Trade Sanctions and the Incidence of Child Labor

Trade Sanctions and the Incidence of Child Labor

Harald Grossmann and Jochen Michaelis*

AbstractThe purpose of this paper is to develop an imperfect competition model of a small open developing countryto analyze the effects of trade sanctions on the incidence of child labor. We show that a uniform tariff leviedby the developed countries on imports produced with the help of child labor is a failure in terms of reduc-ing child labor. A more effective course of action would be a firm-specific tariff where the tariff rate varieswith the amount of child labor incorporated in a single good. While such an instrument reduces child labor,however, it worsens the children’s well-being due to lower income and consumption. Contrary to expec-tations, the entrepreneurs in the developing countries, supposedly the main beneficiaries of child labor,are better off under trade sanctions as they realize higher profits.

1. Introduction

Consumers, particularly in developed countries, value working conditions.They get lesssatisfaction from a good, if it is produced under bad working conditions such as with,for instance, the help of child labor. In the context of an open economy, the use of childlabor by foreign firms, thus, creates a negative externality for the consumers in theimporting country. Imposing a tariff on the import of child labor products may serveas a remedy, and indeed both the US and the EU have already implemented such aninstrument. The Generalized System of Preferences (GSP-scheme) provides for thewithdrawal of tariff preferences for developing countries that disregard internation-ally recognized labor standards, e.g., certain Conventions of the International LaborOrganisation (ILO). Accordingly, a developing country tolerating child labor runs therisk to lose its preferential status, i.e., to be penalized with higher tariffs. The highertariff may be applied to all products from a country or selectively only to those sectorsusing child labor. The contribution of this paper is to ask whether such a scheme is suc-cessful in terms of reducing the amount of child labor. We distinguish between auniform tariff and a firm-specific tariff; the latter is linked to the use of child labor byeach single firm. Our analysis deliberately leaves aside the question whether therecould be more suitable means to combat child labor and/or to improve the well-beingof children in terms of welfare.

There is already a vast amount of literature on the subject of child labor includingexcellent surveys by Basu (1999), and Brown et al. (2003). The nearly undisputed conclusion is that child labor is closely connected to poverty (see Edmonds, 2005;Edmonds and Pavcnik, 2005a). Often a child’s income is necessary for a family tosurvive. Putting children to work raises the current income of the family, but it alsoreduces the well-being and the future income of the children. Baland and Robinson

Review of Development Economics, 11(1), 49–62, 2007DOI:10.1111/j.1467-9361.2006.00352.x

*Grossmann: HWWA-Institute, Neuer Jungfernstieg 21, D-20347 Hamburg, Germany. Tel:0049-(0)42834-341; E-mail: [email protected]. Michaelis: University of Kassel, Economics Department,Nora-Platiel-Str.4, D-34127 Kassel, Germany. Tel: 0049(0)561-8043562; Fax: 0049(0)561-8043083; E-mail:[email protected]. We thank two anonymous referees for very insightful comments. Thepaper also benefited from comments by Michael Bräuninger, Philipp Harms, Jürgen Jerger, Jörg Lingens,Michael Pflüger, participants at a conference in Dresden (Verein für Socialpolitik), and at research semi-nars in Augsburg, Kassel, Koblenz, and Passau.

© 2006 The AuthorsJournal compilation © 2007 Blackwell Publishing Ltd, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main St, Malden, MA, 02148, USA

(2000) show that child labor may be inefficient, when the family is so poor that parentsdo not intend to leave bequests to their children or when capital markets are imper-fect. Banning child labor can help to reach a Pareto-superior outcome, when childrencannot credibly commit to compensate their parents for current income losses in thefuture.

In a path breaking paper, Basu and Van (1998) also deal with the question of whenan outright ban on child labor could be an effective policy tool. They model a familyin which altruistic parents send their children to the labor market only if adult wagesfall below some critical level.This generates multiple equilibria in which a ban on childlabor can move an economy to an equilibrium with higher wages where children donot have to work, but it may also be the case that a ban on child labor hurts workerhouseholds. In Dessy and Pallage (2001) inefficient child labor arises from the lack ofa coordination mechanism between households and firms. Laws that prohibit childlabor and impose compulsory schooling can overcome this situation by modifyingparental decisions to invest in the human capital of their children and firms’ decisionsto invest in skill-biased technologies.

