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The theory of customs unions: A general equilibrium analysis
Journal of International Economics .2 (1972) 89-108.
0 North-Holland Publishing Company
BOOK REYIEWS
Richatd G. Lipsey, The Theory of Customs Unions: A General Equilihrium Analysis. (L.S.E. Research Monograph 7. London: WeidenfeYdand Nicholson, for London School of Economics, 1970, pp. 176.) From 1953 to 1955, while James Meade was writing Trade and WeIfire and The Theory of Ctrstoms Unions, Richard Lipsey was indepen-
dently, also at the L.S.E. but under the supervision of Helen Makower, writing his thesis on customs union theory. When :Meade’sbook became available Lipsey revised his own work, to compare his methods and results w?h Meade’s. He was clearly one of the pioneers of mode.rn customs &on theory, and while he has lpulblishedsome of his resulti; in well-known articles, he chose - unwisely in my view - not to publish his thesis, at least until now. While not many specific results or theor rems emerge that are now ne:wand sufficiently general to be interesting, this book is a most attractive piece of exposition and poses some interesting problems. Lipsey’s main analysis is confined to five chapters. In Chapter 5 he analyses demand effects (what he calls “insercommodity substitution”) with constant real prices (i.e. constant costs) in each of the three countries. Proi%uctionis fixed in each county. Here he considers the case where the customs union is a small country one, prices being set by costs in. the outside country. The results are not surprising in the light of now-familiar second-best analysis (familiar partly thanks to Lipsey himself) and generally iconfirm Meade!‘sresults. Chapter 6 is perhaps the most interesting in the book and suggests scope for further investigat:ion. The assumptions are as in C!hapter 5, except that the demand assumption is lless general: he assumes the Graham demall?d case of a. Cobb---Douglas expenditure function. This makes possible some precise analysis. Initially he assumes not only that the shares of expenditure on the three gootdsin country A are constant irrespective of prices but that they are equal, while Eaterhe allows them to be un:$qual, t;lough still constant. With the .irnitialassumption he obtains tht surprising result that a customs union must improve weE fare, but this does not hold in the general Graham case. For the general Graham case he finds that there are two fa&rs influencing the gains and losses from a customs union. The first is the
90
Book reviews
expen&ure rzZaE’io!z:the larger is the expenditure on ;he domesticallyproduced product relative to the prod~f of the non-union country, tbl more likely is a g:tin from the union : t1\is is intuitively plausible. The second is the height of the pre-union tarSff: the higher it is, the more likely is a welfare gain from a union. 1his is riot easy to explain intuitively and indeed L*ipsey, who generally provides intuitive explanations for his formal results, observes (footnote 8) that in this case his talents fail him. I find the result unexpected and suspect that it depends crucially on the Graham demand assumption. The larger the initial tariff the more trade creation (and hence welfare gain) one would expect when the tz.tiff on imports from the partner is reduced to zero, but also the more trade diversion (and hence perhaps welfare loss) there should be since the initial tariff is maintainedl on imports from the nori-union country. It should be noted that Lipsey’s analysis could be extended rather easily to allow for elasticities of substitution between the three goods that are rtot all unity. For a given initial expeurditlure relation, and given initial tariffs, one might expect a greater probability of gain the greater the ratio el/e2, where el is the elasticity of substitution of the partner country’s product for the domestically-produced product and e2 is the elasticity’ of substitution of the partner% product for the product produced outside the union. I feel sure that a formal proof of this is possible (and perhaps someone has done it?). In Chapter 7 demand effects are assumed awa.y and there are constant costs, so that, in the first instance, Viner’s model and results are obtamed. There are only production effects (what Lipsey calls “intercountry substitution”). Essentially it is the familiar single-country model, with country A facing given prices from B and C. But. then Lipsey introduces an interesting complication (pp$. 77-go), which was avoided at first by assuming that B irritially had no tariff. When B removes its tariff on exports from its union’ partner, A, the latter’s terms of trade improve, so that i.n general equilibrium A no longer faces given prices from its partner. The net result from trade diversion may then be a gain to A!, even though it still leads to a vcrorldloss. In the lengthy Chapter 8 Lipsey presents a more general threecountry two-product model of inter-country substitution with no de mand effects and constant costs in each country. There is some very nice, and quite simple, geometry, and the taxonomy is extensive. Lipsey provides his own review here (“... Chapter 8 seems to m,e excessively tedious in its analysis and sparse in its conclusions”). Some of the results which suggest qualifications to the basic Viner argument seem to
