Trade Liberalization and Worker
Welfare: A Three Sector Analysis
Priniti Panday,
Objective
To study the implications of
trade liberalization policies on worker welfare in an economy producing
tradeable and nontradeable goods using a general equilibrium trade theoretic framework.
Methodology
A general equilibrium trade
model is developed and comparative static analysis is used to determine the
effects of trade liberalization on wages, labor allocation and worker welfare.
The results of the
mathematical model are supported by diagrams.
Background
Trade
liberalization policies in the importable sector directly lowers the domestic price of importables and does not affect
the price of exportables as the latter is determined in world markets. The
price of nontraded goods, on the other hand, could rise or fall depending on
its substitution possibilities with other goods and the magnitude of the income
effect. Assuming that the three goods are gross substitutes in demand and
production and the income effect does not exceed the substitution effect, it
has been shown in earlier papers that the price of nontraded goods decreases
but the extent of this fall is less than the initial reduction in the price of
importables (refer to Sjaastad and Clements, 1981; Clague and Greenaway, 1994).
In the theoretical international
trade literature, the study of trade liberalization has mostly been based
on the changes in relative prices of the economy and the consequent spill
over effects on other variables. In trade models with two sectors (exports
and imports) the export good is generally taken as the numeraire, with trade
liberalization in the importable sector lowering the price of importables
relative to that of exportables (Mayer, 1974; Neary, 1978). In three sector
trade models, which incorporate nontraded goods, the exportable good is again
used as the numeraire and trade liberalization in the importable sector lowers
the price of importables and nontraded goods relative to that of exportables
(Edwards, 1988).
Three sector models have two
sets of relative prices which provide greater scope for a more in-depth analysis
of the effects of trade liberalization. However, when the exportable good
is used as the numeraire, both sets of relative prices move in the same direction
and the difference in magnitude between the two does not provide any significant
additional insight. In this paper,
we take the nontraded good as the numeraire of the system, with trade liberalization
in the importable sector lowering the price of importables relative to nontraded
goods (fall in the true protection of importables) and increasing the price
of exportables relative to nontraded goods (rise in the true protection to
exportables). The two relative prices now move in opposite directions providing
an additional dimension to the study that does not come forth in earlier papers.
The difference in magnitude between the two relative prices is crucial in
much of the analysis of this paper.
Results
In models that take the
export good as the numeraire (Edwards, 1988; Mayer, 1974), in the long run,
trade liberalization in the importable sector raises (reduces) wages in terms
of the price of all goods, as long as importables are the most capital (labor)
intensive sector and exportables the most labor (capital) intensive. In the
short run, regardless of the differences in sectoral factor intensities, wages
fall in terms of the price of exportables and nontraded goods (only exportables
in a two sector model) and rise in terms of the price of importables. Hence,
with the export good as the numeraire, the addition of nontraded goods does not
significantly alter the impact of trade liberalization.
In this paper, we show that
the results obtained in earlier studies are only one of the several possible
effects of trade liberalization and the characteristics of the final outcome
is actually contingent on certain inherent conditions prevalent in the economy.
We demonstrate that the short run results of Edwards’s (1988) paper are valid
only if certain explicit production and demand conditions exist in the economy,
the absence of which results in very different effects of trade liberalization.
For the long run, the results are consistent with those in Edwards‘s study.
Besides studying the effect
on wages, we extend the analysis further to determine the effect on worker
welfare. Trade liberalization is found to improve worker welfare in the short
run if (1) production conditions are such that the extent to which the marginal
product of labor responds to changes in employment is higher in the importable
sector than in the exportable sector, (2) these production conditions coexist
with demand conditions whereby the difference in exportables and importables
in their substitution relationships with nontraded goods is less than the
differences in the responsiveness of marginal product of labor and (3) share
of importables in a typical worker’s consumption basket is greater than or
equal that of exportables. In the long run, trade liberalization is always
welfare improving as long as the importables are the most capital intensive
sector in the economy and exportables the most labor intensive, and the share
of importables is greater than or equal to that of importables in a worker’s
consumption basket.
Discussion Topics
What is the possibility of
empirical verification of the results of this study?
Are developing countries
likely to benefit from trade liberalization? Do they have the necessary
inherent conditions in the economy?
We have defined worker welfare
in terms of the price workers face and the income they earn. However, what
would be the difference if unemployment was added to the model so that not
only earnings, but also the
employment rate would be a part of aggregate welfare?