Transfers, the Terms of Trade and Capital Accumulation

The static trade literature has concluded that, absent distortions and bystanders, transfer induced movements in the terms of trade cannot be large enough (under Walrasian stability) to produce the transfer paradox. Dynamic one-sector models have argued that a transfer paradox is possible, but have relied upon international capital mobility and movements in the world interest rate rather than commodity markets and prices. In a dynamic two-sector overlapping generations model - which allows for both static and intertemporal terms of trade effects -commodity trade can produce a steady state transfer paradox under Walrasian stability, and without distortions or bystanders. The existence of the paradox is due to the effect of the transfer on world capital accumulation which is shown to always (that is, for any ranking of factor intensities and savings rates) improve the donor's terms of trade. Transfers may also be Pareto-improving in the steady state, and produce paradoxical welfare results along the transition path.