Welfare analysis of trade policies in factors and goods

Florencia

Conferencia; The Nineteenth Annual Conference of the ETSG 2017 Florence; 2017

European Trade Study Group

The author studies the welfare implications of trade in goods and factors taking into account traditional trade models. Interesting insights emerge when one considers the sufficient condition under which the gains from free trade in factors can be reaped starting from an initial equilibrium with free or restricted trade in goods, which is derived by Grossman (1984). Firstly, when final goods and factors are substitutes in trade, as in Mundell (1957), Grossman´s proposition does not hold at least for two reasons. If a large country imposes a restriction in trade of goods, though at the final equilibrium the term of trade effect vanishes, the welfare decreases because of the volume of trade effect is negative. For small countries, free factor mobility may deteriorate its welfare if they follows a restricted trade policy in goods. In general, however small countries do not suffer a negative impact in their well-being when trade in factors fully substitute trade in goods. Secondly, when final goods and factors are complementary in trade, as in Markusen (1983), the welfare impact of factor migration will depend on whether the mobile factor is used intensively in the importable or the exportable sector. If the mobile factor is used intensively in the exportable industry, the welfare of a large economy may deteriorate because of the negative effect of the term of trade. Instead, if the mobile factor is used in the importable industry, the welfare may increase if a country turns the terms of trade in its favor. Finally, the extension of the study to these settings serves to understand how the general results of the Grossman?s (1984) analysis apply to particular cases. The main conclusion is that factor mobility accounts for welfare changes once trade policy in goods has been already introduced. In fact, the gains from international factor movements are not necessarily guaranteed.