The International trade Regime: a Global Public goods Perspective

University of Maastricht  Introduction 
  2
The fourth chapter will try to conceptualise the new global challenges mentioned above 
into a systematic theory of GPGs. However, an important difference with national public 
goods will be enlightened. Whereas, at the national level, governments look after the 
production and distribution of most public goods, at the international level no such thing 
exists. Nevertheless cooperation may emerge in the form of international organisations. 
The fifth chapter will apply the starring concepts of GPGs theory to the international trade 
regime. The centuries-long effort to escape the prisoner's trap has lead to the creation of an 
institutionalised multilateral system. Indeed the present trade regime is a delicate framework 
of mutual commitments that reassure all its members that their partners will stick to their 
obligations. The international trade regime emerges as an important global public good that 
immunises against major economic crises and delivers stability and peace through 
interdependence. The main goal of pursuing market efficiency is not here underestimated. 
Although efficiency gains are not public in nature, they represent the powerful incentive that 
leads countries to pursue a multilateral framework in the first place. However, the trade 
system falls short in delivering global equity and this sinks the organisation into a crisis of 
legitimacy as it manifestly emerged with the protests at the 1999 Seattle Ministerial 
Conference. This crisis is also undermining the capability of the multilateral trade system to 
deliver its more direct outcomes in the form of new and further agreements. 
Cooperation is still the only reasonable way-out and the sixth chapter will explore the 
areas where cooperation can be fostered further in order to make the regime more capable 
of enhancing efficiency, stability and most of all, equity. 
 
University of Maastricht Final Thesis Matteo Rizzolli  
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I From National to International Trade 
Economics explains why a system that allows people to exchange the products of their 
work is superior to a system that envisages individual autarky. If this embryo of trade is 
shifted to the international arena, the argument in its favour does not change. From the times 
of Adam Smith and Ricardo, economists have built a solid theoretical framework that 
supports the idea that international trade brings benefits in terms of welfare to the society as 
a whole. However, this does not imply that everyone benefits. Trade generates winners and 
losers. The increase in national welfare essentially means that the sum of the gains to the 
winners will exceed the sum of the losses to the losers. Moreover, in a dynamic context, 
trade policy interacts with other important national policies such as development and poverty 
alleviation. Indeed, the present chapter is not meant to be an apology of free trade. 
International trade is a far too complex phenomenon to be seen only through the eyes of 
economists. In the next chapters political and social sciences will be applied in order to 
understand how open trade fits into the larger picture of globalisation. 
I.A EXCHANGE AND MARKETS AT THE DOMESTIC LEVEL 
Economics is about scarcity. Simply, there are not enough resources to satisfy all the 
wishes of all citizens. Thus, economics studies how individuals and communities try to 
address the problem of scarcity. Because of scarcity, any society must agree upon a 
mechanism that address the following questions what should be produced, how should it be 
produced and to whom it should be given. Western societies have long identified this 
mechanism with the market economy. 
What determines how much of a product is demanded? Consumers are assumed to 
maximise their utility given their budget constraint. So, given the individual preference, the 
price of the product (relative to the price of other products) has a major influence on how 
much of the product is purchased. Consumer's income is another important factor. For 
normal goods, an increase of the available income induces the consumers to buy more of the 
product. By taking the price of the product as the independent parameter and by aggregating 
the demand of all consumers for the same product, it is possible to depict the market 
demand curve as in the left graph on Figure I-1. The curve slopes downward because an 
increase in the product's price is likely to result in a decrease in quantity demanded as 
people switch to substitute products or live with less of the more expensive product. 
 What determines how much of a product is supplied by firms? A company supplies the 
product because it is trying to earn a profit on its activities. The quantity of products supplied 
is likely to be a function of the price of its sales. The production costs are the other relevant 
variable. For a competitive firm, the price at which the firm can sell another unit of its product 
should equalise the marginal cost of production. Adding up all producers of the product, a 
market supply curve as in Figure I-1 is obtained. The curve is usually presumed to be upward 
sloped so that an increase in the product's price results in an increase in quantity supplied. 
If the two curves depicted in the left graph on Figure I-1 represent the national demand 
and supply for the product, then equilibrium occurs at the price at which the market clears 
domestically, with national quantity demanded equal to national quantity supplied. 
I.B MARKETS AND TRADE AT THE INTERNATIONAL LEVEL 
From Ricardo on, the literature has mostly focused on nations as the key units to look at 
when analysing the exchanges that happen at the international scale. Ricardo first realised 
that factor mobility is high within nations but low across nations' frontiers. Labour and capital 
were assumed to be highly reluctant to cross states' borders. In the following years 
economists have elaborated more complex theories that allow for factor mobility, which keep 
into consideration the behaviour of firms and the presence of competing sectors within and 
across states. 
Chapter I  From National to International Trade 
  4
Price
Quantity
DD
SD
Price
Quantity
S
x
Price
Quantity
SRoW
Domestic 
market
Rest of the 
World’s Market
international
market for the good
Dm
D
RoW
Imports
Exports
I.B.1 Reasons for Trade 
Why do individuals in different countries engage in trade? Trade theory answers with a 
variety of models that incorporate different reason for trade, and the expected effects of trade 
on prices, profits, incomes and individual welfare.  
Differences in technology: Advantageous trade can occur between countries if the 
countries differ in their technological capability to produce goods and services. Technology 
refers to the capacity of turning resources (labour, capital, land) into outputs. The absolute 
advantage model and the Ricardian model of comparative advantage are based on such 
considerations. 
Differences in resource endowments: if countries differ in their endowments of 
resources, then they might profit by trading. Resource endowments usually refer to the 
quantity and quality of the workforce, the natural resources available within its borders 
(minerals, farmland), and the sophistication of its capital stock (machineries and 
infrastructures). Differences in resource endowments are reflected into the Heckscher-Ohlin 
Model. 
Differences in demand: Advantageous trade can occur between countries if demands or 
preferences differ between countries. Individuals simply might have different preferences or 
demands for various products. 
Economies of scale in production: In presence of economies of scale in production 
both countries gain from specialisation in the production of just one product because 
production costs fall as the scale of production rises. 
Government Policies: Government tax and subsidies can induce production of certain 
products that become palatable and convenient to individuals in other countries. In these 
circumstances, advantageous trade may arise solely because of differences in government 
policies across countries.  
All these reasons belong to the economic domain. In other words they justify trade 
because of its economic convenience. As it will be argued later, trade might occur also for 
other reasons such as for geopolitical strategies etc. 
I.B.2 From National to International Trade 
In Figure I-1, the demand and supply 
curve are depicted both for the domestic 
market (graph on the left) and for Rest Of 
the Word market (RoW) (graph on the 
right). Demand and supply conditions 
differ between RoW and domestic 
markets, reflecting different conditions 
that can be any of those reasons 
suggested in the previous paragraph, if 
there is no international trade. 
The two markets clear at different 
prices if no trade is allowed. If markets 
are opened up, then someone will 
conduct arbitrage to earn profits from the 
price difference between previously 
separated markets. As international trade 
in the good develops between the two markets, it affects prices. The additional supply 
created by imports reduces the market price in the domestic market. The additional demand 
met by exports increases the market price in the rest of the world. In fact, if there are no 
transportation costs or other frictions, free trade results in the two countries having the same 
price (world price) for the good in question. Free trade equilibrium occurs at the price that 
 
