Imperfect Competition and the Resource Allocative Effects of Effective Protection: Comment

Abstract

Recently in this review, E. J. Ray (1976a) demonstrated two propositions concerning the impact of effective protection on resource allocation under imperfect competition in goods and factor markets. He provided an incorrect proof of his second (correct) proposition, and failed to place it in perspective. In this comment we provide an intuitively appealing but rigorous derivation of it, and note that it follows from Herberg and Kemp (1971), and is equally valid when there are no interindustry flows.' In the second section of his paper,2 Ray investigates the case in which a labour union in the manufacturing sector, X1, successfully maintains industrial wages, wl, at some constant multiple, b, times wages, w2, in the agricultural sector, X2. He assumes labour and capital are substitutable for one another in the production of value added in each sector and that to produce one unit of output for each good a fixed amount of the other is used as an input. Thus al2 is the number of units of X1 used as an input in producing one unit of X2 and a2l is the number of units of X2 used as input in producing one unit of output of XI. With this model Ray shows that changes in relative prices can have perverse effects on outputs. This is not surprising, for as Fishlow and David (1961) and Bhagwati and Ramaswami (1963) have noted and Johnson (1966) has shown, in the presence of a fixed relative wage differential the production possibility frontier may become unconventionally convex to the origin, and when the frontier is convex, one would not be surprised to find that the output of a good falls in response to a rise in its relative price. The problem is, however, more complex than that, because with a factor market distortion, the slope of the production possibility frontier will not be equal to the price ratio. In fact, as Herberg and Kemp (1971, p. 22) have shown in the context of the Ray model, with CES production functions and all aij's equal to zero, it is possible for the price-output relationship to be normal or conventional even when the locus of competitive outputs is (unconventionally) convex to the origin .3 Moreover, as we have shown in an unpublished paper, in this same model with zero a's and variable elasticities of substitution, movement in the priceoutput ratio can be perverse whether the locus of competitive outputs is convex or concave. Thus we must look elsewhere for an explanation. Let: