesses, international trade has shown to benefit economies as a whole.

Dimand, Robert W. "Adam Smith on Portuguese wine and English cloth."  The European Journal of the History of Economic Thought, vol. 25, no. 6. 2018, pp. 1264-1281.

Findlay, Ronald. "Comparative advantage."  The World of Economics . Palgrave Macmillan, London, 1991. Pp. 99-107.

Thweatt, William O. "James Mill and the early development of comparative advantage."  History of Political Economy, vol. 8, no. 2, 1976, pp. 207-234.

The Library of Economics and Liberty. " What Is Comparative Advantage? "

Liberty Fund. " David Ricardo, The Works of David Ricardo (McCulloch ed.) [1846] ," Pages 78-81.

Bryn Mawr College. " Does China Still Have a Labor Cost Advantage? ," Page 16.

United States Census Bureau. " U.S. International Trade Data ."

• Terms of Service
• Editorial Policy
• Privacy Policy

• Liberty Fund
• Adam Smith Works
• Law & Liberty
• Browse by Author
• Browse by Topic
• Browse by Date
• Search EconLog
• Latest Episodes
• Browse by Guest
• Browse by Category
• Browse Extras
• Search EconTalk
• Latest Articles
• Liberty Classics
• Book Reviews
• Search Articles
• Books by Date
• Books by Author
• Search Books
• Browse by Title
• Biographies
• Search Encyclopedia
• #ECONLIBREADS
• College Topics
• High School Topics
• Subscribe to QuickPicks
• Search Guides
• Search Videos
• Library of Law & Liberty
• Home   /  

ECONLIB CEE

International Trade

By arnold kling.

By Arnold Kling,

O n the topic of international trade, the views of economists tend to differ from those of the general public. There are three principal differences. First, many noneconomists believe that it is more advantageous to trade with other members of one’s nation or ethnic group than with outsiders. Economists see all forms of trade as equally advantageous. Second, many noneconomists believe that exports are better than imports for the economy. Economists believe that all trade is good for the economy. Third, many noneconomists believe that a country’s balance of trade is governed by the “competitiveness” of its wage rates, tariffs, and other factors. Economists believe that the balance of trade is governed by many factors, including the above, but also including differences in national saving and investment .

The noneconomic views of trade all seem to stem from a common root: the tendency for human beings to emphasize tribal rivalries. For most people, viewing trade as a rivalry is as instinctive as rooting for their national team in Olympic basketball.

To economists, Olympic basketball is not an appropriate analogy for international trade. Instead, we see international trade as analogous to a production technique. Opening up to trade is equivalent to adopting a more efficient technology. International trade enhances efficiency by allocating resources to increase the amount produced for a given level of effort. Classical liberals, such as Richard Cobden, believed that free trade could bring about world peace by substituting commercial relationships among individuals for competitive relationships between states. 1

History of Trade Theory

David Ricardo developed and published one of the first theories of international trade in 1817. “England,” he wrote, may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time….

To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England. 2

If a painter takes twenty hours to paint a house, and a surgeon could do the job in fifteen hours, it still makes sense for the surgeon to hire the painter. The surgeon can earn enough money in a few hours of surgery to pay for the entire house-painting job. We say that the surgeon’s comparative advantage is in doing surgery, while the painter’s comparative advantage is in painting houses. Ricardo’s theory of comparative advantage explains why a surgeon will hire a house painter and why a lawyer will hire a secretary.

The opportunity to trade with the painter enables the surgeon to paint her house by doing a few hours of surgery. Similarly, international trade enables one country to obtain cloth more cheaply by specializing in the production of wine and trading for cloth, rather than producing both goods for itself.

What determines the pattern of specialization and trade? In the 1920s, Eli Heckscher and Bertil Ohlin offered one theory, called the factor proportions model. The idea is that a country with a high ratio of labor to capital will tend to export goods that are labor-intensive, and vice versa.

The Ricardo and Heckscher-Ohlin theories tend to predict clear patterns of specialization in trade. A country will focus on one type of industry for exports and another type of industry for imports. In fact, the types of industries in which a country exports and the types in which it imports are not dramatically different. This fact has led to the emphasis on another theory of trade, developed by Paul Krugman and others. The idea is that patterns of specialization develop almost by accident and that these patterns persist because of positive feedback. This is known as the increasing-returns model of international trade. “Increasing returns” means that the more of something you produce, the more efficient you get at producing it.

