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BOOK REVIEW
INTERNATIONAL TRADE AND
TRADE POLICY
Edited by Elhanan Helpman and Assaf Razin, MIT Press, 1991. Pp. 292.
Reviewed by
Henry Thompson
This book is a collection of papers on international trade theory from a 1989 conference at
Tel Aviv University. There is a wide range of topics and methodologies. As a collection, the
book has the merit of illustrating the methodology of a number of first class international
economists. Each paper is reviewed briefly below. A final assessment of the book as a whole
follows.
PART I TRADE POLICY: THEORY
A. Paul Krugman, ‘ls Bila tera /km Bad”
Trading blocs create free trade among members and adopt a common tariff with the rest
of the world. Krugman reviews the literature on trade diversion and trade creation, which
concludes that exclusive trade agreements may be welfare damaging. He assumes each
country produces a differentiated product, although production is not modelled explicitly.
Consumers have a CES utility function which values variety. The optimal tariff for a trading
bloc is calculated. It is found that there is a negative relationship between the number of
blocks and the average tariff. Also, a trading bloc lowers welfare because countries in the
Direct all correspondence to: Henry Thompson, Department of Economics, Auburn University,
Auburn, AL 36849.
International Review of Economics and Finance 3(2) 239-243 Copyright 0 1994 by JAI Press, Inc. ISSN: 1059-0560 All rights of reproduction in any form reserved.
239
240 HENRY THOMPSON
bloc may trade less with countries outside the bloc, but increases trade by expanding trade
between countries within the bloc. And, welfare is optimized if there is only one bloc, since
the world would trade freely. If there were many blocs, each would set a low tariff, there
would be a high degree of trade, and welfare would be relatively high. For some number of
blocks in between, welfare must be minimized. Using simulations, Krugman concludes that
a few blocks (three perhaps) would result in the lowest welfare.
B. James A. Levinsohn, “Strategic Trade Policy and Direct Foreign Investment: When are Tariffs and Quotas Equivalent?”
Levinsohn examines the difference between tariffs and quotas in the presence of direct
foreign investment. If there is a domestic market where the only supplier is a foreign
monopolist, a tariff will reduce the foreign monopolist’s rent. The optimal tariff is calculated
by the importing country, and has an advantage over a quota for creating revenue. Tariffs
and quotas are not equivalent in the presence of monopolies. Suppose the foreign monopolist
has the option of jumping the tariff and setting up a plant in the home country if the tariff is
set too high. This potential action limits the level of the tariff. If a quota is set high enough,
the result will be equivalent to the tariff: the foreign monopolist jumps the border and builds
a domestic plant through direct foreign investment. In the presence of the potential of direct
foreign investment, tariffs and quotas are equivalent if they are high enough.
C. Kala Krishna, “Making Altruism Pay in Auction Quotas”
Auctioning import quotas is a way to create revenue and secure some of the scarce rent
from foreign monopolists. In competitive models, the potential yearly gains from auction
quotas have been estimated to be in the seven to nine billion dollar range. Krishna develops
a model of auction quotas in a small economy facing a foreign monopolist. Quota licenses
might be granted to the foreign monopolist to keep the monopolist from pricing away all of
the rents of domestic importers. The monopolist would consider the value of its quota license
in its pricing decision. In this manner, domestic importers may gain rents as well. Instances
of foreign monopolies in international trade are fortunately rare. Krishna presents some
intriguing simulation results.
0. Aaron Tornell, “On the Ineffectiveness of Made-to-Measure Protectionist ProgramY
Protectionism alters the investment decisions of firms, ideally internalizing social benefits
into the protected firm’s decision. The government may precommit to end the protection at
some future date. If a firm invests, it may not need the protection. If it does not invest, it may
be able to have the protection extended. This paper examines protectionist policy which is
contingent on investment, and finds such policy does not necessarily eliminate the time
inconsistency problem.
Book Review 241
E. Peter Neary, ‘Export Subsidies and Price Competition”
The Brander-Spencer case for an export subsidy is based on the possibility of shifting
foreign profits to the home country in the situation of an international duopoly. Neary
examines the outcome in both ex ante games (where the government sets the quota first) and
ex post games (where the firm moves first and expects the subsidy). The ex ante game always
produces higher welfare. If the home firm and foreign firm compete in price, an export
subsidy cannot maximize welfare. It would be interesting to examine this issue in a
simultaneous game, under the assumption that fis continuously lobby for subsidies and
the government continuously determines policy. This paper reinforces the impression that
the political economy of the Ex-Im Bank is not a happy chapter in US trade policy.
F. Harry F/am and Robert W. Staiger, “Adverse Selection in Credit Markets and Infant Industry Protection”
In a model of asymmetric information about firm risk, Elam and Staiger show that
protection can stimulate entry. A risk premium on loans would reflect the default risk of the
pool of potential fiis. Entry of the safest firms would be discouraged by this risk premium.
Protection would encourage entry of the safest firms and lower the average risk in the
industry. The authors develop a model with characteristics of an infant industry in an LDC.