 
  
 
 
 
Figure I-1: The international trade in one product.  
University of Maastricht Final Thesis Matteo Rizzolli  
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clears the international market. The price change results in changes in quantities consumed 
and produced. Within each country the gainers are the consumers of imported goods and the 
producers of exported goods. Those who lose are the producers of import-competing goods 
and the consumers of exported goods. 
By considering an economy with two products some more insights can be drawn. For 
international trade, one product can be exported and the other imported. This two-countries 
two-products economy captures an essential feature of international trade: each country 
tends to be net exporter of some products and a net importer of others. Adam Smith (1776) 
explained why free trade could be advantageous for countries by using the concept of 
absolute advantages1: The idea is simple and intuitive. If one country can produce some set 
of goods at lower cost than a second country, and if the later one can produce some other 
set of goods at a lower cost than the previous one, then clearly it would be best for both to 
trade their relatively cheaper goods. In this way both countries may gain from trade. 
I.B.3 Ricardo and Comparative Advantage 
The famous Ricardian example illustrates the principle of comparative advantage 
involving trade between England and Portugal, both producing wine and cloth2. However, 
instead of assuming, as Adam Smith did, that England is more productive in producing one 
good and Portugal is more productive in the other; Ricardo assumed that Portugal was more 
productive in both goods. Based on Smith's intuition, then, it would seem that trade could not 
be advantageous, at least for England. However, the principle of comparative advantage 
assures that both countries will gain from specialising in producing the good that is cheaper 
in relative terms (wine for Portugal and cloth for England) and then trading the goods they 
produce in excess. Gains arise because of exchange as well as because of specialisation. 
Gains from exchange arise because a Portuguese wine producer will find it convenient to 
export wine in England where he receives more than he receives at home. The same holds 
for English cloth producers. Gains from specialisation occur if the two countries reallocate 
their production in the sector where they have the comparative advantage. In this way, world 
output of both wine and cloth rises without an increase in the quantity of labour employed. 
The efficiency gains from open trade are evident. Specialization and trade increases the set 
of consumption possibilities, compared with autarky, and makes possible an increase in 
production of both goods. In the Ricardian model, trade is truly a win-win situation. 
I.B.4 The Heckscher-Ohlin (Factor Proportions) Model 
 The Heckscher-Ohlin (H-O) model incorporates a number of realistic characteristics of 
production that are left out of the Ricardian model for which only one factor of production, 
                                                 
1 If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the 
produce of our own industry, employed in a way in which we have some advantage (Smith, 1776). 
2 Suppose that the amount of labour required in England to produce one bottle of wine is 3 and 7 for one bolt of 
cloth. In Portugal, the production of one bottle requires 1 unit of labour and 5 units are need for one bolt. So, the 
ratio of the production costs for the two goods is different: in England a bottle of wine will exchange for 3/7 of a 
bolt of cloth because the labour content of wine is 3/7 that for cloth. In Portugal a bottle of wine will exchange for 
1/5 of a bolt of cloth. Thus wine is relatively cheaper in Portugal and, conversely, cloth is relatively cheaper in 
England. The difference in relative prices leads the two countries to trade. Gains arise because of exchange as well as 
because of specialisation. Gains from exchange arise because a Portuguese wine producer, that sells five bottle of 
wine at home for one bolt of cloth, will find it convenient to export wine in England where he receives more than 
two bolts of cloth for the same amount of wine. English cloth producers receive 5 bottles of Portuguese wine for 
every bolt of cloth against less than three bottles they would receive at home. Gains from specialisation also occur. 
Suppose that as a result of trade, 21 units of labour are shifted from wine to cloth production in England and 10 
units are moved from cloth to wine production in Portugal. This reallocation does not alter the total amount of 
labour used by the economy. However, England now will produce 3 more bolts of cloth and Portugal 10 more bottle 
of wine. England will reduce wine production by 7 and Portugal by 2. When countries specialize in their 
comparatively advantageous good, world output of both wine and cloth rises respectively by 3 and 1 without an 
increase in the quantity of labour employed.