Trade Theory, New

A theory that argues that it is possible for protectionism to be sometimes better than free trade. This theory became more prominent in the 1980s as a result of the U.S. trade deficit with Japan. The idea of protection versus free trade is not a novel one, but the basis for trade theories has evolved over time. In fact, free trade has never been an absolute theory of trade. No nation can allow all sorts and conditions of goods to flow through its borders without some form of control. The question is, “To what extent should trade be permissible?”

In the 18th and 19th centuries, the mercantilists were concerned about the acquisition of wealth and unfettered trade. The argument then was that nations that wanted to be rich in order to raise large armies and fight expansionary wars must restrict imports as much as possible while exporting a lot to acquire bullion (precious metals).

The physiocrats David Hume and Adam Smith questioned the wisdom of trade restriction, and the concept of laissez-faire has played a much more dominant role in international trade and markets since the 19th century. The Great Depression of the 1930s drew attention to the need for regulated markets and trade.

The strength of the free trade argument has always been the notion of efficiency and improved consumer welfare. The new trade theory suggests that protection can equally improve consumer well-being in a large and diversified economy. The theory postulates that even though trade can contribute to growth, improvement in income does not necessarily translate into equitable income distribution between employers and employees.

The new trade theory extends the neoclassical tradition of economic analysis by reintroducing the concept of market imperfection, strategic trade theory, new growth theory, and political economy arguments into the explanation of international trade and the benefits of protection.

The pertinence of the new trade theory also finds favor in the developing countries, where economies of scale and imperfect competition are noticeable. These countries also allude to practical reasons to protect infant industries until they have the stature to compete in global markets. It is a theory that is sensitive to generic application because trade intervention is promoted to be selective and targeted with full realization of sector weaknesses and market imperfections.

New liberals are apprehensive of a government's wisdom to selectively target vital sectors of the economy in order to manage international trade. They find justification in the failures of sweeping and sudden reforms or intervention, which have proved to be calamitous in highly regulated economies.