Interpreting the Welfare Effects
by Steven Suranovic ©1997-2004
The real wage calculations show that some workers gain from trade while others lose from trade.
On the other hand we showed that the economy is able to jump to a higher aggregate indifference
as a result of free trade. The increase in aggregate welfare is attributable entirely to an increase in
consumption efficiency. A reasonable question to ask at this juncture is whether the winners from
trade could compensate the losers such that every worker is left no worse off from free trade.
The answer to this question is no, in the context of this model.
In the immobile factor model there is no increase in world productive efficiency. The immobility of factors implies that world output is the same with trade as it was in autarky. This means that the best that compensation could provide is to return everyone to their autarky consumption levels. And, the only way to do that is to eliminate trade. There simply is no way to increase the total consumption of each good for every worker after trade begins.
Sometimes economists argue that since the model displays an increase in consumption efficiency, this means that the country is better-off with trade. While technically this is true, it is important to realize that statements about what's best for a country in the aggregate typically mask the effects to particular individuals. The immobile factor model suggest that in the very short run, movements to free trade will very likely result in a redistribution of income with some groups of individuals suffering real income losses. It will be very difficult to convince those who will lose, that free trade is a good idea because the aggregate effects are positive.
Furthermore since there is no way for the winners to compensate the losers such that everyone gains, the model implies that the movement to free trade can be a zero-sum game, at least in the very short-run. This means that the sum of the gains to the winners is exactly equal to the sum of the losses to the losers.
In the Heckscher-Ohlin model we will show that income redistribution is possible even in the long-run when an economy moves to free trade. However, in that case free trade will be a positive sum gain, in that the sum of the gains will exceed the sum of the losses.
International Trade Theory and Policy Lecture Notes: ©1997-2004 Steven M. Suranovic