Hoisted From Comments: Query On Foreign Trade

A reader asks:

"This is an unrelated discussion, but I was hoping that maybe you (or someone else reading this forum) could help me with a question that may also be of interest to you.

How does a standard neo-Walrasian CGE (computational general equilibrium) model predict economic losses from trade liberalisation?

I understand the logic behind the two goods and country case where welfare gains can be made through the elimination of trade barriers if there exists a comparative advantage (assuming the standard assumptions of perfect competition, constant returns to scale etc.), but how does the logic work with more than two countries and goods?

Is the answer simply that those countries which do not have a comparative advantage (in any or critical goods), experience welfare losses, because they are now importing more (due to lower prices abroad) and exporting less (trade is being diverted to other countries)?

Most (if not all) countries when getting the CGE treatment with full liberalisation scenarios, seem to make welfare gains. Is this because most countries have at least some comparative advantage in some goods, and the theory neglects any adjustment and transaction costs?

Some background on this question: I'm not an economist by trade, but rather study development studies, for which I'm writing a Master's Thesis. My strategy has been to use the Lakatosian methodological framework for studying the hardcore assumptions behind general equilibrium analysis. This has led me to study for example Keen's work, and Fabio Petri's (on the capital controversies) among others. Since I'm not concentrating on heuristics (and I'm not particularly mathematically inclined), I'm not familiar with all the implications of the standar neo-Walrasian theory (e.g. Arrow-Debreu) that the criticism, quite rightly it seems, is able to destroy by attacking its inconsistent or absurdly narrowed assumptions. To the standard unacquainted reader (for example my supervisor) it is however perhaps not only enough to attack the assumptions, but also be able to reduce the theory via its implications. I'm thinking that for a conclusion, I could write up a kind of characterisation of what the theory implies in the narrow sense and a wish list of what problems a perfect economic theory would be able to cover and account for as a contrast (perhaps a distant dream, but why not?)

Any ideas on the above would be appreciated.."

I don't know much about CGE models. I understand that commodities can be indexed in the Arrow-Debreu model on space, and this provides a theory of foreign trade. In the Arrow-Debreu model, the initial endowments of all commodities are taken as given data. This makes it a very short run theory. I was under the impression that the traditional argument about comparative advantage takes place in the Heckscher Ohlin Samuelson (HOS) model, which is a long run model.

Given the presence of produced capital goods and a positive interest rate, many supposed theorems in the HOS model are simply incorrect. In particular, trade according to the pattern of comparative advantage can move a country's Production Possibilities Frontier inward. Ian Steedman is a good author to read here. Perhaps your university library has a copy of the New Palgrave, and Steedman wrote the entry on "Foreign Trade". (I talked to Keen about these ideas before the publication of his book. He said that if he writes another edition, he might put in a chapter on foreign trade.)

I don't think comparative advantage explains the pattern of trade. A theory based on the Keynesian multiplier is another possibility. Literature here includes Luigi Pasinetti's Structural Economic Dynamics: A Theory of the Economic Consequences of Human Learning (Cambridge, 1993). Paul Davidson has proposed some reforms of the international monetary system. I have not read Ha-Joon Chang, neither his Bad Samaritans nor his Kicking Away the Ladder.

Two PDFs that I have downloaded from somewhere or other in the past year and have never got around to reading might be of interest. I am talking about Roberto Mangabeira Unger's Free Trade Reimagined and Robert Driskill's "Deconstructing the Argument for Free Trade".

Another body of literature that I have never explored is new trade theory, as presented by Paul Krugman. Given that comparative advantage fails to justify free trade, I don't see the point of that theory. As I understand it, new trade theory asserts incorrectly that comparative advantage would provide this justification if it were not for increasing returns or oligopoly or something. According to Barkley Rosser (in a 1996 book review in the Journal of Economic Behavior and Organization), Krugman claims more originality for his presentation than can be justified.