International Trade Theory and Policy
by Steven M. Suranovic

Trade 5-5D

Lesson 5D

A domestic firm may lose out in international competition even if it is the lowest-cost producer in the world.

This result is a corollary of Lesson 3. As argued there, it seems reasonable to think that a more efficient firm (i.e., one who produces at lower cost) would drive its less efficient competitors out of business. The same would seem to follow if the two firms are domestic and foreign and the two firms compete in international markets.

However, the Ricardian model of comparative advantage argues that a firm in one country, even if it is the lowest-cost producer in the world, may be forced out of business once the country liberalizes trade with the rest of the world. Even more surprising, despite the decline of this industry, the move to free trade can generate welfare improvements for everybody in the country. In other words, losing production in a highly efficient industry can be consistent with an improvement in welfare for everyone. This contradicts the logic above which would suggest that more efficient (lower-cost) firms should always win (See page 40-9).

It is important to note that this result does not imply that every decline of an efficient industry will improve welfare. Instead, the model merely suggests that one should not jump to the conclusion that the loss of an efficient industry will have negative effects for the country as a whole.

International Trade Theory and Policy - Chapter 5-5D: Last Updated on 6/13/06