Due to adverse selection, firms on average would be too risky in the absence of protection.
While such protection may lower average risk, it is not clear what would happen if the
government subsequently lowered protection. The main dilemma of this and the usual infant
industry argument remains what to do once the infant has grown up.
G. Arye L. Hillman, “‘Protection, Politics, and Market Structure”
A political economy model of endogenous protection is developed to investigate the
relationship between industry characteristics (number of firms and concentration ratios) and
protection. The Alchian-Demsetz model of the firm is used, with firms able to influence their
value through protectionism. A representative democratic model gives rise to problems of
agency. Firms play the game of splitting managerial effort between lobbying for protection
and managing the firm. The concentration ratio of an industry is not necessarily associated
with increased protectionist activity in the model.
H. Gene M. Grossman and Elhanan Helpman, “Growth and Welfare in a Small Open Economy”
Grossman and Helpman examine a small, open economy trading two finished goods
produced with an intermediate good which relies on R&D. Innovation is naturally under-
supplied because of the public nature of knowledge created by R&D. Subsidies to R&D can
increase the growth rate and perhaps welfare, which raises the question of whether subsidies
have encouraged growth historically. Rent seeking in commercial policy formation can lead
242 HENRY THOMPSON
to lower levels of growth and welfare, which suggests the link between subsidies and growth
can only be settled empirically.
PART II TRADE POLICY: EVIDENCE
1. Randi Boorstein and Robert C. Feenstra, “Quality Upgrading and its Welfare Cost in US Steel imports, 1969-74”
Quotas are generally expected to lead to quality upgrading, at least in competitive
industries. The applied literature on quotas and quality upgrading includes studies of the
auto, footwear, and cheese markets. Boorstein and Feenstra extend the literature to US steel
imports during the period when the US first became a net importer of steel. They find solid
evidence of quality upgrading, and utilize price index schemes (exact and divisia) to measure
the welfare loss of the quota.
J. Alasdair Smith and Anthony J. Venables, “Counting the Cost of Voluntary Export Restraints in the European Car Market”
Like the preceding paper, this one examines the effects of quotas (VERs) on an import
market, in this case the market for imported autos in Europe.
The model of an imperfectly competitive market is developed, and numerical simulation
leads to “estimates” of effects. Simulation estimates are inherently different from empirical
estimates based on ideal econometric estimation, and would be well supplemented by an
econometric study. It would also be interesting to extend this literature to include income
redistribution and possibly general equilibrium effects. VERs are found to be an inefficient
and expensive means of protection in the imperfectly competitive European car market. The
appendix completely develops the rather involved partial equilibrium model of imperfect
competition.
PART Ill STRUCTURAL ISSUES
K. Wilfred J. Ethier and Henrick Horn, “Services in international Trade”
Ethier and Horn develop a general equilibrium model of production and trade in services
and manufactures. The structure of production in services is meant to capture four charac-
teristics the authors see as typical:
1) services are specialized for the buyer;
2) firms provide various services;
3) fixed overhead costs give rise to economies of scope; and
4) service markets are competitive.
Book Review 243
Labor produces services and differentiated intermediate goods which are combined to
produce final differentiated outputs. Welfare is examined under service autarky, embodied
service trade, and free trade in services. The clearest results occur between two identical
countries, with trade in services giving higher welfare than service autarky, which outranks
complete autarky. This paper is clearly written and well developed, making a nice contribu-
tion to the growing literature on trade in services.
L. James R. Markusen, “First Mover Advantages, Blockaded Entry, and the Economics of Uneven Development”
A model of entry into a dynamic increasing returns to scale industry in which first entrants
have a comparative advantage is developed. Later entrants will not generally be able to catch
up due to blockaded entry (less efficiency) or at least a lower level of entry. Simulation with
CES production and Cobb-Douglass consumption leads to interesting results.
M. Ronald W. Jones and Peter Neary, “Wage Sensitivity Rankings and Temporal Convergence”
This paper develops the notion of an imperfect dynamic link across sectors in the labor
market. Wage changes in each sector are postulated to only imperfectly adjust to wage
changes across the economy. This labor market structure is set in a simple production
structure. Sectors can be ranked according to wage sensitivity, or how much rents are affected
over time when wages change in the sector. Intersector capital mobility hinges on the degree
of wage sensitivity. This model has definite appeal for applied trade theorists who are faced
with differing wages across sectors. The partial adjustment model can in principle be applied
in trade studies.
SUMMARY
This book will be useful to international trade economists. References in each of the papers
are complete and comprehensive. Various methodologies, from abstract theory to applied
empirical work, are carefully developed and utilized. Of particular note are the papers which
use simulations to arrive at conclusions when the qualitative aspects of the models are
unclear. Computers have relieved theorists from always having to make assumptions
stringent enough to lead to unambiguous qualitative conclusions. If the book has a short-
coming, it is simply that the papers do not relate very well to each other, which may only
reflect the state of the science.