New Trade Theory

(NTT) is the economic critique of international free trade from the perspective of increasing returns to scale and the network effect. Some economists have asked whether it might be effective for a nation to shelter infant industries until they had grown to sufficient size to compete internationally.

New Trade theorists challenge the assumption of diminishing returns to scale, and some argue that using protectionist measures to build up a huge industrial base in certain industries will then allow those sectors to dominate the world market (via a Network effect).

They wondered whether free trade would have prevented the development of the Japanese auto industries in the 1950s, when quotas and regulations prevented import competition. Japanese companies were encouraged to import foreign production technology but were required to produce 90 percent of parts domestically within five years. It is said that the short-term hardship of Japanese consumers (who were unable to buy the superior vehicles produced by the world market) was more than compensated for by the long-term benefits to producers, who gained time to out-compete their international rivals1.

Less quantitative forms of this "infant industry" argument against totally free trade have been advanced by trade theorists since at least 1848 (see: History of free trade.)