Only a few studies discuss the channels through which trade policy influences theincidence of child labor. In Gupta (2002) trade sanctions may raise the welfare of acountry using child labor by reducing unemployment in the adult labor market.However, this does not necessarily reduce the supply of child labor. Ranjan (2001)shows that in a world with credit constraints trade sanctions may fail to reduce theincidence of child labor, as they lead to a decline in income of parents who areunskilled. Jafarey and Lahiri (2002) also demonstrate that the impact of trade sanc-tions on the incidence of child labor crucially depends on the working of creditmarkets. Child labor is more likely to be reduced by trade sanctions when poor fami-lies have better access to credit.The general equilibrium model of Bandyopadhyay andBandyopadhyay (2005) incorporates a nontradable sector. They find that the effect oftrade sanctions on child labor critically depends on the pattern of substitutabilitybetween the service sector and the exportable sector. The empirical literature on therelationship between trade policy and child labor is even more scarce, an exceptionbeing Edmonds and Pavcnik (2005b), who study the rice market liberalizations ofVietnam in the 1990s and find that a greater market integration is associated with lesschild labor.

The model developed here has the following building blocks. We consider a smallopen economy, call it the South, that imports a homogeneous consumption good at anexogenously given world price and exports a range of differentiated products. Theproduct varieties are produced by a large and given number of monopolistically com-petitive firms. Each variety is produced with adult and child labor, which are assumedto be perfect substitutes in production. Supply of adult and child labor are driven byutility-maximization of the households. We follow the Becker (1981) approach andassume that parents and children share a single unified utility function defined overconsumption, schooling of the children and leisure of the adults.

We analyze the effects of a tariff on all South exportables imposed by the rest of theworld (“North”), the tariff base being the amount of child labor incorporated in thesegoods. If all firms are confronted with a uniform ad-valorem tariff, we show that anincrease in the tariff rate has no effect on the factor demand in the South. In particu-lar, child labor does not decline but remains unchanged. On impact the tariff reducesproduct demand and, thus, child labor, but because of a trade account deficit the realexchange rate adjusts implying a demand shift towards South goods. If, however, thetariff rate is firm-specific, each single firm has an incentive to substitute adult for child

50 Harald Grossmann and Jochen Michaelis

© 2006 The AuthorsJournal compilation © Blackwell Publishing Ltd. 2007

labor. Such a shift will be rewarded by a lower tariff rate and, thus, a higher exportdemand. A firm-specific tariff rate is indeed suitable to reduce child labor in South,but nevertheless it does more harm than good since consumption and well-being ofworker households (children) worsen.

The rest of the paper is organized as follows. In section 2 the model is set up. Insection 3 we derive the general equilibrium and in section 4 we perform the analysisof tariff policies. Section 5 discusses the robustness of our results and compares ourframework with alternative policy instruments. Section 6 concludes.

2. The Model

We consider a small open economy (“South”) with a fixed number of households and a fixed number of monopolistically competitive firms.1 The country produces andexports tradables and imports a consumption good. There are two factors of produc-tion in the economy: child labor and adult labor. The rest of the world (“North”) leviesa tariff on South exports where the tariff rate depends on the amount of child laborincorporated in the exported good.

