Classical comparative advantage explains a lot of trade — but not most of it. The biggest trade flows are between SIMILAR rich countries exchanging SIMILAR goods (Germany and France trading cars for cars), which comparative advantage cannot explain (why would similar countries with similar endowments trade?). The 'new trade theory' of the late 1970s solved this puzzle and reshaped the field, with profound implications for small economies like Africa's.
The puzzle: intra-industry trade between similar countries
Comparative advantage predicts that different countries trade different goods (a labour-abundant country exports labour-intensive goods to a capital-abundant one). But the data show the opposite is huge: similar countries trade similar goods (intra-industry trade — Germany exports cars to France AND imports cars from France). This cannot be comparative advantage (the countries are alike), so something else must drive it.
New trade theory: scale and variety
Krugman's insight
Paul Krugman (1979, 1980) showed that economies of scale plus product differentiation generate trade even between identical countries. The logic: production has increasing returns (it is cheaper per unit to make a lot of one variety), and consumers love variety (they want many kinds of car). So each country specialises in producing a few varieties at large scale, and trades them for the varieties the other country specialises in — both countries get more varieties at lower cost than if each made everything itself. Trade here is driven not by differences (comparative advantage) but by scale economies and the gains from a larger market and more variety. This explains intra-industry trade, and it won Krugman the Nobel. The crucial implication: MARKET SIZE matters — a larger integrated market supports more scale, more varieties, and more competitive firms, which is the core economic case for regional integration (the AfCFTA course) and a key handicap of Africa's fragmentation into small national markets.
The gravity model
The most robust regularity in economics
The gravity model predicts bilateral trade between two countries from their economic sizes and the distance between them: Trade between A and B ∝ (GDP_A × GDP_B) / Distance_AB Two countries trade more the larger their economies and the closer they are (distance proxying transport costs, information, and cultural/institutional ties). The gravity model fits the data extraordinarily well — it is arguably the single most robust empirical regularity in all of economics — and it has deep theoretical foundations (Anderson, Eaton-Kortum). Its lessons for Africa are stark: a country's biggest natural trading partners are its large, near neighbours — yet intra-African trade is far below what gravity predicts (the AfCFTA course's central puzzle), because trade costs (poor infrastructure, NTBs, the colonial trade map orienting trade outward) are abnormally high. Gravity says African economies SHOULD trade heavily with each other; the fact that they don't points to removable barriers, which is the economic case for integration.
Firm heterogeneity: who actually exports
The 'new new trade theory' (Melitz, 2003) added a crucial micro fact: firms within an industry differ enormously in productivity, and only the most productive firms export (exporting has fixed costs — establishing foreign distribution, meeting standards — that only productive firms can cover). This has a powerful implication: opening to trade reallocates resources from less-productive (exiting or shrinking) firms to more-productive (exporting, expanding) firms, raising average productivity across the whole industry — a gain from trade that operates through selection and reallocation, not just specialisation. It also explains why most firms don't export (it's the productive minority that do), why export promotion is hard (you can't make an unproductive firm an exporter), and why the productivity of a country's firms — not just its factor endowments — shapes its trade. The Melitz mechanism is central to modern empirical trade economics and to understanding why African firms, often small and low-productivity, struggle to export.
Exercise
An analyst observes that two neighbouring African countries with similar economies and endowments trade very little with each other, while both export raw commodities to Europe and import manufactures from China. (1) Explain why classical comparative advantage struggles to predict trade BETWEEN the two similar neighbours, and what new trade theory adds. (2) Use the gravity model to argue the two neighbours SHOULD trade more, and explain the puzzle. (3) Explain how market size and scale economies bear on these countries' inability to develop competitive manufacturing. (4) Use Melitz to explain why few of their firms export and what that implies for trade policy.