Comparative Advantage and Economies of Scale: When Does Ricardo Dominate Smith?

This paper develops a two‐country, two‐sector (X and Y) model of international trade. One country has comparative advantage in the increasing returns Y‐sector. The direction of trade depends on the relative size of the countries and the relative strength of economies of scale and comparative advantage. An equilibrium where the smallest country exports the Y‐good and the largest country loses from trade is possible. A dynamic equilibrium where the X‐sector is subject to learning by doing locks in the initial pattern of specialization. Yet, there may be few welfare gains from protecting the X‐sector in the small country.