Tariffs upon Real Rewards to Factors of Production | Economics

The tariffs have varying effects upon the real rewards of the factors of production in the short, medium and long term.

1. Short-Term Effect:

In order to investigate the effect of tariff upon the real reward of factors in the short period, we proceed with certain assumptions:

(i) There are the conditions of free trade.

(ii) The country is small.

(iii) It produces both the goods.

(iv) There are two factors of production— labour and capital.

(v) No factor of production is mobile.

As tariff is imposed, there will be an increase in the relative price of the imported good in the short run. It will not bring about any reallocation of labour and capital within the economy. Since the capital-labour ratio will remain unchanged in both the countries, there will also be no change in the marginal products of the two factors.

The labour and capital employed in the import-competing sector will have, in terms of import good, the same real income. Since there is a relative decline in the price of export good, both factors must be better off in terms of the export good. Thus, tariff has the effect of raising the real income of the factor employed in the import-competing industry in the short run.

On the other hand, given the unchanged capital- labour ratio in the export industry in the short run, both labour and capital employed there will have the same real return in terms of the export good. The rise in the relative price of import good, subsequent upon the imposition of tariff, therefore, will imply that both the factors will be worse off in terms of the export good. Both labour and capital employed in the export industry will thus suffer in the short run a loss in the real income.

It may, therefore, be concluded that the tariff in the ‘short period’ will result in a shift of real income from those owing factors of production employed in the export industry to those owing factors used in the import-competing industry.

2. Medium-Term Effect:

The analysis of the effect of tariff on real returns of factors in the medium term is carried on the basis of the following assumptions:

(i) The country is small.

(ii) There are the conditions of free trade.

(iii) There are two goods—export good and import-competing good.

(iv) There are two factors of production— labour and capital.

(v) Labour is a mobile factor, and

(vi) Factor capital is specific and not mobile.

In the short period, the imposition of tariff results in an increase in money wage in the import- competing industry due to an increase in the domestic price of import good. The money wage in the export industry, on the other hand, remains unchanged. But in the medium term, labour will move from export sector to the import-competing sector. This movement of labour will continue so long as money wages are not equalised in the two sectors.

The movement of labour to the import-competing sector causes a fall in the capital-labour ratio in that sector and consequent rise in the marginal product of capital. In terms of import good, therefore, the real return to capital in the import-competing sector must rise. It will increase also in terms of the export good. On the opposite, the outflow of labour from the export sector will cause a fall in the marginal product of capital in the sector.

Consequently, the real return to capital, measured in terms of export good, will also fall in the export sector. Since there is an increase in the relative price of import good, the capital specific to the export sector must also become, in terms of import good, worse off. It means there must be a fall in the real return to capital in the export sector compared to the position in the short period.

As regards the position of labour in the export sector, it may be indeterminate. The influx of labour from export sector to the import-competing sector will result in the erosion of some or all of its short- term gains. The fall in the capital-labour ratio in the import-competing sector will cause a decline in the real wage measured in terms of the import good compared with the free trade situation.

In the case of export sector, the real wage measured in terms of export good must rise, subsequent upon a rise in the capital-labour ratio, when compared with free trade situation. Whether labour will be better off or worse off in the medium term after the imposition of tariff depends upon the proportion of export and import goods in their pattern of consumption.

To conclude, the imposition of tariff in the medium term leads to an increase in the real return to capital specific to import competing sector and a decline in the real return to capital specific to the export sector. The effects of tariff on the mobile factor labour are indeterminate.

3. Long Term Effect:

The long term effects of tariffs upon the real rewards to factors can be analysed under the assumptions given below:

(i) There are the conditions of free trade.

(ii) There are two goods—export good and import good.

(iii) There are two factors of production— labour and capital.

(iv) Both the factors of production are mobile.

(v) The home country is small.

(vi) The home country is capital-abundant.

(vii) The home country exports capital- intensive good.

Since in the medium term, the capital obtained higher return in import-competing sector, there would be transfer of capital from export sector to this sector in the long run. When tariff is imposed, the relative price of the import good rises and transfer of labour and capital takes place from the export sector to the import-competing sector.

This transfer involves a higher capital-labour ratio in both the sectors. It signifies a rise the marginal product of labour in both the sectors and consequently, the real wage rate goes up in the both.

Since there is an increase in the capital-labour ratio, the marginal product of capital will fall in both the sectors. The real return to capital, as a result, will fall in terms of both the goods. Thus, income distribution goes in favour of, as pointed out in the Stopler-Samuelson theorem, the scarce factor (labour) and against the abundant factor (capital).

To conclude, the real return to the abundant factor (capital) will fall in the long run and that of scarce factor (labour) will rise in the long run after the imposition of tariff.