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The Generalized Theory of Transfers and Welfare: Bilateral Transfers in a Multilateral World Author(S): Jagdish N American Economic Association The Generalized Theory of Transfers and Welfare: Bilateral Transfers in a Multilateral World Author(s): Jagdish N. Bhagwati, Richard A. Brecher and Tatsuo Hatta Reviewed work(s): Source: The American Economic Review, Vol. 73, No. 4 (Sep., 1983), pp. 606-618 Published by: American Economic Association Stable URL: http://www.jstor.org/stable/1816561 . Accessed: 30/01/2013 15:15 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The American Economic Review. http://www.jstor.org This content downloaded on Wed, 30 Jan 2013 15:15:53 PM All use subject to JSTOR Terms and Conditions The Generalized Theory of Transfers and Welfare: Bilateral Transfers in a MultilateralWorld By JAGDISH N. BHAGWATI, RICHARD A. BRECHER, AND TATSUO HATTA* Paul Samuelson's (1952, 1954) classic (1954), who did extend the positive analysis papers on the transfer problem addressed to include tariffs, did not go on to ask two separate analytical issues: the "positive" whether immiserization of the transfer recip- effect of a transfer on the terms of trade; and ient (and hence symmetrically enrichment of the welfare effect of the transfer on the donor the donor in a two-country model) could and the recipient. now arise consistent with market stability. Since then, a considerable body of litera- Recently, the welfare analysis of transfers ture has grown up on the positive analysis. has been extended in two different direc- While Samuelson (1954) himself had ex- tions, both apparently unconnected, and both tended the 2 x 2 x 2 free trade analysis to yielding the conclusion that transfers from allow for tariffs and transport costs, subse- abroad can be immiserizing (and that the quent writers have analyzed other extensions donor may improve its welfare) despite of the model: for example, to allow for non- market stability. One route to this conclusion traded goods as with leisure in Samuelson has been the introduction of a third eco- (1971); or general nontraded goods in John nomic agent (or country) that is outside of Chipman (1974) and Ronald Jones (1970, the transfer process. In the Appendix of his 1975). 1960 paper analyzing the interaction between Remarkably, however, the welfare analysis trade policy and income distribution, Harry of transfers has not paralleled these develop- Johnson discussed the possibility of welfare- ments. Since Wassily Leontief (1936) pro- paradoxical redistribution between two fac- duced an example of immiserizing transfer tor-income classes (capital and labor) in an from abroad and Samuelson (1947) argued open economy, thereby providing what can that the example required market instability, be interpreted as a treatment of the three- the proposition that has monopolized atten- agent transfer problem for the case in which tion has been that a transfer in the conven- donor and recipient are both completely spe- tional 2 x 2 x 2 model in its free trade version cialized in the ownership of a single different cannot immiserize the recipient or enrich the factor.' An independent analysis of the donor as long as world markets are stable (in three-agent transfer problem, using a restric- the Walras sense). Interestingly, Samuelson tive model with given endowments of goods and fixed coefficients in consumption, was *Bhagwati: Department of Economics, Columbia also undertaken in an important paper by University, New York, NY 10027; Brecher: Department David Gale (1974).2 Brecher and Bhagwati of Economics, Carleton University, Ottawa, ON KIS 5B6; Hatta: Department of Political Economy, The Johns Hopkins University, Baltimore, MD 21218. We 'After the present paper was submitted for publica- thank the National Science Foundation, grant no. 5- tion, and following its presentation at Rochester, our 24718, for partial financial support of the research un- attention was drawn to this Appendix, which was no- derlying this paper. The paper was written when Brecher ticed by a student of Ronald Jones. Subsequently, we and Hatta were visiting Columbia University, 1981-82. learned from Makoto Yano that Motoshige Itoh had Gratefully acknowledged are helpful comments and pointed out an important related paper by Ryuotaro suggestions from John Chipman, Avinash Dixit, Jacques Komiya and T. Shizuki (1967), whose condition (11) for Dreze, Robert Feenstra, Jacob Frenkel, Ronald Jones, the Johnson case anticipated our equation (12) below. Murray Kemp, Andreu Mas-Colell, Michael Mussa, John We