Lectures on International Trade

Jagdish N. Bhagwati, Arvind Panagariya, T.N. Srinivasan
MIT Press, 1998, 2nd edition

1. Introduction

1.1 Pure Theory of Trade

The theory of international trade divides traditionally into two disciplines distinguished by their theoretical frameworks of analysis: the pure theory and the monetary theory. In this volume we will primarily be concerned with the pure theory of trade, which in essence is an extension of value-theoretic analysis in the Walras-Hicks tradition.

1.2 Distinguishing Features of International Trade Theory

Why do we study international economics as a separate branch of economic theory? Can we truly differentiate it from other disciplines relating to the analysis of "closed" economies? Such methodological questions have been fashionable from time to time among international economists. The classical economists thought that the distinction we are looking for consisted in the "fact" that factors of production were mobile within a country but not across countries so that international economic analysis was distinguished by the novel assumption of factor immobility. This was largely fiction, even at the time of the classical writings: Colonies were being opened up and populated, and through the latter half of the nineteenth-century capital and labor were to play a major role in the development of the New World. Nor was it always the case that factors were perfectly mobile within countries. Indeed, from a strictly theoretical point of view, the analysis that we pursue often allows for international factor mobility, whereas the positive and welfare aspects of domestic factor immobility have equally been brought within the purview of analysis by recent trade theorists.

If there are striking differences between "closed-economy" and "open-economy" analyses, they are to be found elsewhere. There are two political, decision-making aspects of the international economy that, although they are relevant to intranational analysis, have not received equal emphasis outside of trade-theoretic analysis. First, it is inescapable that trade theory should focus, at least in part, on the welfare effects of alternative economic policies (free trade, customs unions, etc.) on individual nations within the international economy. Indeed, it has never been enough for the trade economists to look at world welfare. The individual nations as political units make policy decision in their "national" (as distinct from "world") interest, so many trade problems have eventually had to be looked at from a national viewpoint as well. On the other hand, identical tools of economic analysis, when deployed to examine intranational problems, have generally been addressed to the question of national welfare as distinct from the welfare of individual units (e.g., producers or consumers) within the nation. While the problem of income distribution has been raised as well, it has been largely from the viewpoint of the conceptual difficulties raised by income-distribution changes in ranking alternative policies. In fact, until recently, a lacuna of modern, closed-economy theory has been that welfare problems of individuals and groups within a nation state have not generally received the attention that they deserve as social questions of importance. Second, there are differences at the "monetary" level in "adjustment mechanisms" between countries and within a country. The central points of difference are that (1) the "exchange rate" adjustment is not meaningful within a country with a single currency, whereas in general it is admissible between countries (but can be ruled out by the presence of currency blocks or the operation of the gold standard), and (2) the general improbability of using "adjustment" measures such as tariffs and quota restrictions between regions within a country, whereas tariffs and restrictions have sometimes been used within countries (although international trade is sometimes conducted, as in free-trade areas, under rules that preclude the use of such tariffs and restrictions).

The qualifications to each of these attempted distinctions between trade and other theories underline the central conclusion that they are based on contrasts between intranational (i.e., among regions or sectors within a country) and international economic relations-contrasts pertaining to factor mobility, focus on units within the overall economy, and permissible adjustment mechanisms-that can by no means be drawn firmly.

1.3 Positive and Normative Aspects

Throughout the volume we will draw a sharp distinction between the positive and the normative (or welfare) aspects of trade theory. For example, when discussing the theory of comparative advantage, we will distinguish between the theories that attempt to explain the pattern of trade and the theories that relate to the gains from trade. These distinctions are not always drawn as sharply as they should be. Reputed economists have fallen into the trap of taking the Heckscher-Ohlin theorem-which states that a country will export that commodity that uses its abundant factor intensively-to imply that a labor-abundant country ought (on welfare grounds) to export labor-intensive commodities.

1.4 Organization of the Volume

Part I is addressed to an extended analysis of the general-equilibrium analysis of international trade, involving alternative theories of the pattern of trade (the central focus being on the Ricardian and Heckscher-Ohlin theorems) and the depiction of free-trade equilibrium under different assumptions relating to technology, income distribution, perfection in the factor and commodity markets, and variability of the factor endowments. New theories of trade involving imperfect competition and product creation are also discussed there.

Part II discusses the comparative statics of trade-theoretic analysis, focusing on tariffs and transfers. Two important areas of recent attention — tariffs versus quotas and effective protection — are also considered there.

Part III is concerned with the welfare propositions of trade theory and deals broadly with the questions relating to optimal trade and nontrade policies under alternative assumptions relating to foreign trade opportunities and imperfections in the domestic markets (e.g., involving externalities in production or consumption). The analysis is also extended to the question of optimal policy intervention when noneconomic objectives such as defense production, reduction of import dependence, or maintenance of labor force in a sector (e.g., agriculture in advanced countries or industry in underdeveloped countries) constitute additional constraints subject to which optimal policy would have to be devised in a trading economy. Questions of optimal policy intervention in the presence of capital mobility and labor migration are also considered.

Part IV takes up a number of analytical issues that have recently been raised in the literature on trade, growth, and development. This part also systematizes a great deal of recent work on lobbying for tariffs or import-license premia and on illegal trade.

Our primary emphasis is on intuitive arguments and on simple geometric expositions and illustrations. Policy aspects and the relevance.of theoretical arguments are often discussed in detail. At the same time the underlying formal structure of the argumentation is developed mathematically in a number of chapters. Some of the more mathematical proofs of propositions developed less formally in the text are explored in the three appendixes.

1.5 Standardized Notation

There is no standard notation in the literature on international trade theory; unfortunately, the student will have to become familiar with the particular notation used in virtually every journal paper that must be read in the original. However, we have standardized our notation in this volume. For the bulk of the text, where the traditional trade-theoretic model with two traded goods and two primary factors is used.