<p>The basic result about the effect of trade on income distribution is Stolper-Samuelson in the Heckscher-Ohlin model, which says that trade liberalization is associated with a rise in the prices of the factors of production that are used intensively in the production of goods the country has a comparative advantage in, and vice versa. If you take "skilled" and "unskilled" labor to be two different factors of production, for instance, Stolper-Samuelson says that a country with abundant skilled labor lifting trade barriers should lead to an increase in income inequality. A welfare state committed to keeping relative incomes of workers within a certain range may need to raise distortionary taxes to expand various income transfer programs to "unskilled" workers in this case, which could lead to inefficiency for various reasons. (Even if the taxes used to finance the income transfer are lump-sum, as long as the benefits phase out this leads to high effective marginal tax rates on the lower end of the income scale, i.e a disincentive to work and to acquire new skills.) In this sense, it's indeed true that a generous welfare state can reduce the efficiency gains from free trade. </p>

<p>The rest of the answer is a rant about the concept of "strategic market dumping" that was brought up in the comments, so if you're not interested you can skip that part.</p>

<p>Things like "strategic market dumping" are ill-defined concepts that are usually used to justify tariff increases without having much backing in theory. If "dumping" is expected to go on for a finite period of time and the associated good can be stored at no cost, for instance, then in a perfect foresight world there's an arbitrage bound on the price of the good today which forces it to grow at a rate less than or equal to the real interest rate available in the broader economy. Adding storage costs does not change the basic result very much. In that case, "dumping" is not a good strategy to begin with - if you try to do this, people will buy up the goods you're selling at low prices, hold them until you reverse your policy, and then flood the market with goods they have stored up in their inventories once you stop the "dumping", leaving you worse off. To justify a policy of industry protection, you have to argue that the government can see the reversal of the dumping policy coming and private agents can't - in this case, the real return on an investment in producing and storing oil would be higher than the market real interest rate is saying it will be, so the market outcome will be suboptimal. It's easy to justify any government intervention by saying that the government is clairvoyant and private agents are not, however.</p>

<p>What about labor market (or, more generally, factor market) frictions? Isn't the point of "dumping" to eliminate your competitors through "artificially low" prices which force them to go out of business? Well, here you're making the mistake of assuming that the government knows about labor market frictions and the private sector doesn't, therefore the government should do something about the situation. In real life, the private sector is well aware of the search frictions in the labor market, the difficulty of firing workers in some countries, etc. This means that if they expect the "dumping" strategy to be reversed in the future, they will choose to borrow money or raise capital to stay in business. They will downsize in response to the "dumping" policy, but not as much as you think they would, and certainly not as much to make a government "protection" of the industry a good policy.</p>

<p>Does this mean markets can never allocate resources poorly? Of course not - if the country doing the dumping manages to fool private agents into thinking their "dumping" policy was permanent while it was temporary, then the market allocation will be suboptimal. However, in hindsight every price and every allocation is wrong. We certainly don't expect market allocations to be optimal <em>ex post</em>, so it's not surprising to see cases where it seems like the market allocation was poor and led to many workers being stuck in jobs where wages fell due to international price changes of goods. In fact, this would happen in a stochastic world where markets were functioning perfectly and giving you an <em>ex ante</em> Pareto optimal allocation of resources. Even a social planner with access to all information available at a given date and the mental capacity to solve the associated economic calculation problem would act in ways that sometimes seem foolish <em>ex post</em>. This doesn't mean the social planner is not doing his job properly, it just means there are things about the future that even a social planner can't know with perfection. The argument is no different for market allocations - allocations that are poor <em>ex post</em> do not justify government intervention <em>ex ante</em>.</p>

