Message in a Bottle

Sunday, June 27, 2004

What is the argument for free trade?

What does it mean, in the language of theory, to say that free trade plus transfers pareto dominates autarky? I guess the formal proof would simply employ the following steps:

1. Assume that the aggregate production of the "world economy" is the sum of the individual aggregate production sets, so that the technological possibilities remain the same.

2. Since the autarky production and consumption plans are still feasible, one can simply employ one of the standard proofs for the existence of individual rational pareto efficient allocations, that is allocations where nobody would lose.

3. By the second welfare theorem we can support such an allocation by a price system.

Voila!

I'm pretty sure this is the correct formulation of the standard view found in undergrad microeconomics textbooks. But isn't it widely agreed that it is impossible to actually do the lump sum transfers required by the second welfare theorem? So what is the real case for free trade, if there is one?