** 2 intensities.**

**C. f Bhagwati, o p cit p**

**saying what is implied in the factor-price equalisation theorem - that**
**trade will lower the real wage of the relatively expensive factor of**
**production. ^**

**If the factor price equalisation theorem is theoretically in**
**valid, then clearly so is the Stolper-Samuelson theorem* The factor**
**price equalisation theorem has been extensively criticised and again**
**the criticism is that once the assumptions of two factors and constant**
**factor intensities are relaxed, it is possible that trade will tend**

**2**

**not to equalise factor prices but to move them apart* ** **Trade could**
**further increase the wage of the relatively expensive factor - and**
**conversely, protection could reduce the return to the relatively**
**inexpensive factor. Lancaster’s modifications thus reduce none of**
**the uncertainty as to the effect of protection on factor rewards.**

**All that may reasonably be concluded from the discussion so far**
**is that there will be a redistribution of income in favour of the**
**protected sector. ** **Just who gains from that redistribution is theore**
**tically indeterminate - in practice it will depend upon a variety of**
**factors, of which one will be the factor intensity, but it will**
**include other factors such as the possibility of substitution of one**
**factor of production for another, and the bargaining power of factor**

*TT*

**James and Pearce, ’’The Factor Price Equalisation Ifyth”,**
**loc.cit.,p. 12 footnote 1***

### 2**.**

**James and Pearce, loc.cit.. Harrod, oo.cit.: I*F*Pearce,**
**"A Further Note on Factor Price Commodity Relationships”,**
**loc.cit.**

**groups. ** **It is quite possible that labour may not, in fact, gain at**
**all, but that all the benefit will be received by capital.**

**In general terms these conclusions may be taken to apply to**
**the incidental protection provided by quantitative controls. ** **They**
**will be qualified in three respects. ** **First, we may at least conclude**
**that there will be a distribution of income in favour of importers,**
**but even here we must note the offsetting increase in importers’**
**overhead costs in relation to turnover. ** **Second, the period we are**
**considering is of sufficient length for longer term effects - factor**
**substitution, increased mobility and greater homogeneity of factors**
**etc*, to diminish the importance of short term income redistribution**
**effects. ** **At the same time it is insufficiently long for the short**
**term effects - such as overaward wages and windfall profits not to**
**be important. ** **Third, the overall degree of restriction of imports**
**and, consequently, the extent of incidental protection fluctuated**
**considerably over the period. ** **There were also fluctuations in the**
**extent of such protection provided to individual industries other than**
**the general movements in the licensing controls. ** **There will, there**
**fore, be a number of ’short terms’; there will also be different**
**experiences in different industries within the import competing**
**sector* ** **These can only be considered in the context of an examina**
**tion of the actual system.**

**Import Licensing Control**

**In the two previous chapters we have discussed the more general**
**aspects of the direct control of imports. ** **It is necessary now to give**
**consideration to some more specific aspects of the methods of control**
**used in Australia during the period under review. ** **The discussion in**
**this section will be limited largely to the consideration of the**
**question of the degree of interchangeability in licence use permitted**
**by the system.**

**It has been shown that, in terms of the criterion of aggregate**
**welfare discussed earlier, the econory can be said to be at a position**
**of optimum welfare when prices of the restricted supply of imports are**
**determined simply by internal supply and demand conditions. ** **It will**
**facilitate subsequent a rgument if a simple demonstration is given that**
**the optimum position also requires that the rate of importers**1

**(monopoly) profit on the restricted supply of imports should be equal**
**on all imports.**

**We know that utility is maximised when prices are proportional to**
**marginal cost* We shall refer to the marginal cost of obtaining imports**
**as p, i.e. the import price to the importer which we assume remains**
**unchanged before and after the imposition of the cut in imports. ** **The**
**new internal price, including monopoly profit, we shall call P***

**P ** **u**
**Then the condition of maximum welfare is _i. = li. •**

**P. ** **p.**

**If imports are restricted to a given value K ( a constant ),**
**goods x.,x.,... etc* being valued at prices p.,p.,... etc* then**

**then p ixi + Pjx j ** **+ ... .. K**
**so that p.dx. **

**4**

**p.dx. + ... =**

**0**

**Only if p = XP ( X. indicating proportionality ) i*e***
**if Pi ~ ** **= PJ _ l £ i ** **= ... will it also be true**

**Pi ** **'** **Pj**

**that P.dx. ** **+ P.dx. ** **+ ... = 0 i*e. will U.dx. ** **+ U.dx. **

**4**

**i i ** **J ** **J ** **i i ** **J ** **j**

**... = 0 ** **(Where U., U., .... etc. are the marginal utilities**
**J**

**of the goods x_.,x.., ... etc.)**

**In other words, only if p = ** **will it be impossible to increase**
**welfare* ** **It will be noted that P i ~ ^i. , ** **~ ** **, •••••• etc.**

