Explaining Trade Policy Regimes with the Ricardian Model

The linked working paper was written by three leading economists from the Center for International Development at Harvard University.  There is material written as to why an existing trade regimes may exist, but they tend to lack the evolution of it and the connection it has to the division of labor.  The purpose of the paper is to study the effects of division of labor based on individuals' production and trade decisions, and to examine the equilibrium implication of the inter-dependence between the level of division of labor and the degree of trade liberalization.

Before I go into the summary and commentary on this paper, I must layout some groundwork as to how this paper came about.  It follows the typical Ricardian idea that free trade benefits both countries in question.  However, it brings up the question of why countries may stray from free trade policies.  The paper uses a Ricardian model with transaction costs and endogenous comparative advantage somewhat similar to the model we studied in class.  Also governments play a role in this model so that it may show the effects of tariffs, and the importance of trade negotiations.

Two of the four sections of the paper use mathematical representations of the Ricardian Model to explain how cost and level of division of labor are related, and the effects on welfare and terms of trade based on choice of tariffs.  In section 2, we find out that as transaction conditions improve in both countries, the equilibrium moves to complete international division of labor.  This means that productivity is maximized, and the countries now produce on their corresponding PPF.  The result that I found most interesting is that even if a country's TOT go down, it can receive gains in trade to offset this.  In section 3, countries impose tariffs to benefit their TOT which could result in a tariff war.  If this is the case, tariffs can go so high as to offset these gains as a whole.  This suggests that as trade negotiations move toward free trade, that division of labor will move directly with it.

Overall, I found this paper to be intriguing even though it was difficult to understand the mathematics behind it.  However, it does make sense that as tariffs are lifted, international division of labor occurs in unison due to the specialization that can happen since the countries are more liberalized.  Lastly, it surprises me that even though a country's terms of trade may be worse off, the gains from trade can offset it, actually increasing the economic welfare of the country.