| It is a dearly held conviction among economists that free trade is beneficial. On the other hand, we see considerable popular opposition to trade liberalization. Given that some individuals can lose even in the presence of aggregate gains, their opposition is understandable. However, it threatens further trade liberalization and might even provoke a backlash against what has already been achieved. Thus, it seems desirable to seek Pareto gains where, by definition, nobody is harmed.; The issue is taken up at a theoretical level in the literature which I review in a first paper. In order for trade liberalization to be Pareto improving, the reform must generally be accompanied by redistribution. Using lump sum transfers or Diamond-Mirrlees commodity taxation as alternative means of redistribution, Pareto gains from trade can be established in static general equilibrium models. This result can be generalized for customs unions and also applies to migration.; A second paper (joint work with Giovanni Facchini) extends this literature by showing that a special duty free zone also leads to Pareto gains. Our duty free zone involves an entry fee exempting agents from commodity taxation. It can be viewed as a special case of non-linear taxation. Furthermore, we prove that such a regime dominates free trade with commodity taxation because the duty free zone is an efficient way of distributing the surplus from such a tax scheme.; A third paper goes beyond the static literature by adding a second period. In a general equilibrium model with a continuum of heterogeneous agents, if agents anticipate government redistribution after the reform, their strategic reactions may render Pareto gains unachievable. Hence the long-standing Pareto gains from trade result needs qualifying in general dynamic models. This is a typical problem of strategic under-investment, which can be overcome by subsidizing capital acquisition in addition to carrying out redistribution. |