CC BY-SA 3.0
2018-02-07T17:31:23.373Z
Great answer. Thank you. I live in the UK and I am surprised at the size of the tax burden. Personally, it provides a massive disincentive to work. 20% VAT. 40% over 30-something K/annum, national insurance, CO2 taxes, Common European Tariffs, housing taxation and on and on. The effective rate for someone earning any wealth (with a view, say, to entrepreneurship or investment for further wealth creation) seems outrageous to me - to the point that it is near impossible. Can you help me answer why the UK taxation burden is so high and what economic model supports it?
52d6c6af
CC BY-SA 3.0
2018-02-07T17:41:47.670Z
@Ben The question of the level of taxes is a question about the level of government spending - if the government is going to spend some amount, they have to raise enough revenue for that from somewhere, and taxes are usually the main source of revenue for a government. Why does the British government control such a large share of national output? I don't know enough about Britain to give any reasonable answer to that question.
Ege Erdil
CC BY-SA 3.0
2018-02-07T16:37:28.187Z
2018-02-07T16:37:28.187Z
Ege Erdil
<p>When liberalising trade with developing economies like China, states like the UK seek to benefit from the comparative advantage of cheaper imports.</p>

<p>Cheap imports undercut some native industries (eg. steel making, ship building, pottery) causing (at least in the short term) joblessness and associated negative social outcomes.</p>

<p>The thinking (IIUC) is that those displaced from the marketplace by the imports should move to higher-value-add industries, but in many cases this does not happen. For example towns like Stoke on Trent in the UK whose native industry was decimated (at least in part) by overseas competition, are characterised by chronic joblessness and associated social problems.</p>

<p>In a welfare state like the UK, the cost of those social problems are then borne by the state.</p>

<p>To what extent does this undermine the comparative advantage seen by the UK from cheap imports?</p>

CC BY-SA 3.0
2018-02-07T15:03:30.480Z
Is your question: Engaging in trade is good in one way and bad in another. It is good because we can consume things at a lower cost, which allows us to, ultimately, consume more than would be possible otherwise. It is bad because trade threatens domestic industry. Displaced workers become a cost, to some extent, for the state. Is trade then a net good or a net bad?  If this is your question, then the obvious answer is that each instance presents a cost/benefit analysis that gives a clear answer.
123
CC BY-SA 3.0
2018-02-07T15:08:48.407Z
So you’re saying: yes it can undermine the comparative advantage, but it depends on the circumstances? Do any countries apply transitional or time-limited tariffs to cover the managed decline of an industry? For example: it seems like transitional (with an expiration date) buffer-like tariffs seem reasonable to cover the transition from competitiveness to chronic uncompetitiveness? Such tariffs might also guard against strategic market dumping.
52d6c6af
CC BY-SA 4.0
2018-07-11T18:28:27.937Z
I think this question uses the phrase "comparative advantage" very differently from how economics uses it.
Giskard
CC BY-SA 4.0
2018-07-12T08:19:07.523Z
Can you explain?
52d6c6af
CC BY-SA 4.0
2018-07-12T09:27:31.203Z
@Ben Not in a comment, but you can read about [Ricardo's model of trade](https://en.wikipedia.org/wiki/Comparative_advantage#Ricardo's_example).
Giskard
CC BY-SA 4.0
2018-07-12T09:30:03.717Z
Thank you. I thought comparative advantage was the scenario whereby although a surgeon could mow his lawn better, it remained advantageous for him to hire in a mower to enable him to continue his high value work? The UK imports cheap labour to enable “the surgeon” (native Brits) to get on with his work. So “the surgeon” gets a cheaper latte, but pays more in tax to cover the cost of the native Britons unable to compete with the influx and forced to subsist off the state. How am I wrong?
52d6c6af
CC BY-SA 4.0
2018-07-12T15:23:14.593Z
I agree. This is not effective usage of the concept of "comparative advantage".
nathanwww
CC BY-SA 4.0
2018-07-12T15:29:15.407Z
Yes, the surgeon's taxes and the CEO's taxes will help cover the cost of the social safety net. But the existence of a cost does not constitute evidence that it outweighs aggregate benefits.
nathanwww
CC BY-SA 4.0
2018-07-12T15:31:03.727Z
It is possible to take concern for the situation of workers who become unemployed as a result (and the likely decline in their quality of life as a result), without requiring that the economic impact is negative in aggregate. It can be good for the economy (e.g., defined as aggregate production potential) as a whole and be bad for some individuals at the same time. Welfare payments partly compensate them for their loss, and often workers in sectors known to be specifically negatively impacted by a trade agreement qualify for special subsidies to education or training to help find new work.
nathanwww
<welfare><comparative-advantage>
Is comparative advantage undermined by a welfare state?
52d6c6af
# Is comparative advantage undermined by a welfare state?