In the United States, for example, Detroit became an automobile-manufacturing center. Once the first large automaker located in Detroit, it was natural that other auto companies would be started there because it was easier to find employees with the right skills. Likewise, people with the skills to produce movies were first located in Hollywood. It became uneconomical to try to build an auto plant in Hollywood or a movie studio in Detroit. Thus, Detroit became an exporter of automobiles, and Hollywood became an exporter of movies. The same model of efficiency explains the international arena—why, for example, the Swiss specialize in watches and the Japanese in portable music players.

Gains from Trade

All of the economic theories of international trade suggest that it enhances efficiency. In this regard, international trade is like a new technology. It adds to the productive capacity of all countries that engage in trade. Some of the efficiency is due to comparative advantage, as in the Ricardo and Heckscher-Ohlin theories. In addition, some efficiency comes from taking advantage of increasing returns.

Trade based on comparative advantage should tend to benefit small countries more than large countries. That is because the benefits of comparative advantage are proportional to the difference between the relative prices in world markets and the relative prices that would prevail in home markets without trade. If that difference is large, then a country earns a large advantage from trade. If that difference is small, then there is only a small advantage from trade. Small countries are more likely than large countries to find that relative prices in the world market differ significantly from what would prevail in their home markets.

Another benefit from trade is that it promotes dynamism and innovation within an economy. Improvements in manufacturing quality and productivity in the United States in recent decades have been credited, in part, to the pressure of competition from Japan and elsewhere.

An economy that is closed to trade is one in which inefficient industries and laggard firms are well protected. In fact, studies suggest that barriers to trade are a major cause of extreme underdevelopment. The countries that are most closed to trade tend to be the poorest in the world. Countries that have reduced trade barriers and increased the share of imports and exports in their economies tend to be among the fastest-growing nations.

According to a World Bank study, twenty-four developing countries that became more integrated into the world economy in the 1980s and 1990s had higher income growth, longer life expectancy, and better schooling. Per capita income in these countries, home to half the world’s population , grew by an average of 5 percent in the 1990s compared with only 2 percent in rich countries. China, India, Hungary, and Mexico are among the countries that adopted policies that allowed their people to take advantage of global markets. As a result, they sharply increased the amount of their GDP accounted for by trade. Real wages in these countries rose and the number of poor people fell.

The study also points out that two billion people—particularly in sub-Saharan Africa, the Middle East, and the former Soviet Union—are in countries being left behind. These countries’ integration into the world economy has not increased, and their ratio of trade to GDP has stagnated or fallen. Their economies have generally contracted, poverty has increased, and education levels have risen less rapidly than in the more globalized countries. 3

Another report notes that exports plus imports as a share of output among the richest countries rose from 32.3 percent to 37.9 percent between 1990 and 2001. Moreover, among developing countries, that share rose from 33.8 percent to 48.9 percent over that period. The success of India and China recently, and Japan, Taiwan, South Korea, and other countries in the 1970s and 1980s, is due in large part to trade. 4

The OECD countries, which together have more than $25 trillion in GDP, account for most of world trade. Poor countries account for less than $300 billion in GDP, which is less than one-tenth of world output, and thus account for only a miniscule fraction of world trade.

Purchasing Power Parity

If goods were perfectly tradable across borders, with no trade barriers or transactions costs, then there would be no reason for prices to differ. This gives rise to the idea of purchasing power parity, a theory of exchange-rate adjustment based on the law of one price.

If the same good sells for one hundred dollars in the United States and one hundred euros in Europe, then according to the law of one price the exchange rate between dollars and euros ought to be one. The theory of purchasing power parity is that this relationship holds for an overall market basket of goods and services.

Empirical tests tend to show only a weak tendency for exchange rates to move in the direction of purchasing power parity. This means that cross-border trade is not nearly friction free. The failure of purchasing power parity to hold, except perhaps in the long run, indicates that transportation costs, language-translation costs, and other factors limit the integration of global markets.

Capital Flows and the Balance of Trade

In 2000, U.S. exports were $1.1 trillion and U.S. imports were close to $1.5 trillion. The excess of imports over exports is called a current account deficit. What caused this deficit? Modern economists believe that the trade surplus and capital flows are mutually determined. When a nation’s domestic saving (personal saving plus retained earnings of corporations ) exceeds the domestic uses of saving (financing its private investment and its government budget deficit), then that nation will run a trade surplus, and vice versa.

Imagine that all international trade took place in the form of barter of goods and services. If you wanted to buy a Japanese car, you would have to offer something of equivalent value in return. In that case, trade in goods and services would have to balance, and there would be no trade deficits.

