North-South Trade and the Global Environment

American Economic ReviewGraciela Chichilnisky

1994

Context

• Last 50 years has seen tremendous growth in international trade

• Historic patterns of exports of resource-intensive goods from global South to global North

• Many argue that this trade is good for the South because it reflects their comparative advantage in resource-intensive goods

• (This argument was not restricted to resource-based goods, but to env’lly polluting goods too: see Summers 1991 memo)

Question

• What if the “comparative advantage” is institutional, i.e. the result of weak property rights over natural resources?

• Is it still efficient for developing countries to specialize in dirty goods?

• Are we hurting these countries by trading with them?

Model

• Two countries: N, S• Two goods: A, B (relatively resource intensive)• Two inputs: K, E – where supply of E is Es(pE) with pE being the price

of the resource

Property Rights

• Assume North and South “differ solely in their property rights for a pool of resources from which one input to production is extracted.” (p.856)

• “Tracing the impact of property rights is nothing more and nothing less than a comparative-statics exercise: the comparison of a world equilibrium in which both regions have well-defined property rights with a second world equilibrium in which both regions have well-defined property rights with a second world equilibrium in which the South does not.” (p.856)

How do Property Rights (PRs) affect relative supply of resource intensive

goods?

Proposition 1

• [i] The common-property supply curve for the resource lies below the private-property supply curve, so that under common-property regimes, more is supplied at any given [resource] price.

• [ii] Both supply curves are in-creasing functions of resource prices.

Analytics underlying Proposition 1• i=1,…,N identical harvesters, each exerting extraction

effort, xi

• Let x=∑ixi measure aggregate effort • Define F(x) = aggregate extraction• Since agents are symmetric and identical and move

simultaneously, in equilbirium each agent keeps the average product, Ei = F(x)xi/x, rather than the marginal product of her effort. – Assume F(0)=0, F’>0, F is strictly concave

• Define q = opportunity cost per unit of extraction effort• So each each harvester chooses xi to

maximize pEEi(xi)-qxi

If instead the resource was owned privately, then…

• Last unit of effort chosen so as to solve• Maxx pEF(x)-qx

• Assuming pE>0, the first order condition (FOC) is F’(x)=q/pE

• Define xP(q/pE) as solution to F’(xP(q/pE))=q/pE.

• Note private input supply xP is decreasing in q/pE since F is concave.

Compare this to the condition implicitly defining supply when the

resource is owned in common

• Common property extractor i solves

With FOC:

It’s straightforward to show MPP<MPC for any x:

• MPiC=

• MPiP=F’(x)

Thus• MPi

P-MPiC=

• Thus, for any given q/pE, the x that satisfies a common property extractor’s problem in equilibrium, xc(q/pE), generates F’(xc)<q/pE

• Combine this with fact that F is strictly concave to obtain the following: for fixed q/pE, xP<xc.

• That is, for given relative prices, more of the resource will be supplied when the resource is owned in-common than when privately owned.

Proof of part ii

• In either case can write xi as solution toMaxxi pEEi(xi)-qxi

• As q/pE declines (i.e. pE increases for a given q), solution requires dEi(xi)/dxi to decline.

• Given Ei is concave under either property regime, then it must be that xi is decreasing in q/pE and thus increasing in pE (holding q fixed)

End of Proof of Proposition 1

Note: the statement and proof of Proposition 1 begs the following: given identical goods prices, the

relative price q/pE will be the same under either management regime

In order to do anything else, we’ll need to put some more structure on

the model

Model Features

• Capital supply increasing in rental price: K’(r)>0• Constant returns to scale (CRS) production

functions – Fixed-proportions production functions

• BS=EB/a1=KB/c1

• AS=EA/a2=KA/c2

– B relatively resource intensive impliesD=a1c2-a2c1>0

Full Employment

• Assume all inputs are hired; this entails

Zero Profits entail

• pA=a2pE+c2r

• pB=a1pE+c1r

• Solve this system for r and PE:

Assume specific functional form for E (resource supply)

• ES=αpE/q+E0

– as per proposition 1, α(N)< α(S).• What’s q?– If use capital to extract the resource: q=r– if use subsistence labor (which needs to eat an

extra unit of resource-intensive good (food) to extract an additional unit of the resource), then q=pB

• Assume

Other assumptions

• Define exports and imports:

• Balanced trade implies

• Assume Free Trade• So pA(N)=pA(S)• pB(N)=pB(S)• XS

A(N)=XDA(S)

• XSB(S)=XD

B(N)

Assume economies are identical, except for α(S)> α(N)

Normalize pA=1

Impose restrictive functional form on utility

U(A,B)=B+k if A≥AD*

U(A,B)=B+γA otherwisewhere γ>k/AD*>0.

• Thus, if pB>1/ γ then agents in all countries demand exactly AD* units of the non-resource good.

Use all this to obtain expressions for supplies of each of the outputs as

functions of input supplies

We are almost ready to state and prove some more theorems, but

first…

More definitions

• South is said to have an apparent comparative advantage in the production of resource-intensive good B if, for each price pE, the relative supply E/K from South is greater than that from North.

• South is said to have an actual comparative advantage in good B if South’s relative supply E/K is greater than North’s (for identical pE) when South’s resource is managed privately

Theorem 1Consider the North - South model in which both regions have identical

technologies, the same homothetic preferences, and the same endowment of inputs K.

(a) The model as defined in Appendix B has at most one competitive equilibrium. (b) If the pool from which the environmental resource is extracted is unregulated

common property in the South, then the South exhibits apparent comparative advantages in environmentally intensive goods even though neither region has any (actual) comparative advantage over the other.