Households

The economy is inhabited by worker and entrepreneur households, indexed by h = 1,. . . , H and j = 1, . . . , J, respectively. Each worker household consists of one adult andone child who are assumed to share a single unified utility function (Becker, 1981).2

Utility is defined over a basket of domestically produced goods, Ch, an imported con-sumption good, , the child’s time spent in school, Eh, and the adult’s time devotedto labor, :

(1)

where Ch = n1/(1−e)[ (Cih)(e−1)/e]e/(e−1). The parameter g denotes the expenditure shareof domestic (South) goods, and e (e > 1) is the constant elasticity of substitutionbetween any two domestic varieties. The worker household cares about the child’sschooling for several reasons (Ravallion and Wodon, 2000): first, parents like educatedchildren in its own right, second, both the adult and the child dislike the child’s workeffort, and third, parents will presumably be better off in the future via a higher trans-fer from their adult children. Note that the marginal disutility of the adult’s workingtime is assumed to be constant. This simplifies the algebra tremendously.

Each adult and each child is endowed with one unit of time. The adult allocates timeamong market work and leisure, and, moreover, s/he determines how the child’s timeis allocated among work, , and schooling: 1 = + Eh. Worker household h receivesa wage income from adult labor, WA, and a wage income from child labor, WC, its budget constraint reads PiCih + P* = PCh + P* = WA + WC , where Pi is theprice chosen by firm i, P ≡ (n-1 (Pi)1−e)1/(1−e) is the producer price index for the bundleof domestic goods, and P* is the exogenously given price of the imported tradable. Bychoosing the bundle of domestic goods as numéraire, the budget constraint can berewritten as Ch + q = wA + wC , where θ ≡ P*/P denotes the real exchange rate,and wA and wC are the real wages for, respectively, adult and child labor. Household hmaximizes (1) subject to this budget constraint and subject to the child’s time con-straint. The solution to this problem is as follows:

LhCLh

ACh*

Σ in=1

LhCLh

ACh*Ch*Σ in=1

LhCLh

C

Σ in=1

U C C E Lh h h h hA= + −( ) + +g g r mln ln ln1 *

LhA

Ch*

TRADE SANCTIONS AND CHILD LABOR 51


(2)

(3)

(4)

(5)

Equations (2) and (3) give h’s demand for good i and the imported tradable, respec-tively. Note that the demand for the imported good is decreasing in the real exchangerate. Equations (4) and (5) describe the optimal labor supply decisions. An increase inthe adult’s wage raises the opportunity costs of his leisure and leads to a substitutiontoward work. Moreover, an increase in wA also raises household income and, thus,household consumption allowing for a reduction in child labor (an increase in timespent in school). A higher child wage raises the opportunity costs of schooling, so thatchild labor supply is increasing in its own wage. Because of the increase in householdincome and consumption, the supply of adult labor is decreasing in wC. An interestingfeature of the supply function (5) is the possibility of a zero child labor supply. Asalready emphasized by Basu and Van (1998) and Basu (2002), if the adult wage exceedsa specified threshold, then we will observe a corner solution, i.e., the parents will notsent their children to work at all.

Entrepreneur household j derives utility only from consumption: Uj = g ln Cj +(1 − g ) ln . Entrepreneurs are assumed to have no offspring, they do not supplylabor. They are the owner of the firms, so that each household j receives pure profitsΠj. The budget constraint is given by PiCij + P* = PCj + P* = Πj. In real terms,the budget constraint reads Cj + q = pj, where p denotes real profits. From the solution of j’s maximization problem, we get

(6)

(7)

as an optimal consumption decision.Each North consumer k = 1, . . . , K is assumed to have a utility function defined

over North goods, South goods, and aggregate child labor in the South: =(1 − d*) ln + d* ln Ck − hLC. Demanding South’s tradables, North consumers haveto pay the cross-border price plus an ad valorem tariff, t, levied by the North. Since thepurpose of the tariff is a reduction of child labor in the South, the tariff rate is assumedto increase in the amount of child labor incorporated in South’s tradables. To be moreprecise, we assume a firm-specific tariff rate, i.e., the tariff rate levied by the North on its imports of good i depends on the child labor used by firm i: ti = ti( ) with ti′ ≡ (∂ ti /∂ ) > 0. Therefore, in North the consumer price of good i is (1 + ti)Pi. Withthis at hand we can derive North’s demand for good i as

(8)Cn

t L P

t PYt

iki i

Ci

k

K e

=+ ( )( )

+( )

=

−

∑ 1 111

qd * *1 +

,

LiC

LiC

Ck*

Uk*

C jj* =

−( )1 g pq

Cn

PP

iji

e

j=

−1 g p

C j*

C j*C j

*Σ in=1

C j*

Lwwh

CA

C= −1

rm

.

