The Theory of Trade in Middle Products

Abstract

The bulk of international commerce consists of trade in intermediate goods, raw materials, and goods which require further local processing before reaching the final consumer. Although this has become a common observation, it has yet to receive central attention in the pure theory of international trade. A further observation is that few items in international trade are pure raw materials or primary factors which have not received any value-added from other local inputs. Put together, these remarks suggest that in the typical productive spectrum whereby primary factors and labor help produce and transform commodities into the final state required by consumers, international trade takes place in "middle products". The purpose of this article is to develop and analyze a model of international trade that recognizes as its central feature that the composition of the outputs of industrial activity at early stages need not match the composition of intermediate inputs at final stages of the productive spectrum. The first section of the paper reveals the features of the model by analyzing the resource shifts and cost changes as the ratio of final outputs changes along a transformation schedule. Sections II-VI proceed to apply the model to analyses of tariffs, changes in the terms of trade, technical progress, transfers, and exchange rate devaluation. Possible extensions are discussed at the end of the paper. The model analyzed here builds upon two models standard in the trade literature, the Heckscher-Ohlin model with two mobile factors, and the specific factor models. It is considerably richer in structural detail than either of these precursors, and yet not much more difficult to analyze. It allows scope for the influence of demand, even for small countries which face world markets for traded "middle products". And it reveals how assymetries between the productive structures of different countries - e.g. at different stages of the development process - might systematically lead to asymmetrical patterns of income redistribution as conditions of trade are altered.