To obtain a Japanese car without trading goods and services, the Japanese have to accept financial assets in exchange for cars. These assets could be dollars, shares of U.S. companies, corporate bonds or other private debt instruments, or U.S. government debt. A country that is accumulating foreign assets will necessarily run a trade surplus. A country that is selling assets to foreigners will necessarily run a trade deficit. A country will accumulate assets when its domestic saving is greater than its domestic uses of saving. A country will sell assets when its national saving is insufficient for its domestic uses of saving.

Typically, one would expect wealthy countries to have excess saving and to invest in capital-poor countries. From this perspective, it is an anomaly that the United States is a capital importer and China is a capital exporter. However, the United States is a relatively attractive country in which to invest, and American policies tend to encourage consumption rather than saving.

Economic theory indicates that international trade raises the standard of living. A comparison between the performance of open and closed economies confirms that the benefits of trade in practice are significant.

About the Author

Arnold Kling is the author of Learning Economics, a nonmathematical introduction to economics. He was an economist at the Federal Reserve and at Freddie Mac before founding Homefair.com in 1994. His personal Web site is http://arnoldkling.com .

Further Reading

See http://www.independent.org/students/garvey/essay.asp?id=1381 .

Quoted from paragraphs 7.15-7.16 in On the Principles of Political Economy and Taxation . Available online at: http://www.econlib.org/library/Ricardo/ricP.html .

See http://econ.worldbank.org/prr/globalization/ .

See http://www1.worldbank.org/economicpolicy/globalization/documents/AssessingGlobalizationP1.pdf .

RELATED CONTENT By Douglas A. Irwin

A brief history of international trade policy.

International Trade Essay Examples and Topics

The benefits and disadvantages of free trade.

• Words: 3331

Gulf’s Indian Ocean Connections and Cultural Exchanges

• Words: 1440

Canada in the Global Business Environment

• Words: 1187

Challenges in International Management

• Words: 2491

The Impact of Corruption on International Trade

• Words: 2040

The Effects of the Release of U.S. Oil on the Market

Trade relations between turkey and russia.

• Words: 1937

The UAE and Singapore Mediation Convention

• Words: 2053

Joe Biden’s Inaction on the Need to Eliminate Existing Tariffs

Trump’s trade dump: agreement with china, importance of free trade agreements, impact of ancient chinese innovations, ecuador and oil production, global business and competitiveness.

• Words: 1128

The Problem of Developing Countries Access to the WTO Dispute Settlement

• Words: 1385

Export Sector Efficient Management in Saudi Arabia

The united states-australia trade relationship.

• Words: 2686

Import and Export Strategies and Sara Lee in Venezuela

• Words: 4510

America’s Involvement in the Saudi Arabian Oil Market

Common agricultural policy in italy.

• Words: 1168

Impact of European Union Trade Policy on World Economy

• Words: 3655

The U.S. vs. Canada Corn Dispute

• Words: 1739

Should Common Agricultural Policy Be Reformed?

• Words: 3090

Brexit and United Kingdom Politics

• Words: 1265

Argentina’s International Trade: Themes and Issues in Modern Global Economy

• Words: 1629

Oil Wealth: A Blessing or a Curse for the Gulf States?

• Words: 1640

Doha Round Trade Negotiations

Transport processes between australia and the united states.

• Words: 2235

The Doha Round Effectiveness in Solving Global Issues

Argentina-kenya international trade in agriculture.

• Words: 2532

Protectionism and Free Trade System

Doha round and its role for trade negotiations.

• Words: 1551

Sino-American Trade War in 2018

How will brexit send flight prices soaring higher, turkey-islamic state of iraq and syria oil trade.

• Words: 5557

North American Free Trade Agreement’s Influence

• Words: 1103

Globalization in Economics and International Relations

Thailand-us international trade and labor laws.

• Words: 1641

The United Arab Emirates-Argentina Trade Relations

• Words: 2217

Russia as a World Trade Organization Member

European confederation business environment.

• Words: 4052

Bretton Wood Institutions’ Criticism and Response

• Words: 3167

Asia Pacific Regional Cooperation and Conflicts

• Words: 3045

Iran Influence in OPEC Negotiations

• Words: 1217

Trade: U.S. Antidumping Duties on Washing Machines

Commerce and political alliances.

• Words: 1383

Negotiations in International Trade and Politics

Colonisation and drug trade.

• Words: 2792

USA and the Kingdom of Saudi Arabia International Business Transactions

• Words: 2599

Trade in Human Organs across Borders

Laws and regulations for business transactions in canada and brazil, state power and economic crisis.

• Words: 3241

International Trade as a Significant Issue in International Political Economy

• Words: 2807

Global Warming Impact on International Business: Apple and HP

• Words: 1642

How Globalized the Food Market Really Is?

• Words: 1090