International Trade - Theory and Policy, 2010a

However, since there are more of both goods in the aggregate, it is conceivable that government
intervention, which takes some of the extra goods away from the winners, could sufficiently compensate
the losers and leave everyone better off in trade.
The possibility of an effective redistribution depends in some circumstances on the way in which the
redistribution is implemented. For example, taxes and subsidies could redistribute income from winners
to losers but would simultaneously affect the domestic prices of the goods, which would affect
consumption decisions and so on. With the secondary effects of taxes and subsidies, it becomes uncertain
whether a redistribution policy would work. For this reason, economists will often talk about making
a lump-sum redistribution or transfer. Lump-sum transfers are analogous to the transfers from rich to poor
made by the infamous character Robin Hood. Essentially, goods must be stolen away from the winners,
after they have made their consumption choices, and given to the losers, also after they have made their
consumption choices. Furthermore, the winners and losers must not know or expect that a redistribution
will be made, lest that knowledge affect their consumption choices beforehand. Thus a lump-sum
redistribution is exactly what Robin Hood achieves. He steals from the wealthy, after they’ve purchased
their goods, and gives to the poor, who were not expecting such a gift.
Although lump-sum compensations make perfect sense in theory, or in principle, it is worth noting how
impractical they are. There is no government that has tried to institutionalize this process by creating a
Division of Robin Hoodian Transfers. In practice, lump-sum transfers rarely occur.
Compensation may not always be as straightforward as in the previous example, however. Another
possible outcome in a free trade equilibrium is for more of one good to be consumed but less of another
relative to autarky. In other words, the free trade consumption point may occur at a point like C2 in Figure
5.11 "Compensation Difficulties". In this case, it would not be possible to compensate everyone with as
much steel as they had in autarky since the economy is consuming less steel in the free trade equilibrium.
However, even in this case it is potentially possible to arrange a redistribution scheme. The reason is that
the economy could potentially choose a consumption point along the red line segment, as at point C1
Since the red segment lies in the range in which more of both goods is available, compensation to make
everyone better off with trade remains a possibility.
Figure 5.11 Compensation Difficulties
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