17.2: Two-Way Trade

Learning Objective

1. Distinguish between one-way trade and two-way trade.
2. Explain why two-way trade may occur.

The model of trade presented thus far assumed that countries specialize in producing the good in which they have a comparative advantage and, therefore, engage in one-way trade. One-way (or interindustry) trade occurs when countries specialize in producing the goods in which they have a comparative advantage and then export those goods so they can import the goods in which they do not have a comparative advantage.

However, when we look at world trade, we also see countries exchanging the same goods or goods in the same industry category. For example, the United States may both export construction materials to Canada and import them from Canada. American car buyers can choose Chevrolets, Fords, and Chryslers. They can also choose imported cars such as Toyotas. Japanese car buyers may choose to purchase Toyotas—or imported cars such as Chevrolets, Fords, and Chryslers. The United States imports cars from Japan and exports cars to it. Conversely, Japan imports cars from the United States and exports cars to it. International trade in which countries both import and export the same or similar goods is called two-way (or intraindustry) trade.

Two reasons countries import and export the same goods are variations in transportation costs and seasonal effects. In the example of the United States and Canada both importing and exporting construction materials, transportation costs are the likely explanation. It may be cheaper for a contractor in northern Maine to import construction materials from the eastern part of Canada than to buy them in the United States. For a contractor in Vancouver, British Columbia, it may be cheaper to import construction materials from somewhere in the western part of the United States than to buy them in Canada. By engaging in trade, both the American and Canadian contractors save on transportation costs. Seasonal factors explain why the United States both imports fruit from and exports fruit to Chile.

Another explanation of two-way trade in similar goods lies in recognizing that not all goods are produced under conditions of perfect competition. Once this assumption is relaxed, we can explain two-way trade in terms of a key feature of monopolistic competition and some cases of oligopoly: product differentiation. Suppose two countries have similar endowments of factors of production and technologies available to them, but their products are differentiated—clocks produced by different manufacturers, for example, are different. Consumers in the United States buy some clocks produced in Switzerland, just as consumers in Switzerland purchase some clocks produced in the United States. Indeed, if two countries are similar in their relative endowments of factors of production and in the technologies available to them, two-way trade based on product differentiation is likely to be more significant than one-way trade based on comparative advantage.

In comparison to the expansion of one-way trade based on comparative advantage, expansion of two-way trade may entail lower adjustment costs. In the case of two-way trade, there is specialization within industries rather than movement of factors of production out of industries that compete with newly imported goods and into export industries. Such adjustments are likely to be faster and less painful for labor and for the owners of the capital and natural resources involved.

Because two-way trade often occurs in the context of imperfect competition, we cannot expect it to meet the efficiency standards of one-way trade based on comparative advantage and the underlying assumption of perfectly competitive markets. But, as we discussed in the chapter on imperfect competition, the inefficiency must be weighed against the benefits derived from product differentiation. People in the United States are not limited to buying only the kinds of cars produced in the United States, just as people in Japan are not limited to buying only cars produced in Japan.

Key Takeaways

• Specialization and trade according to comparative advantage leads to one-way trade.
• A large percentage of trade among countries with similar factor endowments is two-way trade, in which countries import and export the same or similar goods and services.
• Two-way trade is often explained by variations in transportation costs and seasonal factors; in similar goods it often occurs in the context of models of imperfect competition.
• Adjustment costs associated with expansion of two-way trade may be lower than for expansion of one-way trade.

Try It!

The text argues that two-way trade must be a result of transportation cost, climate, or imperfect competition. Explain why.

Case in Point: Two- Way Trade in Water: A Growth Industry

Figure 17.9

Brian Smithson – Water – CC BY 2.0.

In the 1930s, the successful introduction into the United States of French-made Perrier showed that U.S. consumers were open to a “new” bottled beverage. Since then, the U.S. bottled water business has taken off and bottled water is now the second largest commercial beverage category by volume, after carbonated soft drinks.

Seeing the increased popularity of bottled water, both PepsiCo and Coca-Cola launched their own bottled water brands, Aquafina and Dasani, respectively. Both of these brands are made from purified tap water. Dasani has minerals added back into it; Aquafina does not. Other brands of water come from springs or artesian wells. While domestic brands of water have multiplied, Americans still drink some imported brands. Representing only about 3% of the U.S. market, the volume of imported water nonetheless has about doubled in the last five years.

And U.S. bottled water companies are also eyeing markets in other countries. As New York Times columnist and book author Thomas Friedman noted as he was being shown around a customer call center in Bangalore, India, the water on the desktops of the telemarketers was none other than Coke’s Dasani.

Whether the differences in brands of water are perceived or real, it may not be too long before restaurants develop water lists next to their beer and wine lists. In the U.S. and in other countries around the world, there is likely to be a domestic section and an imported section on those lists. Two-way trade in water seems destined to be a growth industry for some time to come.

Sources: Thomas L. Friedman, “What Goes Around…” The New York Times, February 26, 2004, p. A27; Tom McGrath and Kate Dailey, “Liquid Assets,” Men’s Health 19:2 (March 2004): 142–49; Statistics from Beverage Marketing Corporation at www.bottledwater.org/public/Stats_2004.doc.

Answer to Try It! Problem

In the absence of one of these factors, there would only be one-way, or interindustry, trade, which would take place according to comparative advantage, as described in the first section of this chapter, with a country specializing in and exporting the goods in which it has a comparative advantage and importing goods in which it does not. Efficiency differences would be the only basis for trade.