Book
mviews
9-l
hinge o’n general equilibrium terms of trade effects f- Tindividual ccx ntries which Vines had ignored. .Sor e oT the peculiarititt: may also hinge on the constant cost assumption.. In Chapter 9 he allows for production a& demand effects, making again the Graham assumption. He analyses (and finds severe faults with) the Makower-Morton article, and from a model with specific figures comes out with some general conclusions; these are qualitative suggestions of reasonable possibilities, similar in kind to those in Meiide’s book. Finally it should ‘be nc ted that Lipsey explains very clearly Meade’s method of general equihbrium analysis wit!h small changes. In the preface he points out that he now reahses thaI Meade’s method. is ind(eed genera! and not partial equilibtium, contrary to what he thought when he wrote his thesis (a mistake of interpretation others have also ma and he shows the considerable limitations of Meade’s method once discrete. changes are allowed for. This is a very good book, well worth publishing even now. It is a model of careful thecoretical exposition. Thle customs union theorist was obviously father to the successful textlblook author! Trade theorists,, including some renowned ones, should read this book to learn how to expound complex theoretical arguments. The subject has advanced since the book was written, notably thianks to Vanek, but it is still illuminating (perhaps beclause, as Lipsey says, “the techniques are crude”), and challenging ([because. ‘“marly of the ideas are not fully worked out”).
W.M. Corden Nuffield College Oxford
Carlos I.5 L&Z Alejakndro, Essays on the Economic History of the Argentine Republic. (New Haven and London: Yale University Press, 1970. A Publication of the Yale Economic Growth Center., pp. 54.1, Statistical Appendix, Index, $18.50.) The ffamiliar puzzle about Argentina is why a cot&y of the world’s highest growth rates from II 865 been grouped with the world’s rich countries
that had one
0 North-Holland Publishing Company
BOOK REYIEWS
Richatd G. Lipsey, The Theory of Customs Unions: A General Equilihrium Analysis. (L.S.E. Research Monograph 7. London: WeidenfeYdand Nicholson, for London School of Economics, 1970, pp. 176.) From 1953 to 1955, while James Meade was writing Trade and WeIfire and The Theory of Ctrstoms Unions, Richard Lipsey was indepen-
dently, also at the L.S.E. but under the supervision of Helen Makower, writing his thesis on customs union theory. When :Meade’sbook became available Lipsey revised his own work, to compare his methods and results w?h Meade’s. He was clearly one of the pioneers of mode.rn customs &on theory, and while he has lpulblishedsome of his resulti; in well-known articles, he chose - unwisely in my view - not to publish his thesis, at least until now. While not many specific results or theor rems emerge that are now ne:wand sufficiently general to be interesting, this book is a most attractive piece of exposition and poses some interesting problems. Lipsey’s main analysis is confined to five chapters. In Chapter 5 he analyses demand effects (what he calls “insercommodity substitution”) with constant real prices (i.e. constant costs) in each of the three countries. Proi%uctionis fixed in each county. Here he considers the case where the customs union is a small country one, prices being set by costs in. the outside country. The results are not surprising in the light of now-familiar second-best analysis (familiar partly thanks to Lipsey himself) and generally iconfirm Meade!‘sresults. Chapter 6 is perhaps the most interesting in the book and suggests scope for further investigat:ion. The assumptions are as in C!hapter 5, except that the demand assumption is lless general: he assumes the Graham demall?d case of a. Cobb---Douglas expenditure function. This makes possible some precise analysis. Initially he assumes not only that the shares of expenditure on the three gootdsin country A are constant irrespective of prices but that they are equal, while Eaterhe allows them to be un:$qual, t;lough still constant. With the .irnitialassumption he obtains tht surprising result that a customs union must improve weE fare, but this does not hold in the general Graham case. For the general Graham case he finds that there are two fa&rs influencing the gains and losses from a customs union. The first is the