are grateful for having both of these references Riley, Lars Svensson, and Robert Willig, from anony- brought to our attention. mous referees, and from seminar participants at Berke- 2 Gale constructs an example in which the donor is ley, Harvard, Minnesota, Rochester, Chicago and the enriched along with the recipient. Furthermore, this University of California-Los Angeles. immediately implies that a reverse transfer will immis- 606 This content downloaded on Wed, 30 Jan 2013 15:15:53 PM All use subject to JSTOR Terms and Conditions VOL. 73 NO. 4 BHAGWATIETAL.: TRANSFERS AND WELFARE 607 (1981) also independently pioneered this with a tariff.3 The latter proliferation led to analysis in the context of a three-agent model the generalized theory of immiserizing growth where the recipient country is split into one (Bhagwati, 1968b) whose major, influential subset of "national" factors and another of proposition is that growth, in the presence of "foreign" factors, and the conditions for the a distortion implying departure from full immiserization of the national factors after optimality, can be immiserizing since the receiving a transfer from abroad are analyzed primary gain from growth at optimal policies and shown explicitly to be consistent with may be outweighed by an accentuation of market stability. the loss from the distortion vis-'a-vis the opti- Another route has been to consider mal policies. transfers in the presence of exogenously Can a similar, striking generalization be specified domestic distortions. Thus, Brecher developed in regard to the transfer-induced and Bhagwati (1982) have analyzed the case paradoxes? It is the general conclusion of of a transfer in the presence of a production our analysis in this paper that, indeed, it can. distortion in the recipient country and shown We demonstrate that the phenomenon of that the recipient can get immiserized despite immiserizing transfers from abroad (and the market stability if the recipient's "overpro- analytically symmetric phenomenon of en- duced" good is inferior in the donor's con- riching transfer payments) in the presence of sumption. Hatta, in an early unpublished market stability can arise only if there is a paper (1973a), has also demonstrated for a distortion characterizing the economy in closed economy with constant-cost produc- question. tion that a transfer between two agents, when This general conclusion is critically depen- there is a distortionary wedge between pro- dent on our demonstration below that the ducer and consumer prices, could immiserize three-agent case, which appears prima facie the recipient consistent with market stability. to involve no distortion while producing the Peter Diamond (1978) has also recently con- noted paradoxes, is indeed characterized by sidered the welfare impact of transfers when what Bhagwati (1971) has called a foreign a price distortion exists in an economy with distortion, since the country is not using an convex technology, and he gives compara- optimal tariff. Moreover, the exercise of their tive-static results that are consistent with joint monopoly power by the recipient and paradoxes. donor (viewed as members of a customs This recent proliferation of paradoxical union) vis-a-vis the nonparticipant agent will cases of immiserizing transfers (and enrich- be shown to eliminate the paradoxes in ques- ing transfer payments) is reminiscent of the tion. earlier multiplication of cases involving im- Thus, in Section I, we develop the basic miserizing growth, with Bhagwati's (1958) analysis of transfers when there are two eco- analysis of the case of a large country in free nomic agents (countries) engaged in the trade being followed by Harry Johnson's transfer process, but there is an added agent (1967) analysis of the case of a small country outside the transfer process so that we have a bilateral transfer in a multilateral context. Conditions are established for immiseriza- erize the (new) recipient. A simple calculation, more- tion of the recipient, for enrichment of the over, shows that the Gale example is Walras-stable. donor and for the "double perversity" when Gale's work has stimulated a number of papers, most of these two paradoxical outcomes arise simul- which assume fixed commodity endowments and/or fixed consumption coefficients. A notable exception is taneously. Economically intuitive explana- an analysis of the three-agent transfer problem by tions of these results are derived in a number Makoto Yano (1981), who introduces substitutability in of alternative ways. both production
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