Free trade, economic growth, and income redistribution in Bolivia

The traditional argument in favor of free trade is based on the idea that when an economy opens itself to international competition, it adopts international prices. These new prices rearrange the production process, forcing the country to move along its production possibilities frontier toward producing goods with relatively higher international prices. The gains from trade can then be illustrated with the economy facing international prices or terms of trade. For each unit of exports, the terms of trade indicate how many units of imports the country acquires in exchange. Higher terms of trade is preferred since the same amount of exports could be exchanged for more imports, or fewer exports could be exchanged for the same amount of imports.; With an economically integrated region in South America, Bolivia is likely to move along its production possibilities frontier toward increased production of primary commodities, in which it has a proven comparative advantage.; For a small country like Bolivia, specialization and export of primary commodities have the potential of being harmful to the country. As a country specializes in the production and export of primary commodities with high price variances, higher variability in the terms of trade may slow output growth. Empirical results show a negative relationship between the price variance of export commodities and output growth in Bolivia.; The effects of terms of trade instability on real income per capita is analyzed with the Marshal-Lerner condition. Terms of trade instability over the past six years has decreased Bolivia's real per capita income. Also, a simple general equilibrium model of production and trade is developed to analyze the income redistribution due to changing prices.; The small-scale computable general equilibrium model of production and trade predicts that with a projected fall in agricultural and services prices and projected increases in the prices of minerals, natural gas, and manufacturing, both skilled and unskilled labor will lose with free trade. The return to capital in agriculture and services will fall. Capital in minerals, natural gas, and manufacturing sectors will benefit from free trade.