(Asked by: username_0 on 2018-02-07)

When liberalising trade with developing economies like China, states like the UK seek to benefit from the comparative advantage of cheaper imports.

Cheap imports undercut some native industries (eg. steel making, ship building, pottery) causing (at least in the short term) joblessness and associated negative social outcomes.

The thinking (IIUC) is that those displaced from the marketplace by the imports should move to higher-value-add industries, but in many cases this does not happen. For example towns like Stoke on Trent in the UK whose native industry was decimated (at least in part) by overseas competition, are characterised by chronic joblessness and associated social problems.

In a welfare state like the UK, the cost of those social problems are then borne by the state.

To what extent does this undermine the comparative advantage seen by the UK from cheap imports?

**Tags:** welfare, comparative-advantage

> **Comments:**
> **username_1**: Is your question: Engaging in trade is good in one way and bad in another. It is good because we can consume things at a lower cost, which allows us to, ultimately, consume more than would be possible otherwise. It is bad because trade threatens domestic industry. Displaced workers become a cost, to some extent, for the state. Is trade then a net good or a net bad?  If this is your question, then the obvious answer is that each instance presents a cost/benefit analysis that gives a clear answer.  
> **username_0**: So you’re saying: yes it can undermine the comparative advantage, but it depends on the circumstances? Do any countries apply transitional or time-limited tariffs to cover the managed decline of an industry? For example: it seems like transitional (with an expiration date) buffer-like tariffs seem reasonable to cover the transition from competitiveness to chronic uncompetitiveness? Such tariffs might also guard against strategic market dumping.  
> **username_2**: I think this question uses the phrase "comparative advantage" very differently from how economics uses it.  
> **username_0**: Can you explain?  
> **username_2**: @Ben Not in a comment, but you can read about [Ricardo's model of trade](https://en.wikipedia.org/wiki/Comparative_advantage#Ricardo's_example).  
> **username_0**: Thank you. I thought comparative advantage was the scenario whereby although a surgeon could mow his lawn better, it remained advantageous for him to hire in a mower to enable him to continue his high value work? The UK imports cheap labour to enable “the surgeon” (native Brits) to get on with his work. So “the surgeon” gets a cheaper latte, but pays more in tax to cover the cost of the native Britons unable to compete with the influx and forced to subsist off the state. How am I wrong?  
> **username_3**: I agree. This is not effective usage of the concept of "comparative advantage".  
> **username_3**: Yes, the surgeon's taxes and the CEO's taxes will help cover the cost of the social safety net. But the existence of a cost does not constitute evidence that it outweighs aggregate benefits.  
> **username_3**: It is possible to take concern for the situation of workers who become unemployed as a result (and the likely decline in their quality of life as a result), without requiring that the economic impact is negative in aggregate. It can be good for the economy (e.g., defined as aggregate production potential) as a whole and be bad for some individuals at the same time. Welfare payments partly compensate them for their loss, and often workers in sectors known to be specifically negatively impacted by a trade agreement qualify for special subsidies to education or training to help find new work.  

