Gains from Trade

Dixit and Norman (1980) Model

Proposition

Suppose a country moves from autarky to free-trade. If the government ensures that each individual can still afford her autarky choices by lump sum transfers and taxes, then the total government revenue is greater than or equal to zero: the lump sum taxes collected from those gaining from trade are more than enough to cover the subsidies to those harmed by trade.

Two Sources of Gains

(1) Consumption Gains
From consuming at a point different from autarky.

(2) Efficiency Gains
From producing at a point different from autarky.

Examples

(1) The United States during December 1807 to March 1809

Congress imposed a nearly complete embargo on international trade at the request of President Jefferson.

Irwin (2001) calculates that the welfare cost to the United States was some 8% of GDP.

(2) Japan during 1639 to 1859

Bernhofen and Brown (2002) calculate an upper bound to the gains from trade for Japan of 4 to 5% of GDP.

Memo

The idea of using lump sum transfers is not realistic.

[Reason 1] Requires too much information

Needs the knowledge of each individual's autarky consumption and factor supplies.

[Reason 2] Incentive compatibility problem

The attempt to implement a policy would lead individuals to not truthfully report the information needed.

Two Possible Solutions

(1)Commodity Taxes and Subsidies

Dixit and Norman, 1980, Dixit, 1986

Allow good and factor prices for producers to move to their free-trade levels, but hold good and factor prices for consumers fixed at their autarky levels.

Pros

Only requires information on the goods and factor prices.

Cons

The factor prices is not always available (ex: in a case where the factor prices need to be measured per unit of effort).

Individuals have moving costs. If u(c, v) is strictly quasi-concave, individuals have a unique choice of where to work and are unwilling to shift between locations at the autarky wages (the production point cannot move from the autarky one).

Examples

Unification of East and West Germany

Feenstra and Lewis, 1994

Moving subsidies can restore Pareto gains through subsidizing workers to move.

Examples

Trade Adjustment Assistance (US)

(2)Building into a policy an incentive to tell the truth (Feenstra, McMillan, and Lewis, 1990)


Imperfect Competition and Increasing Returns to Scale

Corollary of Grinols 1991 Theory

A sufficient condition for Pareto gains from trade is that the output of every industry subject to increasing returns to scale or imperfect competition does not fall when going from autarky to free trade, and at least one such industry expands.

Markusen 1981

For two countries that are identical except size, the smaller country will experience an increase in the imperfect competitive industry, but not the larger country.

Helpman and Krugman 1985

In a monopolistic competition model, suppose that the world output of each differentiated goods industry does not contract, then the opening trade will lead to at least as many goods, and at least as much output of each.


R. Feenstra, 2004, "Advanced International Trade," pp.179-187