Technical Progress, Terms of Trade and Welfare under Variable Returns to Scale.

The implications of variable returns to scale (VRS) have been extensively studied by trade theorists (e.g. Batra, 1968; Jones, 1968; Kemp and Negishi, 1970; and Eaton and Panagariya, 1979). It is, however, notable that virtually no efforts have been made to examine the welfare implications of growth for an open economy in the presence of VRS. The only exception is a recent study by Eaton and Panagariya (1982). They derived sufficient conditions for growth, rising either from factor accumulation or technical progress, to improve the welfare of a small country characterized by VRS.[1]
The purpose of this paper is to analyse the welfare implications of economic growth, identified specifically with Hicks-neutral technical progress, for a small as well as a large country in the presence of VRS. We obtain several alternative sufficient conditions for growth to be welfare-increasing. In addition, the effects of growth on the terms of trade in the case of a large country, as well as the effect of technical progress in both countries on the terms of trade, are examined.
We have examined the welfare implications of Hicks-neutral technical progress for a small as well as a large country characterized by variable returns to scale. For a small country, technical progress improves welfare if it occurs in the industry in which external economies are greater or external diseconomies are smaller in the two-sector model. However, technical progress occurring in the other industry need not improve welfare. It is also shown that technical progress taking place in the exportable industry necessarily results in a deterioration in the terms of trade of the home country regardless of the returns to scale in both industries. In addition, the welfare effects of Hicks-neutral technical progress are not clear-cut in the case of a large country with variable returns to scale. If e<SUB1> > e<SUB2>, an induced deterioration in the terms of trade is necessary for growth to be... [ABSTRACT FROM AUTHOR]