---

## 1 answers

### Answer by username_4 on 2018-02-07. Score: 4 | Accepted answer

The basic result about the effect of trade on income distribution is Stolper-Samuelson in the Heckscher-Ohlin model, which says that trade liberalization is associated with a rise in the prices of the factors of production that are used intensively in the production of goods the country has a comparative advantage in, and vice versa. If you take "skilled" and "unskilled" labor to be two different factors of production, for instance, Stolper-Samuelson says that a country with abundant skilled labor lifting trade barriers should lead to an increase in income inequality. A welfare state committed to keeping relative incomes of workers within a certain range may need to raise distortionary taxes to expand various income transfer programs to "unskilled" workers in this case, which could lead to inefficiency for various reasons. (Even if the taxes used to finance the income transfer are lump-sum, as long as the benefits phase out this leads to high effective marginal tax rates on the lower end of the income scale, i.e a disincentive to work and to acquire new skills.) In this sense, it's indeed true that a generous welfare state can reduce the efficiency gains from free trade.

The rest of the answer is a rant about the concept of "strategic market dumping" that was brought up in the comments, so if you're not interested you can skip that part.

Things like "strategic market dumping" are ill-defined concepts that are usually used to justify tariff increases without having much backing in theory. If "dumping" is expected to go on for a finite period of time and the associated good can be stored at no cost, for instance, then in a perfect foresight world there's an arbitrage bound on the price of the good today which forces it to grow at a rate less than or equal to the real interest rate available in the broader economy. Adding storage costs does not change the basic result very much. In that case, "dumping" is not a good strategy to begin with - if you try to do this, people will buy up the goods you're selling at low prices, hold them until you reverse your policy, and then flood the market with goods they have stored up in their inventories once you stop the "dumping", leaving you worse off. To justify a policy of industry protection, you have to argue that the government can see the reversal of the dumping policy coming and private agents can't - in this case, the real return on an investment in producing and storing oil would be higher than the market real interest rate is saying it will be, so the market outcome will be suboptimal. It's easy to justify any government intervention by saying that the government is clairvoyant and private agents are not, however.

What about labor market (or, more generally, factor market) frictions? Isn't the point of "dumping" to eliminate your competitors through "artificially low" prices which force them to go out of business? Well, here you're making the mistake of assuming that the government knows about labor market frictions and the private sector doesn't, therefore the government should do something about the situation. In real life, the private sector is well aware of the search frictions in the labor market, the difficulty of firing workers in some countries, etc. This means that if they expect the "dumping" strategy to be reversed in the future, they will choose to borrow money or raise capital to stay in business. They will downsize in response to the "dumping" policy, but not as much as you think they would, and certainly not as much to make a government "protection" of the industry a good policy.

Does this mean markets can never allocate resources poorly? Of course not - if the country doing the dumping manages to fool private agents into thinking their "dumping" policy was permanent while it was temporary, then the market allocation will be suboptimal. However, in hindsight every price and every allocation is wrong. We certainly don't expect market allocations to be optimal *ex post*, so it's not surprising to see cases where it seems like the market allocation was poor and led to many workers being stuck in jobs where wages fell due to international price changes of goods. In fact, this would happen in a stochastic world where markets were functioning perfectly and giving you an *ex ante* Pareto optimal allocation of resources. Even a social planner with access to all information available at a given date and the mental capacity to solve the associated economic calculation problem would act in ways that sometimes seem foolish *ex post*. This doesn't mean the social planner is not doing his job properly, it just means there are things about the future that even a social planner can't know with perfection. The argument is no different for market allocations - allocations that are poor *ex post* do not justify government intervention *ex ante*.

> **Comments:**
> **username_0**: Great answer. Thank you. I live in the UK and I am surprised at the size of the tax burden. Personally, it provides a massive disincentive to work. 20% VAT. 40% over 30-something K/annum, national insurance, CO2 taxes, Common European Tariffs, housing taxation and on and on. The effective rate for someone earning any wealth (with a view, say, to entrepreneurship or investment for further wealth creation) seems outrageous to me - to the point that it is near impossible. Can you help me answer why the UK taxation burden is so high and what economic model supports it?  
> **username_4**: @Ben The question of the level of taxes is a question about the level of government spending - if the government is going to spend some amount, they have to raise enough revenue for that from somewhere, and taxes are usually the main source of revenue for a government. Why does the British government control such a large share of national output? I don't know enough about Britain to give any reasonable answer to that question.  

---

