the scale of production increases, the average cost per product decreases. These
economies of scale might appear in production, in R&D, in purchasing, in
marketing or in distribution. A very simple case of economies of scale are the dis-
counts offered on quantity purchases (which are in turn based on the supplier’s
economies of scale). Economies of scale in production may be the result of a
division of labour and specialization or of cost-cutting measures (for example,
robots in auto manufacturing) which only become profitable at a certain
minimum production level. After all, it would hardly pay to set up a robot
assembly line if you are only going to produce three cars.
In addition to these economies of scale, which are known as internal
economies of scale (in other words, within one company), there are also external
economies of scale. These are closely related to the size of an industry and not to
the size of the individual company. A concentration of companies in a particular
region, for example semiconductor manufacturers in Silicon Valley in California,
may give rise to a good infrastructure, a specialist labour force and a network of
suppliers (see also Porter’s analysis in Section 5). This means that individual com-
panies within this industry can achieve economies of scale, despite the fact that
large companies produce no more efficiently in the sector than small companies.
How do such economies of scale affect international trade? We noted previ-
ously that international trade depends on absolute or relative comparative cost
advantages, which are the result of differences in factor endowments. According
to the classic theories of trade, countries with comparable factor proportions will
not trade with one another because they will not be able to gain absolute or
relative comparative cost advantages. However, when economies of scale are
applied, a system in which one country produces one product and a second
country produces another can nevertheless offer advantages. Because production
can take place on a larger scale, the average costs of both products will drop. Both
countries can therefore gain through specialization and international trade.
How can we predict which country will produce which product if neither
country can gain a cost advantage? The answer is: we can’t. It is frequently a
combination of serendipitous factors which leads to a certain industry setting
up first in a certain country. Through internal and/or external economies of
scale, this country will be able to build up such an advantage that it becomes
very difficult for anyone else to catch up.
4 THE REASON FOR MULTINATIONAL COMPANIES
The theories discussed in the previous section explain how international trade –
the conveying of goods across borders – arises and what constitutes it. A second
assumption – the first being constant returns to scale (see Section 3) – which
the classic theories make, is that the production factors present in a particular
The International Division of Labour 15