Learning Objectives
By the end of this section, you will be able to:
- Define the term path dependence.
- Explain how a path dependency analysis of trade is different from the comparative advantage approach.
- Define the phrase factor endowments.
- Define the concept of an export-led growth model.
- Analyze different “real world” examples that support the path dependency approach to understanding international trade.
Given the critiques outlined above, many progressive and radical (heterodox) economists believe that the orthodox economic free trade theory is chronically incapable of addressing important, real world, concerns. Because of its failure to explain real world conditions, the orthodox model is also incapable of suggesting policy approaches that may be helpful in correcting many of the problems that emerge when trade between countries expands and grows. For example, in the orthodox world of free trade, any, and all, trade protections are perceived as inefficient and costly. As a result, if the real world provides evidence of the effectiveness of trade restrictions, a story built on the benefits of free trade cannot and will not be functionally applicable. Using the free trade story in this regard would generate inaccurate analyses, failing to recognize that trade protections have had historic usefulness toward assisting an economy’s economic development. In this instance, the free trade story is of no practical/functional use. What is needed, instead, is a different theory of how trade works. A sound theory of regarding trade should be able to demonstrate how trade restrictions may stimulate more economic growth and/or improve a country’s economic development prospects.
Because theorists outside of the orthodoxy view the orthodox economic trade story as being impossibly limited in its real world applications, heterodox economists generally begin their trade story from a different perspective. For many heterodox economists, in the real world, specialization and trade are path dependent. Path dependence means that history matters. A given country’s productive situation is the byproduct of past circumstances, past decision making (with respect to domestic economic choices as well as the country’s place in the global economy). Further a country’s economic development, it’s future productive possibilities and future economic position in the global economy, depends on the choices it makes in the present.
To follow the logic of comparative advantage, a country identifies its comparative advantage, specializes and then trades. So if agricultural products are the only products that a country has a comparative advantage producing, then the country will specialize in the production of agricultural products only and then trade for the other non-agriculture products that are desired. In response to this scenario, heterodox economists ask, for how long does a country only produce agricultural products? After all, from an economic development standpoint it is well known that there is not a single advanced developed economy that only produces agricultural products. In fact, the production of products in all advanced developed economies are overwhelming diverse.
Economic Development and the Case for Conscious Diversification
The United States is widely recognized for having one of the most diverse economies in the world. U.S. based firms produce agricultural products, light and heavy manufactured products, industrial products, pharmaceutical products, and so on and so forth. Aside from no longer being de-stabilized due to weather volatility or changes in consumer tastes and preferences, a diversified economy can better endure overall market volatility because some sectors may grow when others contract. Additionally, as markets change, as new technologies emerge, a diversified economy is better apt to be able to find uses for new technologies and integrate those technologies into their economy. As a result, in the path-dependency-trade-story, diversification, rather than simple specialization and trade, is encouraged because diversification is an economic development strategy. Importantly, as is noted by the critiques provided above, diversification cannot be achieved by comparative advantage and a free trade environment.
By evaluating trade through a lens of path dependency, heterodox economists are able to correct for some of real world limitations associated with the orthodox free trade story. For example, the very nature of path dependency requires strategic thinking and public policy planning on the part of countries and their governments. Countries will often target industries for protection from international competition because they see an industry as generating a high-value added, high income, and significant employment outcome for their economy. The automobile industry is an example of industry where countries have been apt to enact policies to encourage both domestic production as well as foreign direct investment into the production of automobiles. Countries such as Azerbaijan, Egypt, and Malaysia all have developing internal domestic automobile producers. Additionally, China is currently the world’s largest producer and consumer of automobiles with production being generated by a large number of foreign firms such as Volkswagen and General Motors as well as the domestic Chinese producer, Geely. The benefit of having a viable domestic automobile industry is that automobiles are one of the highest value added mass-consumed products in the world. If a country can produce automobiles to meet even just some of its internal consumer demand for automobiles, then the country will be retaining valuable domestic expenditures in the form of valuable domestic income.
Finally, a path dependency approach to examining trade between countries empowers the heterodox economist to understand why some countries have had more relative success than others with respect to economic development. By thinking of trade as a result of path dependency, the role of trade restrictions, industrial planning, and targeted competition can reveal to the theorist tactics and approaches that have successful enhanced economic development or, alternatively stifled economic development. As a result, the fact that advanced developed economies have a history of managed trade, rather than free trade, can be understood as strategic decision making. Undoubtedly, advanced developed economies owe some of their economic position to the strategic trade choices that they made in the past. Furthermore, the recent success of a country like China can also be explained as being related to the strategic, State planned and managed, trade decisions that the Chinese government has implemented. Finally, the path dependency approach can also be utilized to explain why persistent free trade policies have also been use to undermine the economic development of many countries, exacerbating persistent inequalities between countries.