Models of comparative advantage in international trade explain specialization using differences in autarky relative prices. This literature has traditionally focused on the Heckscher–Ohlin and Ricardian models. The former emphasizes differences in factor abundance across countries and in factor intensity across goods; the latter focuses on relative productivity differences across countries and goods. However, unrealistic assumptions and stark assumptions have hindered empirical assessment of these models. Contemporary models now allow researchers to overcome these hurdles. New models of Ricardian comparative advantage incorporate realistic geography and multiple countries. Similar advances have freed the Heckscher–Ohlin model from some of its theoretical straightjackets. In addition, researchers have started to provide microfoundations for the Ricardian model and to formalize how institutions and factor market distortions might generate patterns of comparative advantage. Trade economists have also started to think about magnitudes in a different way; that is, through general equilibrium counterfactual experiments.
Peter M. Morrow
While the modern theory of international trade allows for many different modeling assumptions, the gains from trade can often be calculated using a common set of statistics. In particular, the share of a country’s output that is consumed domestically, the elasticity of bilateral trade with respect to trade costs, and the relationship between markups and firm size, each have a clear role in the gains from integration. All of these statistics may also be structurally linked to the degree of firm heterogeneity, usually the dispersion in firm-level productivity. Accordingly, the presence of firm heterogeneity may have a meaningful impact on the welfare response to trade liberalization. A quantitative application of a common firm heterogeneity model indicates that increased dispersion of firm-level productivity has a disproportionately large and positive impact on the gains from trade for smaller, less-developed countries.