The Welfare Economics of International Trade

M. Kemp, H. Wan

• Publisher: Taylor & Francis
• Year: 2013
• ISBN:
  9781136455841
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book provides a careful account of the leading propositions about the welfare gains associated with international trade and investment under differing institutional arrangements and policy choices.

The Welfare Economics of International Trade

MURRAY C. KEMP

University of New South Wales, Australia

HENRY Y. WAN JR

Cornell University, New York, USA

1. INTRODUCTION

Questions relating to the gainfulness or otherwise of international trade and investment have interested economists at least since Adam Smith's rebuttal of the Mercantilist dogma that balanced trade is never gainful, and we now have at our disposal a well-stocked arsenal of propositions about the trading gains of single countries and of groups of countries under alternative institutional arrangements and policy choices.

However many of these propositions are restricted to the class of small countries, that is, countries which cannot vary their net demands by enough to influence world prices¹; moreover many of them trace the welfare implications of merely infinitesimal changes in trading conditions. Since nearly all of world trade is between large countries, and since all policy changes are discrete, such propositions are of only modest general interest.

In this survey therefore we concentrate on two nested propositions which are valid for economies of any size, which are global in scope and which are of considerable historical and intellectual interest. Of course, an interesting proposition is valid only in a restricted environment. In due course it will be necessary to specify in detail the kinds of world economy in which each of the two propositions thrives. That task is left for later chapters, especially Chapters 2 and 3. Here we limit ourselves to an admittedly vague and incomplete account of the scope and mutual relationships of the propositions.

A. The gains from trade for a single free-trading country

The first proposition asserts the gainfulness of trade for a single free-trading country. It is the oldest and best known of all propositions in the theory of international trade, indeed in the entire history of economic thought.

PROPOSITION 1 (The Gainfulness of Trade for a Single Free-Trading Country): If an initially autarkic or non-trading country s abandons all artificial obstacles to international trade, either in the whole set of potentially tradeable goods or in some proper subset, and if the preferences, technologies and endowments of the trading partners are suitably restricted then there is a scheme of lumpsum compensation in s and an associated competitive world equilibrium such that no individual in s is worse off than in autarky.

Of course, nothing as elaborate as Proposition 1 was proved or even formulated by Adam Smith. The formulation had to wait until Pareto's teaching had penetrated the Anglo-Saxon consciousness. The opening of trade by country s enlarges the set of aggregate consumption vectors available to it; that much was understood by Torrens and Ricardo. However the opening of trade may also change domestic commodity prices and, therefore, the distribution of income in s. Indeed it typically raises the real income of some individuals and reduces the real incomes of others (notably those with skills specific to import-competing industries and without other sources of income). This possibility is not visible in the one-factor models of Torrens and Ricardo. If, following Pareto, we decline to compare the utilities of different individuals, we shall be able to make general statements about the gainfulness of international trade only if the opening of trade is accompanied by the introduction of a scheme of compensation which ensures that no individual is impoverished. To establish Proposition 1, therefore, one must display such a scheme and then demonstrate the existence of a ‘compensated’ trading equilibrium.

A general proof of existence had to wait for the appropriate tools. These were supplied, by Arrow, Debreu, McKenzie, Gale and Nikkaido, only in the ‘fifties of this century. In fact a general proof of Proposition 1 became available only in 1972, barely in time for the bicentenary of the Wealth of Nations.

The simultaneous application of Proposition 1 to each of several initially autarkic but now free-trading countries yields an interesting corollary.

COROLLARY TO PROPOSITION 1 (The Gains from Trade for a Group of Free-Trading Countries): If each member of a group of countries abandons autarky and trades freely within the group (and only within the goup) and if simultaneously each member of the group eliminates all internal impediments to trade then there exist schemes of lumpsum compensation, one for each country, and an associated world free-trade competitive equilibrium such that no individual, whatever his country of residence, is worse off than in autarky.

It is important to understand that the Corollary is not equivalent to Proposition 1. The latter implies the former. However the reverse implication does not hold; for Proposition 1 is valid whether or not the trading partners of country s are free trading, whereas the Corollary requires that all countries be free trading.

B. A more general proposition

For our second general proposition we look to the welfare economics of customs unions, that is, subsets of countries which have eliminated all duties on their mutual trade, imposed a common set of duties on trade with excluded countries, and removed all other distorting taxes. What we offer, however, is a customs-union proposition extended to accommodate countries which abandon autarky for free trade.

PROPOSITION 2 (The Existence of Gainful Customs Unions): If an arbitrary initial world trading equilibrium is disturbed by the formation of a customs union comprising some subset of countries then there can be found a common external tariff vector and a scheme of lumpsum compensation, restricted to individuals in the union, such that there exists a new world trading equilibrium in which

(a) no individual member of the union is worse off than before the formation of the union,

(b) if there is net pre-union trade between member and non-member countries, no individual, whether a member of the union or not, is worse off than before the union, and

(c) the net tariff revenue of the union is at least as large as the net compensation accruing to individual members of the ...

Table of contents

• Front Cover
• Half Title
• FUNDAMENTALS OF PURE AND APPLIED ECONOMICS
• Title Page
• Copyright
• Title Page
• Copyright
• Contents
• Introduction to the Series
• Preface
• 1. Introduction
• References
• Index