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Diversification or specialization: What is the path to growth and development?

Dany Bahar

In general, international trade theories predict that once countries open up to trade outside their borders they will specialize in goods for which they have comparative advantage. Early theories of trade explained comparative advantage being driven by relative productivity difference (as explained by David Ricardo) or by relative abundance of factors of production (as explained by Eli Heckscher and Bertil Ohlin).

Most recent theories incorporate monopolistic competition and firm level analysis in their models to allow for countries (or firms within a country) to specialize in varieties of goods in order to explain what economists refer to as intra-industry trade—when two countries trade among themselves products within the same industry, such as cars, for example (Helpman and Krugman 1985, Melitz 2003). All in all, most trade theories would predict that a country leaving anautarky state will respond to incentives to specialize in either goods or non-perfect substitutable varieties of goods.

This results from international competition driving less productive firms out of the market (and with them their products) and only those firms that are productive enough to compete in world markets will survive.


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