AN EXERCISE IN WORLDMAKING 2009 - ISS

11 The Interesting Facts Of The New Trade And Growth Theories 127
to occur between these economies, and no potential gains from trade. In
the presence of economies of scale, the larger the scale on which production
takes place, the more efficient the production – i.e. doubling the inputs
to production will more than double its output, while the notion of
increasing return to scale means an increase in output that is proportionally
greater than a simultaneous and equal percentage change in the use
of all inputs, resulting in a decline in average costs. From the notions
above we see that economies of scale refer to a firm's costs, and returns
to scale describe the relationship between inputs and outputs in a long
run production function.
The assumption of increasing returns in the new trade theory gives
rise to imperfectly competitive markets. Imperfect competition, in turn,
makes possible the theoretical explanation of intra industry trade. Trade
among countries with relatively similar endowments has been the fastest
growing component of global trade flows throughout the post-War period.
Even if countries had the same overall K/L ratio, their firms would
continue to produce differentiated products and the demand of consumers
would generate intra-industry trade. This phenomenon does not conform
to the neo-classical paradigm, whereby the greater trading opportunities;
the bigger the differences between the productive endowments
of countries. Furthermore, a large proportion of trade among industrialized
nations consists of two-way flows of very similar products. Such
intra-industry trade is also difficult to accommodate within the neoclassical
models, which predict that countries specialize in different sectors
according to their comparative advantage and thus exchange different
products. Intra-industry trade allows countries to benefit from larger
markets. Countries produce fewer varieties of goods at a larger scale with
higher productivity and lower cost. Consumers benefit from the increased
range of choices. Intra-industry trade implies that a country can
be an exporter as well as an importer.
2.2 What Is the New Growth Theory?
The new growth theory is a view of the economy which incorporates
two important points: (i) viewing technological progress as a product of
economic activity. Previous theories treated technology as a given, or a
product of non-market forces. The new growth theory is often called
“endogenous” growth theory, because it internalizes technology into a
model of how markets function; (ii) holding that unlike physical objects,