Explain the fallacy in detail stating the the stolper-samuelson theorem as carefully as possible.Also use the economist reading.

Explain the fallacy in detail stating the the stolper-samuelson theorem as carefully as possible.Also use the economist reading.

Tariffs and wages

An inconvenient iota of truth

The third in our series looks at the Stolper-Samuelson theorem

Aug 6th 2016 | From the print editionof The Economist

IN AUGUST 1960 Wolfgang Stolper, an American economist working for Nigeria's development ministry, embarked on a tour of the country's poor northern region, a land of "dirt and dignity", long ruled by conservative emirs and "second-rate British civil servants who didn't like business".

In this bleak commercial landscape one strange flower bloomed: Kaduna Textile Mills, built by a Lancashire firm a few years before, employed 1,400 people paid as little as £4.80 ($6.36) a day in today's prices. And yet it required a 90% tariff to compete.

Skilled labour was scarce: the mill had found only six northerners worth training as foremen (three failed, two were "so-so", one was "superb"). Some employees walked ten miles to work, others carried the hopes of mendicant relatives on their backs. Many quit, adding to the cost of finding and training replacements. Those who stayed were often too tired, inexperienced or ill-educated to maintain the machines properly. "African labour is the worst paid and most expensive in the world," Stolper complained. 

He concluded that Nigeria was not yet ready for large-scale industry. "Any industry which required high duties impoverished the country and wasn't worth having," he believed. This was not a popular view among his fellow planners. But Stolper's ideas carried unusual weight. He was a successful schmoozer, able to drink like a fish. He liked "getting his hands dirty" in empirical work. And his trump card, which won him the respect of friends and the ear of superiors, was the "Stolper-Samuelson theorem" that bore his name.

The theorem was set out 20 years earlier in a seminal paper, co-authored by Paul Samuelson, one of the most celebrated thinkers in the discipline. It shed new light on an old subject: the relationship between tariffs and wages. Its fame and influence were pervasive and persistent, preceding Stolper to Nigeria and outlasting his death, in 2002, at the age of 89. Even today, the theorem is shaping debates on trade agreements like the Trans-Pacific Partnership (TPP) between America and 11 other Pacific-rim countries.

The paper was "remarkable", according to Alan Deardorff of the University of Michigan, partly because it proved something seemingly obvious to non-economists: free trade with low-wage nations could hurt workers in a high-wage country. This commonsensical complaint had traditionally cut little ice with economists. They pointed out that poorly paid labour is not necessarily cheap, because low wages often reflect poor productivity—as Kaduna Textile Mills showed. The Stolper-Samuelson theorem, however, found "an iota of possible truth" (as Samuelson put it later) in the hoary argument that workers in rich countries needed protection from "pauper labour" paid a pittance elsewhere.

To understand why the theorem made a splash, it helps to understand the pool of received wisdom it disturbed. Economists had always known that tariffs helped the industries sheltered by them. But they were equally adamant that free trade benefited countries as a whole. David Ricardo showed in 1817 that a country could benefit from trade even if it did everything better than its neighbours. A country that is better at everything will still be "most better", so to speak, at something. It should concentrate on that, Ricardo showed, importing what its neighbours do "least worse".

If bad grammar is not enough to make the point, an old analogy might. Suppose that the best lawyer in town is also the best typist. He takes only ten minutes to type a document that his secretary finishes in 20. In that sense, typing costs him less. But in the time he spent typing he could have been lawyering. And he could have done vastly more legal work than his secretary could do, even in twice the time. In that sense typing costs him far more. It thus pays the fast-typing lawyer to specialise in legal work and "import" typing.

In Ricardo's model, the same industry can require more labour in one country than in another. Such differences in labour requirements are one motivation for trade. Another is differences in labour supplies. In some nations, such as America, labour is scarce relative to the amount of land, capital or education the country has accumulated. In others the reverse is true. Countries differ in their mix of labour, land, capital, skill and other "factors of production". In the 1920s and 1930s Eli Heckscher and his student, Bertil Ohlin, pioneered a model of trade driven by these differences.

In their model, trade allowed countries like America to economise on labour, by concentrating on capital-intensive activities that made little use of it. Industries that required large amounts of elbow grease could be left to foreigners. In this way, trade alleviated labour scarcity.

That was good for the country, but was it good for workers? Scarcity is a source of value. If trade eased workers' rarity value, it would also erode their bargaining power. It was quite possible that free trade might reduce workers' share of the national income. But since trade would also enlarge that income, it should still leave workers better off, most economists felt. Moreover, even if foreign competition depressed "nominal" wages, it would also reduce the price of importable goods. Depending on their consumption patterns, workers' purchasing power might then increase, even if their wages fell.

Working hypothesis