International Trade Theory and Policy
by Steven M. Suranovic

Trade 5-5B

Lesson 5B

Trade theory shows that some people will suffer losses in free trade.

A common misperception about international economics is that it teaches that everyone will benefit from free trade. One often hears that voluntary exchange, whether between individuals or between nations, must benefit both parties to the transaction, otherwise the transaction would not occur. Although this argument is valid for exchange between two people, the conclusion changes when one considers two countries made up of multiple individuals. (See pages 30-3 through 30-5)

Economists themselves often espouse the position that free trade is beneficial to all, albeit often with the caveat, "... at least in the long run". In the short run, factors of production may be relatively immobile across industries (see pages 70-1 and 70-2). In the presence of immobility, it can be shown that while export industries would gain from free trade, import-competing industries would lose (see page 70-17). Thus, in the short run, resource adjustment problems can explain losses to some groups.

In the long run, once all resources can move to alternative industries, some models (e.g. Ricardian) suggest that everyone in the economy would benefit from free trade (See page 40-9a). Other models (e.g. Heckscher-Ohlin), however, suggest that some groups may continue to lose even in the long run (See page 60-12).

Another complication is that not everyone will make it to the long run. As John Maynard Keynes once remarked, "In the long run, we are all dead." If not dead, it is surely true that some individuals will retire from the labor force before the long run arrives. These individuals may be unfortunate enough to experience only the negative short-run losses to an industry. Upon retirement, their short-term losses may carry over to long-run losses.

Economists will often dismiss concerns about potential losses from trade liberalization by proposing that compensation be provided. The "compensation principle" suggests that some of the gains could be taken away from the winners and given to the losers such that everyone becomes better off as a result of free trade. Although the principle is valid conceptually, effective implementation of it seems unlikely (See discussion on page 60-13).

International Trade Theory and Policy - Chapter 5-5B: Last Updated on 6/13/06