90
Book reviews
expen&ure rzZaE’io!z:the larger is the expenditure on ;he domesticallyproduced product relative to the prod~f of the non-union country, tbl more likely is a g:tin from the union : t1\is is intuitively plausible. The second is the height of the pre-union tarSff: the higher it is, the more likely is a welfare gain from a union. 1his is riot easy to explain intuitively and indeed L*ipsey, who generally provides intuitive explanations for his formal results, observes (footnote 8) that in this case his talents fail him. I find the result unexpected and suspect that it depends crucially on the Graham demand assumption. The larger the initial tariff the more trade creation (and hence welfare gain) one would expect when the tz.tiff on imports from the partner is reduced to zero, but also the more trade diversion (and hence perhaps welfare loss) there should be since the initial tariff is maintainedl on imports from the nori-union country. It should be noted that Lipsey’s analysis could be extended rather easily to allow for elasticities of substitution between the three goods that are rtot all unity. For a given initial expeurditlure relation, and given initial tariffs, one might expect a greater probability of gain the greater the ratio el/e2, where el is the elasticity of substitution of the partner country’s product for the domestically-produced product and e2 is the elasticity’ of substitution of the partner% product for the product produced outside the union. I feel sure that a formal proof of this is possible (and perhaps someone has done it?). In Chapter 7 demand effects are assumed awa.y and there are constant costs, so that, in the first instance, Viner’s model and results are obtamed. There are only production effects (what Lipsey calls “intercountry substitution”). Essentially it is the familiar single-country model, with country A facing given prices from B and C. But. then Lipsey introduces an interesting complication (pp$. 77-go), which was avoided at first by assuming that B irritially had no tariff. When B removes its tariff on exports from its union’ partner, A, the latter’s terms of trade improve, so that i.n general equilibrium A no longer faces given prices from its partner. The net result from trade diversion may then be a gain to A!, even though it still leads to a vcrorldloss. In the lengthy Chapter 8 Lipsey presents a more general threecountry two-product model of inter-country substitution with no de mand effects and constant costs in each country. There is some very nice, and quite simple, geometry, and the taxonomy is extensive. Lipsey provides his own review here (“... Chapter 8 seems to m,e excessively tedious in its analysis and sparse in its conclusions”). Some of the results which suggest qualifications to the basic Viner argument seem to
Book
mviews
9-l
hinge o’n general equilibrium terms of trade effects f- Tindividual ccx ntries which Vines had ignored. .Sor e oT the peculiarititt: may also hinge on the constant cost assumption.. In Chapter 9 he allows for production a& demand effects, making again the Graham assumption. He analyses (and finds severe faults with) the Makower-Morton article, and from a model with specific figures comes out with some general conclusions; these are qualitative suggestions of reasonable possibilities, similar in kind to those in Meiide’s book. Finally it should ‘be nc ted that Lipsey explains very clearly Meade’s method of general equihbrium analysis wit!h small changes. In the preface he points out that he now reahses thaI Meade’s method. is ind(eed genera! and not partial equilibtium, contrary to what he thought when he wrote his thesis (a mistake of interpretation others have also ma and he shows the considerable limitations of Meade’s method once discrete. changes are allowed for. This is a very good book, well worth publishing even now. It is a model of careful thecoretical exposition. Thle customs union theorist was obviously father to the successful textlblook author! Trade theorists,, including some renowned ones, should read this book to learn how to expound complex theoretical arguments. The subject has advanced since the book was written, notably thianks to Vanek, but it is still illuminating (perhaps beclause, as Lipsey says, “the techniques are crude”), and challenging ([because. ‘“marly of the ideas are not fully worked out”).
W.M. Corden Nuffield College Oxford
Carlos I.5 L&Z Alejakndro, Essays on the Economic History of the Argentine Republic. (New Haven and London: Yale University Press, 1970. A Publication of the Yale Economic Growth Center., pp. 54.1, Statistical Appendix, Index, $18.50.) The ffamiliar puzzle about Argentina is why a cot&y of the world’s highest growth rates from II 865 been grouped with the world’s rich countries
that had one