International Trade, Redistribution and Institutional Change

In international trade theory, the Stolper-Samuelson theorem demonstrates how changes in relative goods prices affect the returns to factors of production.  The theorem predicts that a rise in the relative price of a good will lead to an increase in the real return of the factors used intensively in its production.  The resulting redistribution of domestic income has important political economy implications. Social groups who benefit from the redistribution through an increase in their own income may gain enough de facto political power to demand changes in institutions in order to preserve their gains.  The question of whether or not these institutional changes bring about increased political participation and/or long term economic growth is at the center of an intense intellectual debate.

One aspect of the debate focuses on how the expansion of international trade in medieval Europe led to major institutional reforms that were fundamental to the rise of Western Europe.  It is argued that these reforms were mainly led by commercial interests outside the royal circle and their demands supported long term economic growth.  These reforms included the expansion of property rights protections, constraints on the power of monarchs, the creation of a legal system, and the emergence of business corporations.  Another aspect of the debate emphasizes that eventually commercial interests may promote worse economic outcomes.  The reason is that once these interests achieve enough political power and become part of the establishment, they are able to manipulate economic policy and build institutions that exclude the rest of society from political participation and the gains from trade. As a result society becomes politically closed, unequal and stratified.

The intellectual challenge that emerges from this debate is to identify a critical juncture where growth promoting institutions are transformed into rent extracting ones.  Recent research has begun to try to do this.


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