Globalization and the Gains from International Trade - Essay Example

?Globalization and Gains from Trade i) and explain the ical ‘gains from international trade proposition’ (GFITP). In 1939, Samuelson developed a theorem built around centrally-planned nations, suggesting that free trade is better than autarky. Subsequently, Samuelson expanded his original theorem and others like Kemp and Kenen validated it (Grandmont & McFadden 1972, p.109). Samuelson’s theorem consolidated the ‘gains from international trade proposition’ (GFITP) that have long been espoused by economists. Using certain assumptions, Samuelson concluded that although it cannot be illustrated that everyone stands to gain under free trade, it can nevertheless, be proven that no one could be any less worse (Kemp 1995, pp. 3-4). According to him, in a free system, both production and consumption always end up higher than those in autarkic states. A free trade society is better off since the trade frontier rises high above the autarkic frontier on all aspects implying that it can obtain more all of such goods minus some of the tedious inputs (Samuelson 1962, pp. 820-821). Kemp believes that gains in free trade is evinced only if none of the countries within the globalised system is worse off than those in smaller customs unions. Free trade, according to him, is just one of the integral characteristics of globalisation that ultimately gives rise to more global development (Kemp1987). Kemp (1962) expanded on Samuelson’s theory by proving that GTIF is applicable to countries of whatever size under similar assumptions. Using the equation p1 z1 – w1 a1 ? p1 z0 - w1 a0, Kemp concluded that it is impossible to make everyone better off by a mere redistribution of goods under autarky and illustrated, using the same utility curves employed by Samuelson, that free trade is better than autarky (see Fig. 2). In said illustration, P and R represent two individuals, the dashed curve g0g0 represents collection of goods under autarky and dashed curve h0 h0 represents a new production mixture under autarky. If trade is opened up together with the introduction of lump sum taxes and subsidies, z1 and u1 will appear. In such a case, both g0g0 and h0h0 curved dashes pass south west of u1 implying that the collection of goods and production are not better under autarky than in free trade. Point pp also passes below u1 because it operates under autarkic condition, but point RR, which operates under free-trade, can neither lie inside autarkic levels. In sum, the GFTIP has four core theories, assuming a fixed market with finite numbers of individuals and commodities: free trade is better than no trade, whether an economy is small or big; any improvement in trade is beneficial in the case of small open economies; trade in further products is likewise beneficial for small open economies, and; a relationship involving any trade agreement is mutually beneficial for any subset of trading countries (Kemp 1995, p. 105). ii) Carefully explain and annotate the proof of the classical GFITP provided by Grandmont and McFadden (1972). Why is this proof generally regarded as the first satisfactory proof of the classical gains from international trade proposition? The first satisfactory and complete proof of the classical GFITP is believed to be that propounded by Grandmont and McFadden in 1972. The reason for the long lag of time between proposition and proof lies in technicality: the absence of a lump sum compensated world before World War II (Kemp and Wan 1972). Grandmont and McFadden proved that autarkic countries can subsequently evolve into free trade without harming their consumers through internal financing to ensure, at least, that consumers are not worse off than before. With the classical GFITP reduced into Propositions A and B, Grandmont and McFadden developed a model to prove their validity (1972, p. 110). In the Grandmont-McFadden model, both Propositions A and B assume decentralised and multiple-consumers nations with competitive domestic markets. Proposition A states that “Given a world competitive trade equilibrium allocation, any alternative allocation feasible under autarky which makes some consumers better off must make some other consumers in that nation worse off.” On the other hand, Proposition B states that “Given an allocation achieved under autarky, a system of world trade prices and lump-sum transfers can be found for which a competitive equilibrium allocation will exist and will be at least as satisfactory as autarky for every consumer” (Grandmont and McFadden 1972, p. 110). The Grandmont-McFadden model is underpinned by sets of assumptions on aspects of supply, demand and distribution policy, which collectively reflect a group of nations with competitive domestic economies. The assumptions on supply are: (Y.1) Yk is a closed subset of RN [Y=net production; k=country; RN=N-dimensional Euclidean space]; (Y.2) Inaction is possible; (Y.3) Yk is convex [crucial factor, but least feasible]; (Y.4) There is free disposal [least plausible]; (Y.5) World resources and production possibilities are limited, and; (Y.6) The set of efficient points in Yk is bounded (Grandmont and McFadden 1972, pp. 114-118). On the other hand, the assumptions on demand are: (D.1) i of k can subsist on goods in Nk [N=set of goods; i=consumer; k=country]; (D.2) values of the demand function are non-empty for + prices and incomes > than subsistence level; (D.3) Dik is positively homogenous of degree 0 on Qik.; (D.4) Dik is a convex subset of Bik, and; (D.5) Dik is a closed upper hemicontinuous correspondence for the set of p Є P and incomes above subsistence (Grandmont and McFadden 1972, pp. 114-118). Finally, the assumptions on distribution policy are: (E.1) Tik is a positively linear function on ?k and is continuous on Pk for iЄI, and; (E.2) At least one n1 in an autarky and at least one i in every nation will demand an unlimited amount of commodity if given income above subsistence (Grandmont and McFadden 1972, pp. 114-118). With the aforesaid assumptions laid down, three theorems are then subsequently developed: Theorem 1 states that