Paul Krugman: Why Similar Countries Trade

How Paul Krugman explained trade between similar countries using economies of scale and consumer love of variety, and his role as a public commentator.

Traditional trade theory, based on comparative advantage, explained why countries with different resources trade: a country rich in land exports food, a country rich in capital exports machines. But by the 1970s, much of world trade was between similar rich countries, often in similar products: Germany selling cars to France and France selling cars to Germany. Why?

New trade theory

In papers from 1979 and 1980, Paul Krugman offered an answer, now called new trade theory:

Economies of scale: producing more of a product lowers the cost per unit. So each country’s firms specialise in particular varieties.
Love of variety: consumers like choice, such as different car models or brands.
Trade lets countries specialise in some varieties while consumers enjoy many.

This explains intra-industry trade: countries exporting and importing similar goods.

Economic geography

Krugman extended these ideas to explain why industries cluster in certain places, founding the new economic geography. Economies of scale and transport costs lead production to concentrate, creating core and peripheral regions.

The Nobel

Krugman won the Nobel prize in 2008 for his analysis of trade patterns and the location of economic activity.

The public commentator

Krugman became one of the best-known economists through his columns for The New York Times, which he wrote for about 25 years until 2024. He wrote on the Asian crisis, the 2008 crisis, the liquidity trap and US politics, often arguing for fiscal stimulus during downturns.

Asian growth debate

In a famous 1994 article, The Myth of Asia’s Miracle, Krugman argued that East Asian growth came mainly from more inputs, not productivity gains, and would slow. The debate about East Asian growth continued for years.

Cars across the border

Germany exports Volkswagens to France, while France exports Renaults to Germany. Neither country lacks the ability to build cars; economies of scale let each specialise in certain models, and consumers in both countries enjoy more choice.

Thinking trade only happens between different kinds of countries

Much trade is between similar rich countries in similar products, explained by scale economies and variety.

Key takeaways

Krugman's new trade theory explains trade between similar countries.
Economies of scale and love of variety drive intra-industry trade.
He founded new economic geography and won the 2008 Nobel.
He was a prominent public commentator for decades.