Imperfect labor mobility and the trickle-down effect in international trade

Abstract

Purpose Unlike the common belief in the so-called “trickle-down effect,” trade-induced output growth in a small open economy does not necessarily improve the domestic welfare of the economy. The purpose of this paper is to analyze the conditions under which the trickle-down effect does not work properly such that the connection between trade-induced output growth and welfare improvement is broken. Design/methodology/approach This paper introduces an inter-sectoral migration barrier in the general equilibrium model and conducts various simulation experiments under reasonable parameter values. Findings This paper demonstrates that subsidizing export industries may raise the total value-added of an economy but deteriorate aggregate welfare. This worsens especially when the supply of non-tradable domestic goods is inelastic, and the demand for them is more substitutable by tradable goods. Practical implications To reinforce the trickle-down effect, it is necessary to facilitate efficient labor reallocation and to induce capitalization in the non-tradable sector. Originality/value That output growth and welfare improvement do not always move in the same direction requires a reappraisal of the former common belief on the trickle-down effect which emphasizes output growth as an indicator of welfare improvement.