Working Paper: NBER ID: w3176
Authors: Shantayanan Devarajan; Dani Rodrik
Abstract: How likely is trade liberalization to produce efficiency gains in the presence of imperfect competition, scale economies, and higher-than-average wages in the modern sectors -- all common features of developing economies? These features create a potential conflict to the extent that traditional notions of comparative advantage would lead us to expect that the modern sectors will be squeezed with liberalization. In this paper we investigate the issue by using an applied general equilibrium model calibrated to Cameroonian data. Under perfect competition, the traditional expectations are borne out: manufacturing sectors on the whole contract, and the cash crops sector (mainly coffee and cocoa) is the main beneficiary; the welfare effect is a wash since the beneficial consequence of expanded imports is offset by labor being pulled away from the modern, high-wage sectors. By contrast, under imperfect competition (in the modern sectors only), trade liberalization produces welfare gains of the order of 1 to 2 percent of real income. The key is the pro-competitive effect of liberalization: domestic firms now perceive themselves as facing a higher elasticity of demand, which spurs them to increase production. Therefore, the modern sectors do much better in terms of output than in the perfectly competitive benchmark. The introduction of scale economies amplifies these results. Under reasonable circumstances imperfect competition will make liberalization more desirable, even in the absence of firm entry and exit.
Keywords: trade liberalization; imperfect competition; Cameroon; general equilibrium model
JEL Codes: F13; O24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Trade liberalization under imperfect competition (F12) | welfare gains (D69) |
| Trade liberalization (F13) | perception of demand elasticity (D12) |
| Imperfect competition (L13) | welfare gains (D69) |
| Scale economies (F12) | welfare gains (D69) |
| Trade liberalization under perfect competition (D41) | contraction of manufacturing sectors (O14) |
| Trade liberalization under perfect competition (D41) | benefit to cash crops sector (coffee and cocoa) (Q02) |
| benefit to cash crops sector (coffee and cocoa) (Q02) | net welfare effect that is neutral (D69) |
| Labor drawn away from modern high-wage sectors (J49) | net welfare effect that is neutral (D69) |