Lwwh

AC

A= + −1 r

m

Cw L w L

h

AhA C

hC

* =−( ) +( )1 g

q

Cn

PP

w L w Lihi

e

AhA C

hC=

+( )

−1 g



where Y* is North’s exogenously given real income, and (1 + t)P ≡ (n−1 ((1 + ti) ×Pi)1−e)1/(1−e) is the consumer price index of North’s importables. If firm i hires additional child laborers, then it will be punished by a reduction in export demand viaa higher tariff rate.3 Or to put it differently (and more positively), if a firm substitutesadult labor for child labor, it will be rewarded by an increase in its product demand.

Aggregation over all worker and entrepreneur households and export demand leadsto market demand for variety i:

(9)

where

(10)

and Z′: = (∂Z/∂ ) < 0. The derivation of (9) makes use of p = pj = Y − wALA −wCLC, where Y is aggregate real production and LA = and LC = . Theincome of worker and entrepreneur households adds up to wALA + wCLC + p = Y.

Firms

Each firm i employs adult laborers and child laborers to produce its output Yi.The technology

(11)

shows diminishing returns to labor (0 < a < 1). Adults and children are assumed to beperfect substitutes in production. Of course, this is an unrealistic assumption, but itsimplify matters and we can show that all results will go through, if we follow instead,for example, Basu and Van (1998), and assume that the child’s productivity is a con-stant fraction of the adult’s productivity.

Firm i maximizes its profits with respect to and . The

market demand (9) serves as constraint. By combining (9) with product-market equilibrium, Ci = Yi, the profit function can be rewritten as pi = Z1/e − wA − wC ,where k ≡ 1 − 1/e measures the degree of product-market competitiveness. Solving themaximization problem gives

(12)

(13)

From these first-order conditions, a first result may be stated in

Proposition 1. A firm-specific tariff drives a wedge between the adult and the childwage, a profit maximum requires that wC falls short of wA.

Proof. Because of Z′ < 0 the second term on the right-hand side of (13) is negative.

w we

PP

ZC A ie

= +

′

−1

1

.

wPP L L

ZA ie

iA

iC

=

+

−1 ak

LiCLi

AY iK

LiCLi

Ap ii

iA

iA C

iCP

PY w L w L= − −

Y L Li iA

iC= +( )a

LiCLi

A

LhCΣh

H=1Lh

AΣhH

=1

Σ jJ=1Li

C

Z Ln

Yt L

tYt

iC i i

C e

,* *

1 +. . .( ) ≡ +

+ ( )+

−1 1

1g qd

C C C CPP

Zi ih ij iki

e

k

K

j

J

h

H

= + + =

⋅( )

−

===∑∑∑

111

,

Σ in=1



To maximize profits the firm hires adult (child) labor up to the point at which themarginal revenue of adult (child) labor equals the adult (child) wage. Despite bothkinds of labor are assumed to be perfect substitutes in production, their marginal rev-enues differ. Since the employment of an additional child laborer leads to a rise in thetariff rate levied by the North and hence to a lower product demand, the marginalrevenue of a child laborer is lower than the marginal revenue of an adult laborer. Inorder to be indifferent and to employ both kinds of labor, the firm has to be compen-sated for the lower marginal revenue by a lower wage rate.

