An Exposition and Exploration of Krueger's Trade Model

This paper provides a diagrammatic exposition of Anne Krueger's (1977) model of developing country trade and within that context examines the effects of tariffs on real factor rewards, with and without international capital mobility. The model has an agricultural sector employing labour and land, plus a manufacturing sector producing several goods using labour and capital. It is shown that without capital mobility the effects of tariffs on the real returns to all three factors are largely well defined but very sensitive to the pattern of specialization. With mobile capital, however, a tariff on any produced good raises the real wage. Interpr&tation et developpement du modele de commerce international d'Anne Krueger. Ce m6moire propose une presentation graphique du modele de commerce international pour un pays en voie de developpement developp6 par Anne Krueger. Dans ce contexte, l'auteur examine 1'effet des droits de douane sur la remun6ration des facteurs de production dans l'hypothese de mobilit6 internationale du capital mais aussi dans l'hypothese oui une telle mobilite n'existe pas. Le modele met en scene un secteur agricole qui utilise les facteurs travail et terre et un secteur manufacturier qui produit plusieurs biens en utilisant les facteurs travail et capital. On montre que si l'on assume que le capital est immobile, les effets des droits de douane sur les rendements reels des trois facteurs de production sont en gros bien d6finis, mais ces r6sultats d6pendent d'une mani&re dramatique du pattern de sp6cialisation. Quand on postule que le capital est mobile, cependant, un droit de douane sur n'importe quel bien produit va accroltre le niveau du salaire reel. I N T R O D U C T I O N In her 1977 Graham lecture Anne Kruger described a model of specialization and trade among many countries that she suggested was particularly appropriate for developing countries. The model is also useful for developed countries, however, and provides a nice synthesis of two strands within the pure theory of international trade: the Heckscher-Ohlin model and the specific factors model. In this paper I will elaborate on the exposition of her model, focusing in particular on an issue that she For their helpful comments on earlier drafts of this paper, I would like especially to thank Anne Krueger, Richard Porter, and Robert Stem, as well as other participants in the Research Seminar in International Economics at Michigan and the 1983 NBER summer institute on international economics. An anonymous referee also made useful suggestions. Canadian Journal of Economics / Revue canadienne d'Economique, XVII, No. 4 November / novembre 1984. Printed in Canada / Imprime au Canada 0008-4085 / 84 / 731-746 $1.50 ? Canadian Economics Association This content downloaded from 207.46.13.114 on Thu, 26 May 2016 05:50:36 UTC All use subject to http://about.jstor.org/terms 732 / Alan V. Deardorff did not address: the effects of trade policy on factor prices, especially in capital-scarce developing countries. Consider, for example, how tariffs will affect wages in a developing country. Three answers suggest themselves, based on theories of international trade. First, the Stolper-Samuelson theorem, in the two-dimensional Heckscher-Ohlin model, suggests that a tariff in a labour-abundant developing country will lower the real wage of labour.1 Second, a specific-factors model with only labour mobile between industries gives an ambiguous effect of a tariff on the real wage, depending on what workers consume. Finally, a model such as MacDougall's (1960), with international investment, suggests that a tariff can benefit labour by attracting more foreign capital for it to work with.3 The Krueger model is particularly appropriate for sorting out these possibilities because it is a hybrid of the Heckscher-Ohlin and specific-factors models. Thus, it gives scope for both of the first two effects of a tariff mentioned above. In addition, one can add a simple form of international capital mobility to the model and thus evaluate MacDougall's argument. Throughout the paper I examine only countries that are small enough to take international prices as given. Also, I simply assume that a tariff raises the domestic price above the world price by its full amount. For a tariff alone this is appropriate only if the good is imported both with and without the tariff. The results of this paper therefore apply to non-prohibitive tariffs on imported goods.4 Alternatively, however, the results also apply without such a qualification if the policy is not a tariff by itself, but rather a tariff accompanied by an equal subsidy to exports of the same good. This policy combination does raise the domestic price above the world price, whether the good is exported, imported, or neither.5 This is an analysis of factor prices. It is not an analysis of welfare, even for groups within the economy. A change in a factor's real return may imply a similar change in the welfare of the factor's owners, but only if two conditions are met. First, the owners of the factor must own only the one factor and not any other. Second, the owners must not experience a change in taxes or transfer payments vis-a-vis government, or any changes in the benefits they derive from public goods. With a tariff or export subsidy it is impossible for the second of these conditions to be met for all factor owners, since something must be done with the tariff revenue and a subsidy must be financed. In the second section I describe the Krueger model, including a geometric analysis 1 See Stolper and Samuelson (1941) or any textbook on international economics. 2 Modern interest in the specific-factors model dates from Jones (1971) and Samuelson (1971). If labour's preferences are typical of the economy as a whole, then Ruffin and Jones (1977) establish a presumption that a tariff will lower the real wage. 3 In essentially a one-sector model, MacDougall (1960) showed how a capital inflow would raise the wage of labour and informally suggested a tariff as one cause of the capital inflow itself. He did not evaluate the combined effects of the tariff plus the capital inflow. 4 When capital is perfectly mobile, Mundell (1957) has shown in a two-sector Heckscher-Ohlin model that any positive tariff is prohibitive. In the Krueger model this need not be the case. 5 The results do not apply to an export subsidy alone, which would not change prices to consumers. The necessary modifications in the argument for this case should be obvious. This content downloaded from 207.46.13.114 on Thu, 26 May 2016 05:50:36 UTC All use subject to http://about.jstor.org/terms Kreuger's trade model / 733 to make her results more accessible. Also, since later results depend crucially on a country's patterns of specialization and trade, I shall delineate how these depend on factor endowments and tastes. In the third section I analyse the effects of a tariff. As might be expected, effects on real wages can conform to either the Stolper-Samuelson or the specific-factors predictions described above, depending on the pattern of specialization. In addition, real wages may rise if the tariff is levied on more labour-intensive imports. Also, the model generates effects on rental prices of both capital and land. Finally, I introduce international capital mobility in the fourth section. A tariff then can indeed raise real wages unambiguously, and regardless of the capital intensity of the imported good. The increase normally accompanies an inflow of capital, but it can also occur with an outflow of capital if the tariff shifts specialization to a more labour-intensive good.