infonet-economy

In this paper the transfer problem is analysed in a three country, three commodity (including one non-traded good) trade model where two countries belong to a customs union. The three countries A, B and C each produce three goods and engage in an asymmetric pattern of trade. Countries A and B form a customs union and C remains outside the union. Several results are obtained. Following the tradition in the literature on transfers and the terms of trade the results are classified into three groups: orthodox, anti-orthodox and mixed. In the orthodox case, donor (recipient) impoverishment (enrichment) occurs irrespective of the favourable (adverse) movement in the terms of trade. In the anti-orthodox case, donor (recipient) enrichment (impoverishment) occurs as a consequence of the favourable movement in the term of trade. In the mixed cases, the outcomes are not clearcut. The major result that we obtain is that changes in welfare, terms of trade and the relative price of the non-traded good are identical in the donor and the non-participating country as a consequence of the transfer. Thus an intra union transfer has effects on the non-participating country. Consider the orthodox case. Country B (donor) makes a transfer to country A (recipient), who are both in the union. Country B's welfare falls, terms of trade deteriorate and the relative price of the non-traded good falls. Country C, the non-participating country, suffers from the same effects. Structural adjustments occur in all the three countries — output of the non-traded good changes vis-a-vis the traded good and this change in composition is identical for the donor and the non-union country. In the anti-orthodox case both the donor and the non-participant country gain from the transfer. The non-union country cannot remain passive to transfers among the union members.