Why do countries trade with each other? What determines the patterns of trade? At the end of the 1970s, these old questions caused increasing unease among a few economists. Surely, classical and neoclassical approaches could well explain inter-industry trade flows between countries that were different, either in sectoral productivities or factor endowments: Japan imports bananas and exports cars, Brazil exports mangoes and imports machinery. So far, so good. But what about trade flows between industrialized countries, which by far dominated global trade? How should intra-industry trade be explained? And why have multinational companies become so important? Ad hoc explanations abounded, but usually failed to provide adequate answers. Moreover, certain assumptions of traditional trade models, such as full competition at the international level, seemed inappropriate at least for some markets.
New trade theory was the answer to this long-standing undercurrent of discontent, and Paul Krugman (then the wunderkind of the MIT's economics department, now Princeton and New York Times) and Elhanan Helpman (formerly Tel Aviv University, now Harvard) were among the spearheads of this approach. In particular, new trade theory breaks with traditional analysis by relaxing the assumption of constant returns to scale and assuming imperfect competition in understanding how the international economy works. While in the early 1980s many special models proliferated, seemingly incompatible with traditional trade theory, but also with each other, this book for the first time provided an integrated theoretical approach. In fact, it offers MIT-style "minimum necessary" modelling at its best, such as mirror-image factor endowments in an Edgeworth box, or the use of Lancaster-type preferences in a trade model. Despite these innovative assumptions, there's no news but the old news with regard to some basic insights of older trade models; comparative advantage is alive and kicking, as is the role of factor endowments. What is surprising from a methodological perspective in this opus magnum is the amount of creative silliness, combined with intellectual rigour and discipline. It was thus less surprising that Stockholm heard, at least for Paul Krugman, who was awarded the Nobel prize in 2008.
Thanks to monographs like this one, the question "Why do countries trade with each other?" is still a fascinating one nearly two-hundred years after the publication of Ricardo's Principles. When I used some of the book's theoretical key statements for empiricial work in my PhD thesis, it was at the frontier of economic research (the book, not my goddam thesis). Now, it no longer is - its findings have been mainstreamed into economic theory textbooks. Still, this book is no beachtowel read for those who want to get a glimpse of modern economic theory, and even advanced students may initially find it inaccessible. However, those who diligently work their way through it will be richly rewarded: You wish to know about the impact of: China's integration into the world economy? Trade effects of multinational companies? Outsourcing of labour-intensive production stages to developing countries? It's all in! When I (6 ft 5) read Krugman's works on trade issues first, I immediately noticed the difference between a tall and a great economist. After a second read of this monograph many years on, I realized what it actually is: a masterpiece at 25!