**Pa **

**Pj**

**are the rates of importers* (monopoly) profit on goods i,j, .... . etc**
**and it is clear that the position is an optimum in terms of welfare**
**when the rate of importers* profit is equal on all imports.**

**This demonstration has been based on an assumption that import**
**prices remained unaltered as a result of changes in the quantities**
**imported. ** **For most purposes this assumption is probably justified but**
**there is some advantage, for the purpose of subsequent discussion, in**
**considering the effect on the conclusion of differences in the supply**
**conditions of the imports restricted.**

**supply elasticities are infinitely elastic* ** **Given that the total**
**amount of foreign exchange to be spent on imports is fixed, it is**
**possible for the restricting country to gain by reducing imports of**
**the items for which the supply conditions are inelastic, and by using**
**the foreign exchange thus saved to increase imports of the items for**
**which supply conditions are relatively elastic* ** **Restricting imports**
**of the items in inelastic supply will tend to push down their price,**
**whereas the price of the items in elastic supply will be relatively**
**unaffected by changes in the quantities imported* ** **The total volume**
**of imports will thus be increased* Whether there will be a gain in**
**welfare depends upon whether the increase in welfare resulted from**
**the change in the terms of trade is more than sufficient to offset**
**the loss of welfare within the restricting country due to the movement**
**away from the equality of profit rates* ** **It is clear that the problem**
**is closely analogous to that of the optimum tariff in the sense of**
**being an optimum discriminatory tariff* ** **A condition for the optimum**
**degree of discrimination in a regime of import restrictions may be**

**1**

**derived as follows***
_

**The following analysis is based substantially on that of**
**Fleming and Meade* ** **See J*M* Fleming, ”0n Making the Best of**
**Balance of Payments Restrictions on Imports”, Economic Journal.**
**Vol. **

**LXI, **

**No.241 (March 1951), pp.48-71$ J*E. Meade, Trade and**

**Welfare, Ghapt***

**XXXIV, **

**and Mathematical Supplement, Chapt.**

**XX .**

**Assume two countries and only two classes of imports. ** **Let**
**supply be a function of its own price alone, so that**

**dx^**
**= s ** **h** **;**
**11**
**- ** **dPo ** **.**
**S ** **—** ***■ ** *’* **where S. . is the**
**11**
**pi** ***2** **p2**

**1 supply elasticity’ in the foreign country of the i ’th good.**

**The condition that the amount of foreign exchange spent on imports**
**is fixed gives**

**P. *i +** **k (a constant)**
**Differentiating and rearranging**

**( dx, **

**dp ) **

**( dx^**

**P**

**( —**

**‘ + —**

**) + Pz3^ J**

**1 1 j *1 **

**Pi j **

***2**

**dP**2** )**

**) = 0**

**Pp **

**)**

2 ### )

**(i)**

**A change in welfare will result from a change in the amount traded,**
**but since, as shown above, any movement away from the situation in**
**which the rate of profit is equal on all imports will result in a loss**
**of welfare, the change in the amounts traded has to be weighted by the**
**protective effect of the import restriction.,**

**The change in welfare (dW) is thus given by**

**dW =**

**V i**

**dx**

**( P _ P )**

**1 ( 1___ I )**

**( ,**

**Sg. **

**(!2_1**

***1 **

**I **

**P1 **

**I + **

### 1,3X2

***2 **

**i**

### )

**!a)**

**)**

**(ii)**

**Solving for d£ l ** **and ^ 2 ** **in the supply equations and substitut**

**ing in (i); the solving for dxu ** **in (i) and substituting in (ii) gives**
**— Jat**

**dw = Plxx **

**Silfuj**

### *1 ( n )

### (p, _

**p,)(**

### a., ) (p, _ p,)( s„ )

### ( pi ) r + sn) ( p2 ) r + °22)

**At the optimum d W is zero; which means that the term**
**(l - S-.J**

**( sxi )**

**( **

**P1 K 1 + ^l) ( **

**P2 )(1 + S22)**

f e - >
**(iii)**

**Hence the condition is**

**(pi - pD**

**(**

**1** + sn

**) = ( ****P2**** - ****P2**** )(**

**1 + s.**

**(iv)**

**Thus we c^n see from this condition that if S**02** = ** **the margin**
**of difference between the domestic and the import price should be the**
**same for both goods. ** **If S ^ is less than S ^ , i.e. less elastic, then**
**the rate of profit on x^ should be less than that on ****x^;**** imports of**
**should be further restricted, and imports of x^ relaxed.**

**In other words, if account is taken of the conditions of supply**
**of individual imports, the equality of profit rates should be sought**
**only if the supply elasticities are equal* ** **If the supply elasticity**
**of one import item is greater than that of another, the profit margin**
**of the second item whose supply is inelastic should be allowed to**

**increase relative to that of the first item i.e* the second item should**
**be licensed more restrictively than the first, the licensing of which**
**should be relaxed***

**This condition, in the form given here, is useful only as a means**
**of demonstrating the principle involved* ** **The assumptions governing**