Factor price equalisation

Nevertheless there have been widespread misgivings about the effects of international trade upon wage earners in developed countries. Samuelson‘s factor price equalisation theorem indicates that, if productivity were the same in both countries, the effect of trade would be to bring about equality in wage rates.

As noted above, that theorem is sometimes taken to mean that trade between an industrialised country and a developing country would lower the wages of the unskilled in the industrialised country. However, it is unreasonable to assume that productivity would be the same in a low-wage developing country as in a high-wage developed country.

It has been argued that, although there may sometimes be short-term pressures on wage rates in the developed countries, competition between employers in developing countries can be expected eventually to bring wages into line with their employees' marginal products.

Any remaining international wage differences would then be the result of productivity differences, so that there would be no difference between unit labour costs in developing and developed countries, and no downward pressure on wages in the developed countries.

Terms of trade

There has also been concern that international trade could operate against the interests of developing countries. Influential studies published in 1950 by the Argentine economist Raul Prebisch and the British economist Hans Singer suggested that there is a tendency for the prices of agricultural products to fall relative to the prices of manufactured goods; turning the terms of trade against the developing countries and producing an unintended transfer of wealth from them to the developed countries.

Their findings have been confirmed by a number of subsequent studies, although it has been suggested that the effect may be due to quality bias in the index numbers used or to the possession of market power by manufacturers. The Prebisch / Singer findings remain controversial, but they were used at the time – and have been used subsequently – to suggest that the developing countries should erect barriers against manufactured imports in order to nurture their own “infant industries” and so reduce their need to export agricultural products.

The arguments for and against such a policy are similar to those concerning the protection of infant industries in general.

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THE EFFECTS OF TRADE: INFANT INDUSTRIES AND TRADE POLICIES

The term "infant industry" is used to denote a new industry which has prospects of becoming profitable in the long-term, but which would be unable to survive in the face of competition from imported goods. That is a situation that can occur because time is needed either to achieve potential economies of scale, or to acquire potential learning curve economies.

Successful identification of such a situation followed by the temporary imposition of a barrier against imports can, in principle, produce substantial benefits to the country that applies it – a policy known as “import substitution industrialization”. Whether such policies succeed depends upon governments’ skills in picking winners, and there might reasonably be expected to be both successes and failures.

It has been claimed that South Korea’s automobile industry owes its existence to initial protection against imports, but a study of infant industry protection in Turkey reveals the absence of any association between productivity gains and degree of protection, such as might be expected of a successful import substitution policy.

Another study provides descriptive evidence suggesting that attempts at import substitution industrialisation since the 1970s have usually failed, but the empirical evidence on the question has been contradictory and inconclusive. It has been argued that the case against import substitution industrialisation is not that it is bound to fail, but that subsidies and tax incentives do the job better. It has also been pointed out that, in any case, trade restrictions could not be expected to correct the domestic market imperfections that often hamper the development of infant industries.

Trade policies

Economists’ findings about the benefits of trade have often been rejected by government policy-makers, who have frequently sought to protect domestic industries against foreign competition by erecting barriers, such as tariffs and quotas, against imports. Average tariff levels of around 15 per cent in the late 19th century rose to about 30 percent in the 1930s, following the passage in the United States of the Smoot-Hawley Act.

Mainly as the result of international agreements under the auspices of the General Agreement on Tariffs and Trade (GATT) and subsequently the World Trade Organisation (WTO), average tariff levels were progressively reduced to about 7 per cent during the second half of the 20th century, and some other trade restrictions were also removed. The restrictions that remain are nevertheless of major economic importance.

The largest of the remaining trade-distorting policies are those concerning agriculture. In the OECD countries government payments account for 30 per cent of farmers’ receipts and tariffs of over 100 per cent are common. OECD economists estimate that cutting all agricultural tariffs and subsidies by 50% would set off a chain reaction in realignments of production and consumption patterns that would add an extra $26 billion to annual world income.

Quotas prompt foreign suppliers to raise their prices toward the domestic level of the importing country. That relieves some of the competitive pressure on domestic suppliers, and both they and the foreign suppliers gain at the expense of a loss to consumers, and to the domestic economy, in addition to which there is a deadweight loss to the world economy.

When quotas were banned under the rules of the General Agreement on Tariffs and Trade (GATT), the United States, Britain and the European Union made use of equivalent arrangements known as voluntary restraint agreements (VRAs) or voluntary export restraints (VERs) which were negotiated with the governments of exporting countries (mainly Japan) - until they too were banned.

Tariffs have been considered to be less harmful than quotas, although it can be shown that their welfare effects differ only when there are significant upward or downward trends in imports. Governments also impose a wide range of non-tariff barriers that are similar in effect to quotas, some of which are subject to WTO agreements.

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