INTERNATIONAL RESOURCE ALLOCATION: Trade with Incomplete Information 5


In Proposition 3 and its proof we saw that the operation of the price mechanism brings about full efficiency or maximum world income when L/L* ^ L/L*. When a NIE obtains, we can make the weaker claim that world income increases relative to autarky:
w6628-10

than the domestic fall-back option (it is zero in an integrated equilibrium). The first term in brackets is positive because тс is a convex function of w. An analogous argument shows that foreign income is also higher in the NIE than in autarky, hence world income is higher.

World profits and world wages are also higher with trade than in autarky, because both are a fixed proportion of world income with a constant elasticity profit function.

Discussion
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Informational versus traditional barriers to trade. The standard model most closely related to ours is the one-good, two-factor model of trade, analysis of which dates back at least as far as Becker (1957) and MacDougall (1960). Internationally mobile capital in this model plays the same role as producers in our model. The source of gains from trade in the two models is identical. In the standard model a trade barrier typically takes the form of an ad valorem tax on profits earned abroad. Such a tax (or a “taste for discrimination” as in Becker (1957)) drives a constant proportional wedge between home and foreign returns to capital, leading to a constant proportional wedge between home and foreign wage rates. It follows that full efficiency can never be achieved with this trade barrier. In contrast, although an informational barrier, like a traditional trade barrier, is uniform across producers ex ante, ex post some producers effectively evade it if they are “lucky” in their international matching. If there are enough of these good matches relative to the difference between the countries’ endowments, wages in the two countries will be equalized and full efficiency will be achieved.

As long as the traditional trade barrier is not prohibitive (trade is positive), the ratio of the home to the foreign wage is insensitive to the ratio of the home to the foreign labor endowment: the relative labor demand curve is horizontal at the relative wage determined by the wedge between home and foreign returns to capital.