Trade Theory Vs Reality: The Banana Trade War

ABSTRACT To what extent can academic trade theories be applied to real world trade issues? We analyze how well modern trade theories and ideas from political economy explain the European Union/United States banana trade war that started in 1993. We show that older trade models, like the Heckscher-Ohlin theorem, only explain observed trade patterns with several core assumptions relaxed. In contrast, the New Trade Theory, with the introduction of heterogeneous firms and monopolistic competition, presents a much more convincing explanation for the banana trade. Finally, we analyze the role of political economy in facilitating the rise and fall of economically inefficient banana tariffs over the course of a two-decade trade war.