The Redistribution of Efficiency Gains: Transfers or Tariffs?

This paper is concerned with some theoretical issues in cooperative multilateral trade policy reform. The focus of the paper is on the structure of the policy reform problem, particularly as it applies to piecemeal policy reform, and on the similarity in roles that can be played by income transfers on the one hand and tariffs reforms on the other as redistributive policy instruments. More specifically, the paper is concerned with the mechanism by which efficiency gains arising out of trade policy reforms can be distributed amongst countries to achieve a strict Pareto improvement in welfare. Traditionally, trade theorists have assumed the existence of lump sum income transfers to distribute efficiency gains. Turunen-Red and Woodland (2000) have shown that income transfers accompanying quota reforms can be replaced by suitable multilateral tariff reforms to achieve the same welfare outcome. In the current paper, we generalize this idea to deal with discrete policy reforms. And, we develop several applications to enhance understanding of the connection between tariffs and transfers. If lump sum transfers are not available policy instruments, the achievement of a strict Pareto improvement must depend on changes in distortionary taxes, such as domestic taxes or tariffs on trade. Our results show that, under a mild condition on the world trade matrix, it does not matter whether lump sum transfers are available. Transfers can be replaced by a carefully chosen set of tariffs to achieve the same welfare outcome. This ability to replace transfers by tariffs is a result of the structure of the model of international trade: the terms of trade effects for a country and a lump sum transfers are equivalent, and there are sufficient tariff instruments to enable countries to neutralize the domestic price effects of terms of trade movements.