What is trade diversion?

Trade diversion refers to a situation where trade shifts from a more efficient producer to a less efficient producer as a result of preferential trade agreements or trade blocs. This happens when a country changes its trading partners due to the imposition of tariffs or trade barriers on external countries, which makes imports from those countries more expensive.

In this context, the correct choice accurately captures the concept of trade diversion as it highlights the movement of production from a low-cost producer to a high-cost producer. This underscores the inefficiency created when tariffs or trade agreements favor certain trading partners, leading to a misallocation of resources and production efficiency.

The other choices do not correctly describe trade diversion. A reduction in trade barriers would actually promote trade creation, not diversion, as it allows greater access to efficient producers. Investments moving to developing countries can be part of foreign direct investment strategies but does not specifically relate to trade diversion. Lastly, export subsidies on local products could influence domestic markets but do not describe the phenomenon of shifting trade patterns due to preferential treatment.