f Bhagwati, o p cit p

In document The control of imports : Australia 1952-1960 (Page 145-153)

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


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


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


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 importers1

(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.


p.dx. + ... =


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.


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.



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


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.


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


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


dP2 )

) = 0






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 ) ( ,






I +








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


*1 ( n )

(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 - >


Hence the condition is

(pi - pD


1 + sn

) = ( P2 - P2 )(

1 + s.


Thus we c^n see from this condition that if S02 = 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


In document The control of imports : Australia 1952-1960 (Page 145-153)