an autarkic competitive equilibrium exists if the first 4 and the last conditions of the supply sector and all the 5 conditions of the demand section are met; Theorem 2 states that a world competitive equilibrium exists if the same conditions are met by a group of nations and in addition, satisfy (E.1), and; Theorem 3 states that a Pareto non-inferior equilibrium exists if all conditions are met similar to the second theorem and in addition, are viable autarkically. Furthermore, each nation must be able to give income to their respective consumers under the following conditions: at a value equal to the consumers’ consumption before free trade at free trade price, and; a non-negative fraction of the income of the national balance (Bhagwati 221). The first two theorems prove the existence of equilibrium under autarky and free trade when countries abide by sensible distribution policies whilst the third theorem proves that general equilibrium is attainable by mixed economies with social welfare allotment policies. The proof provided by Grandmont and McFadden is considered the first satisfactory proof of GFITP because of its completeness. Moreover, it proves that Pareto non-inferior allocation can be supported without need of redistribution or crossing borders (Bhagwati 1999, p. 217). With specifications of trading economies adopted from Arrow, Debreu and McKenzie, the proof stipulates the following: completeness and accessibility of markets; coexistence of all agents; convexity of preferences; absence of money in trading, and absence of market distortions (Gangopadhyay and Chatterji p. 8). iii) Carefully explain three recent challenges to the classical GFITP. Are these challenges successful? Why? Some of the recent challenges came from the following sources: Newberry and Stiglitz (1981), Cordella, Minelli and Polemarchakis (1999) and Cordella and Ventura (1992). Newberry and Stiglitz argued that it cannot be simply assumed that free markets will be Pareto optimal and therefore, under certain conditions, there is a need for governments to intervene through introduction of buffer stock or restrictions when risks exist. By using a model of two farmers from two different countries both raising one risky crop and one safe crop, Newberry and Stiglitz argue that free trade is Pareto inferior to autarky. With no free trade, the law of supply and demand will necessarily raise the price of the risky crop when output falls, which provides security to farmers. This cannot be had under free trade, which increases the riskiness of growing the crop compelling farmers to substitute growing that risky crop with a safer one. In short, if trading countries have incomplete sets of markets resulting in inefficient internal equilibria, free trade will render the individuals in these countries worse than their former conditions (1981, pp. 1-34). On the other hand, Cordella, Minelli and Polemarchakis (1999), who adopted a model that eschews strict monotonicity and positive prices because they are purportedly unnatural, whilst adopting the assumption of source relatedness espoused by McKenzie, argued that it is not certain that gains in international free trade is more Pareto efficient than domestic transfers. The implication of Cordella et al’s study is that under alternative assumptions, the elements of GFITP are applicable and by the same logic, a Pareto non-inferior condition may be obtained in autarky as in free trade (pp. 1-6). Finally, Cordella and Ventura (1992) argued against the proposition that autarkic allocation, which has established a competitive equilibrium allocation, is sufficient for Pareto gains in a subsequent international free trade. The crux of their argument is that such Pareto benefit is unlikely if the domestic transfers are made after trade in world markets (Shimomura 2002, pp. 162-163). All of these challenges, however, have failed to completely demolish the gains from free trade proposition because of their inherent flaws. The Cordella-Ventura challenge, for example, failed to establish time dimensions and therefore, was inappropriate to debunk the proofs previously proffered that have clearly established such compensatory measures and other efficacious transfers as dependent on state practices and not on the status gained by a country as a consequence of world equilibrium. The crux of the failure largely rests on its inability to use the same underlying basis of the proof to discredit it. On the other hand, the Cordella et al challenge also failed because its assumptions were not up to par with those used by Grandmont and company in 1972, which were based on Arrow and Debreu. Finally, the Newberry-Stiglitz challenge is based on an erroneous principle of the competitive position of household utilities in a conventional slope under missing markets condition (Shimomura 2002, pp. 163-164). References: Bhagwati, J. (1999). Trading blocs: alternative approaches to analyzing preferential trade agreements. MIT Press. Cordella, T., Minelli, E., and Polemarchakis, H.M. (1999). ‘Trade and Welfare.’ Information, Markets and Social Choice: Essays in Honor of K.J. Arrow. Cambridge University Press 332-337. Gangopadhyay, P. and Chatterji, M. (2005). Economics of globalisation. Ashgate Publishing, Ltd. Grandmont, JM & McFadden, D. (1972). ‘A technical note on classical gains from trade.’ Journal of International Economics 2: 109-125. Kemp, M. (1987), “Gains from trade”, (in) The New Palgrave Dictionary of Economics, 1st Edition, (eds.) J. Eatwell, M. Milgate, P. Newman, Volume 2, pp. 453 – 454. Kemp, M. (1995). The gains from trade and the gains from aid: essays in international trade theory. Routledge. Newberry, D. and Stiglitz, J. (1981). ‘Pareto Inferior Trade and Optimal Trade Policy.’ Econometric Research Program Research Memorandum No. 281. Samuelson, P.A. (1962). ‘The gains from technical trade once again.’ The Economic Journal, Vol. 72 (288): 820-829. Shimomura, K. (2002). ‘Recent challenges to the classical gains-from-trade proposition.’ German Economic Review 3: 485-489. International trade theory: a critical review by Kemp, M. 2008. Oxon: Routledge. Read More