(c) At a world equilibrium the two regions trade, and the South exports environmentally intensive goods at a price that is below social cost. The equilibrium is not Pareto efficient.

(d) Trade makes things worse, in the sense that the overuse of the resource increases as the South moves from autarky to trade. Furthermore, trade leads to lower resource prices worldwide.

(e) The South shows apparent gains from trade, even though it has no actual gains from trade. It extracts more environmental resources, and it produces and exports more environmentally intensive goods than is Pareto efficient.

Proof of (b)---South exhibits apparent comparative-advantage in

resource-intensive good

(Yet) more assumptions:

• capital is used for extraction (so q=r) • capital stock is fixed:

Invoke Factor Price Equalization Theorem

• Since the countries engage in free trade, and have the same production technologies for A and B, by the Factor Price Equalization Theorem, input prices will be the same.

• i.e. pE/r is same in North as South

• From Proposition 1, this implies South supplies more of the resource, E.

• Moreover, since the two countries start out with the same capital endowment, and South uses more of it for extracting the resource, then

and so, by the Heckscher-Ohlin Theorem, South Supplies relatively more of the resource intensive good than does North. Q.E.D.

Note

Chichilnisky obtains this same result by deriving an explicit expression for BS, however that form of proof is specific to the functional forms employed, while a proof relying on the HO theorem holds more generally.

Theorem 1, part (c): At a world equilibrium (i) the two

regions trade, and the South exports environmentally sensitive goods (ii) at a price that is below social cost

Chichilnisky claims that, because preferences are homothetic, we know North and South demand A and B in the same proportions and thus South exports good B– However, her claim that preferences are

homothetic is inconsistent with (B9), which implies AD(S)=AD(N)=AD*.

• (A different proof is needed)

Proof of part c (part i)

Proof of part ii• It’s hard to figure out exactly where she proves the world price is

below social cost.• Possibly, it’s when she points out that the new world price for

resources is below the autarkic price in North (which was a price that equaled marginal social cost)

• As a proof that the trading-equilibrium price is below South’s marginal social cost, however, this proof is incomplete, since marginal social cost depends on the amount harvested, and, in the free trade equilibrium, South harvests more than North does in equilibrium.

• She could fix this by showing/mentioning that extraction costs are increasing, thus, since South’s free-trade production of B exceeds North’s autarkic production, while the free trade price is less than North’s autarkic price, then South’s MSC in the free-trade equilibrium is less than social cost.

Part (d)

• (i) Trade makes things worse, in the sense that the overuse of the resource increases as the South moves from autarky to trade.

• (ii) Furthermore, trade leads to lower resource prices worldwide.

Proof of part d (i)

• Because the world price of the resource-intensive good rises (relative to autarky), South produces more of it and harvests more of the resource.

• Because South was already over-producing B in autarky, South is definitely over-producing B in free-trade equilibrium (relative to a world in which both countries have well-defined PRs)

Proof of part d (ii)

• Actually, the appendix proves the opposite: – because FT raises price of B in South, pE also rises

(Stolper-Samuelson theorem). – Thus, for South at least, trade raises the resource

price.

Part (e)

• “[i] The South shows apparent gains from trade, even though it has no actual gains from trade. [ii] It extracts more environmental resources, and it produces and exports more environmentally intensive goods than is Pareto efficient.”

Proof of part e (ii)

That South produces more than is Pareto efficient follows from proof that South produces more than North does in Autarky (which is the Pareto efficient amount for both countries)

But where’s the proof of part e(i)?

• None given.

Really?

• No proof?• But isn’t this the heart of the paper…to say

that trade makes South worse off?• Technically, the Theorem doesn’t make that

claim…it just says that trade doesn’t make South better off.

However the preamble to Theorem 1 does make such a claim:

• “The following theorem shows that trade by a region with ill-defined property rights with another with well-defined rights leads to … actual losses from trade.” (p.858)

What would you need to actually prove these claims?

• You’d have to prove that South’s welfare is lower in the free-trade equilibrium with weak Southern PRs than in the autarkic equilibrium with weak Southern PRs.

What Chichilnisky does …

• Shows that global welfare in the free trade equilibrium with weak Southern PRs is lower than in the free-trade/autarkic equilibrium with strong Southern PRs.

• This is the wrong counterfactual– this logical error was made frequently by anti-

globalization protestors in 1990s• many argued that, because wages in LDCs were lower than

those in industrialized countries, the trade was “unfair”– what’s unfair is that those folks get paid so little– but will restricting trade with LDCs raise LDC wages? not likely.

So is it true?• If a country has a restricted/open access

resource, does opening up to free trade necessarily mean it will be worse off?

• Maybe, maybe not– Brander and Taylor (1997): in model with dynamic

resource externalities, when South’s resource is severely depleted, South may end up importing resource-intensive good and experience welfare-improvement

– McAusland (2005): If the world price is sufficiently high, the weak-PR country can still benefit from trade even though it harvests even more

Take home points

• For policymakers– If a country exhibits a domestic market failure,

such as insecure property rights over natural resources, then opening to free trade may exacerbate that market failure, lowering welfare overall.• This was shown in 1960s and 1970s for a general class

of domestic market failures. • See, for example. Bhagwati, J. 1971. “The generalized

theory of distortions and welfare” in Trade, Balance of Payments, and Growth.

Take home points cont.

• For Students– Don’t believe everything you read, no matter how

highly ranked the journal in which it is published and how well cited the article• Chichilnisky (1994) is cited 427 times (Google Scholar)

– Question everything (and work through the proofs)

• For authors– identify the correct counter-factual– learn to write!