How likely is trade liberalization to produce efficiency gains in the
presence of imperfect competition, scale economies, and higher-than-average
wages in the modern sectors -- all common features of developing economies?
These features create a potential conflict to the extent that traditional
notions of comparative advantage would lead us to expect that the modern
sectors will be squeezed with liberalization. In this paper we investigate
the issue by using an applied general equilibrium model calibrated to
Cameroonian data. Under perfect competition, the traditional expectations
are borne out: manufacturing sectors on the whole contract, and the cash
crops sector (mainly coffee and cocoa) is the main beneficiary; the welfare
effect is a wash since the beneficial consequence of expanded imports is
offset by labor being pulled away from the modern, high-wage sectors. By
contrast, under imperfect competition (in the modern sectors only), trade
liberalization produces welfare gains of the order of 1 to 2 percent of real
income. The key is the pro-competitive effect of liberalization: domestic
firms now perceive themselves as facing a higher elasticity of demand, which
spurs them to increase production. Therefore, the modern sectors do much
better in terms of output than in the perfectly competitive benchmark. The
introduction of scale economies amplifies these results. Under reasonable
circumstances imperfect competition will make liberalization more desirable,
even in the absence of firm entry and exit.
*Published:
European Economic Review, July 1991.
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