Consumer heterogeneity and network size as trade benefits

Heterogeneity in countries' technology can lead to benefits from trade. Trade exposes countries to new technologies devised abroad, and they can adopt them to improve the quality of the goods they manufacture or make them cheaper. There is some doubt about countries' ability to adopt technologies from distant countries if they merely see the end product as the way the technology works may not be obvious or it may not be viable in the countries' circumstances.

Heterogeneity in consumer preferences could lead more directly to similar benefits. For example, it may be that a consumer in one country wants a good that is only made in a second country, and in the second country no-one wants the good. This argument is from traditional trade theory (where productive heterogeneity is emphasised usually). Consumer heterogeneity can be combined with technology transfer to get a situation where if trade occurs, technology is transferred and only then could the second country manufacture the first country's wanted good. Traditional trade theory has been criticised as although short-term outcomes can be optimal for all countries involved, in the long run a country may have been specialised in a commodity that does not offer good development possibilities, for example cash crops in a declining or volatile market with little learning for the workers involved.

A third benefit of trade could arise through network size effects. The argument is related to the one for heterogeneity of consumer preferences. A larger market increases the chance of consumer heterogeneity hugely. It also allows for specialisation and economies of scale in production. On the negative side, there is the possibility that the expanded market will mean that domestic consumers will be able to purchase all goods cheaper internationally than domestically. Classical comparative advantage would argue that this is not a problem; the domestic producers make goods in which they are relatively less disadvantaged, sell it cheaply internationally, and buy internationally the goods in which domestic production is heavily disadvantaged, so gaining over purely domestic production. There are some problems with reaching the final benefits if there are inflexibilities in price as the argument breaks down, or if domestic bankruptcies creates big social difficulties, these being omitted from the argument.

I find a helpful way of thinking about these effects is the island economy approach, where someone is alone on an island and producing for themselves, then someone else arrives and trade between them is possible. A successful trade policy gets the benefits of trade while avoiding the disadvantages as far as possible.