SENSE AND SURPRISE IN COMPETITIVE TRADE THEORY 2010 WEAI PRESIDENTIAL ADDRESS

I. INTRODUCTION The competitive theory of international trade is well known for its abundance of "paradoxes." Perhaps the most widely known is the Leontief Paradox, associated with the rather startling results presented by Leontief (1953) that the trade pattern of the United States suggested that its export sectors were more labor-intensive than factor proportions found in its import-competing sectors. This result stimulated decades of research, but is not the focus of the present paper. Other so-called paradoxes include the Metzler (1949) result, wherein a country levying a tariff on an imported item may end up with a lowering of its domestic price. That is, a tariff may not be protective. (1) Lerner (1936), who earlier hinted at the Metzler outcome, emphasized the possibility that a tariff might instead worsen a country's terms of trade, which is at the opposite extreme to the Metzler result. Both of these paradoxes are attributed to possible income effects in demand. More recently, income effects stemming from asymmetry in demand patterns (among countries) were shown to open the door to paradoxical results if one country makes a transfer to another in a world in which other countries are also engaged in trade in the same commodities. The surprising results: The Giver in the transfer might end up better off (i.e., it may pay to give rather than to receive), and/or the Recipient of the transfer may end up worse off. (2) Finally, a classic result that does not depend on asymmetries in taste patterns, but rather upon the degree of elasticity in demand and the nature of growth is the question of whether a country that unequivocally grows (transformation schedule shifts out) can be made worse off as a consequence of growth (the so-called immiserizing growth paradox). (3) This is an issue familiar to particular sectors of the economy, for example, agriculture--can a good harvest yield lower returns because of the subsequent price fall? Instead of revisiting these familiar paradoxes here, I wish to concentrate on the production side of competitive models used in international trade and to focus on the question involving ways of judging economic models. Clearly the question of realism often comes up, whether it is in terms of assumptions made or of outcomes expected. Here I suggest a different criterion: Does the model conform in many ways to common sense? (That is, would one be tempted to suggest that the model is not necessary because common sense would lead to the same results?) And, if it does, do the outcomes in certain scenarios seem to be paradoxical or surprising? If so, can the model reveal in simple terms why these somewhat surprising results make sense? (4) I shall restrict myself to a pair of basic models of production used in competitive trade theory--the Specific Factors Model on the one hand, and the Heckscher-Ohlin model on the other. I shall argue that in many ways both conform to common sense, but, in addition, provide the very tools that expose the underlying rationale for surprise. II. A PRELIMINARY QUESTION Consider any economy that is characterized by competitive markets and constant returns to scale technology. Suppose, for such an economy, there is an increase in the factor endowment bundle. To fix on an example, suppose there is an increase in the economy's labor force. The very general question I wish to ask is: How does such an economy absorb this increased endowment to maintain full employment of all factors? Note that if this economy is not engaged in international trade there will likely result a change in commodity prices as they adjust in order to equilibrate local supply and demand. Given the points I wish to make later, let me assume that the country is engaged in free trade with the rest of the world. If this economy were particularly small, world prices could be taken as given. Even if world prices are disturbed, it is legitimate to ask how the economy absorbs the extra supplies before any change in commodity prices takes place. …