1. As in the Ricardian model, trade never makes a country worse off.
2. However, trade hurts some people: Owners of factors specific to the exports sector gain at the expense of factors specific to the import sector.
3. Trade causes large changes in returns to specific factors, and smaller changes in returns to mobile factors.
4. Are there ways for the government to tax winners in order to compensate losers from trade? TAA is an example.
In the Ricardian model of Chapter 2, we showed that free trade could never make a country worse off, and in most cases free trade would make it better off. This result remains true when we add land and capital as factors of production, in addition to labor. Provided that the relative price with international trade differs from the notrade relative price, then a country gains from international trade. This conclusion does not mean, however, that each and every factor of production gains. On the contrary, we have shown in this chapter that the change in relative prices due to the opening of trade creates winners and losers. Some factors of production gain in real terms and other factors of production lose. To demonstrate this result, we have used a short-run model, in which labor is mobile between sectors, but land and capital are each specific to their sectors.
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TransFair USA guarantees a minimum purchase price for coffee farmers, acting as insurance against a falling market price. But during periods when the market price is rising, it is challenging to ensure that farmers deliver their coffee.
During winter and spring of the 2005 harvest, a dilemma surfaced in rural areas of Central America and Mexico. Fairtrade cooperative managers found it increasingly difficult to get members to deliver coffee to their own organization at fair-trade prices. The co-op managers were holding contracts that were set months before at fixed fair-trade prices of $1.26 per pound, but now the world coffee price was higher. Growers were seeing some of the highest prices paid in five years, and the temptation was great to sell their coffee to the highest local bidder, instead of delivering it as promised to their own co-ops.
In most cases, the co-ops’ leaders were able to convince farmers to deliver coffee, but often based on arguments of loyalty, as the fair-trade fixed price was now lower than the premium prices being offered by the local middleman. It was not the model that the founders of fair-trade coffee pricing had envisioned when they created the program.
“It’s worth noting that we were pleased to see prices rise in late 2004,” says Christopher Himes, TransFair USA’s Director of Certification and Finance. “This price rise, in conjunction with the impact fair trade was already having, increased the income and living standards of coffee farmers around the world. The most challenging thing during this time for TransFair USA was the speed with which the local differentials [between the fair-trade price and the world price] rose in Indonesia. They quickly skyrocketed to 80 cents [per pound] or higher, making the market value of farmers’ coffee higher than that of some of the…fair-trade contracts.”
Source: David Griswold, http://www.FreshCup.com, June 2005.
Classical economists believed that, in the short run, factors of production that could not move between industries would lose the most from trade. We have found that this is true for the factor that is specific to the import-competing industry. That industry suffers a drop in its relative price because of international trade, which leads to a fall in the real rental on the specific factor in that industry. On the other hand, the specific factor in the export industry—whose relative price rises with the opening of trade—enjoys an increase in its real rental. Labor is mobile between the two industries, which allows it to avoid such extreme changes in its wage—real wages rise in terms of one good but fall in terms of the other good, so we cannot tell whether workers are better off or worse off after a country opens to trade.
Economists have carefully proved that, in theory, the gains of individuals due to opening trade exceed the losses. This result means that, in principle, the government should be able to tax the winners and compensate the losers so that everyone is better off because of trade. In practice, it is very difficult to design programs to achieve that level of compensation. In this chapter, we looked at one compensation program—Trade Adjustment Assistance—that is used in the United States and other countries to compensate people who are laid off because of import competition. There are many other policies (such as import tariffs and quotas) that are intended to protect individuals from the effect of price changes resulting from international trade, and we examine these policies later in the book.
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