The Trade Account

The South exports a bundle of differentiated goods to the North and imports a con-sumption good from the North. The cross-border price of South exports is given byP Ci,k. North’s spending on these goods, d*P*Y*, however, equals the cross-border price plus the tariff:4 (1 + t)P Ci,k = d*P*Y*. The value of South’simports, P*C*, can be expressed as constant share that South consumers allocate toNorth goods, P*C* = (1 − g )PY. Since—by assumption—all South households spendall their income on consumption goods, no household has an incentive to lend or toborrow internationally, the net foreign position is zero. Consequently, there is a balanced trade, the value of South’s imports equals the value of its exports: d*P*Y*/(1 + t) = (1 − g )PY. In real terms the trade account reads

(14)

A higher tariff rate t raises the price of South goods in the North and as a result lowersthe demand for South goods. To keep the trade account balanced, South’s income Yhas to decline and/or the real exchange rate q has to rise.

3. General Equilibrium

In order to address the question how North’s tariff policy affects the South economy,we have to embed our model in a general equilibrium framework. Our focus will beon a symmetric equilibrium in which all n firms are identical: Pi = P; = LA/n; and

= LC/n for all i. Moreover, the firm-specific tariff rate will be the same for all firms:ti(⋅) = t for all i. The symmetry assumption also implies = LA/H as well as = LC/Hfor each worker household h.

The structural form of our model is summarized in Table 1. In this table, equation(15) describes the technology. Equations (16) and (17) are the demand functions for,respectively, adult and child labor. To derive (16) we substitute the trade account (14)into the definition of Z, equation (10), and insert the result, Z = Y/n, into (12). Thedemand for child labor (17) shows that the wedge between the wages for adult andchild labor is increasing in the real value of South’s exports and, thus, increasing in thereal exchange rate, North’s preference parameter for South goods, and North’s incomeand decreasing in the level of the tariff rate. This is intuitive, since these factors deter-mine the decline in product demand and, thus, the decline in the marginal revenuefirms have to face when shifting employment from adult to child laborer. The aggre-gate supply of adult and child labor are given by (18) and (19), respectively. Equation(20) is the tariff rate index, indicating that t is increasing in child labor per firm. Equa-tion (21) replicates the trade account.

LhCLh

ALi

CLi

A

qd g* *1 +

Yt

Y= −( )1 .

ΣkK

=1Σ in=1

ΣkK

=1Σ in=1



Table 1. Structural Form of the Model

(15)

(16)

(17)

(18)

(19)

(20)

(21)

So we get a system of seven equations with seven endogenous variables: Y, LA, LC, wA,wC, q, and t. Unfortunately, due to non-linearities we cannot give a closed form solu-tion of the model. However, by focusing on the case where there is no firm-specifictariff rate in the initial (free-trade) equilibrium, i.e., by restricting the analysis to anincrease in the tariff rate from a zero level, we can derive the implications for all Southvariables including child labor.

4. Effects of North’s Tariff Policy

According to the GSP-scheme of the US and the EU higher tariffs are applied eitherto all products from a country or to specific sectors using child labor. In our frame-work, the former case is modeled as a uniform tariff, whereas the latter case is modeledas a firm-specific tariff. To simplify matters we assume that the North introduces thefirm-specific tariff rate in two steps. At first, the North imposes a uniform tariff on allSouth goods, and subsequently switches from a uniform to a firm-specific tariff rate.On impact the switch is assumed to be revenue-neutral.

Initial (Free Trade) Equilibrium

In the initial equilibrium with free trade we have t = 0 and = 0. Since a switch fromadult to child labor will not be punished by a loss in product demand, the marginalrevenue of adult and child labor and, thus, the wages will be the same. This can be seenfrom (17), where = 0 implies wC = wA. For wC = wA the supply functions (18) and (19)deliver the levels of, respectively, adult and child labor in the initial equilibrium:

(22)

(23)L HCti

( ) = − ⋅′=0

m rm

.

L HAti

( ) = + − ⋅′=0

1 r mm

′ti

′ti

qd g* *1 +

Yt

Y= −( )1 .

t t L nC= ( )

L Hww

CA

C= −

1rm

L Hww

AC

A= + −

1 rm

w wn

Yt

tC Ai= −

+⋅ ′1

1qd * *

wL L

YAA C

=+

ak

Y L L niA C= +( ) ⋅ −a a1



The total amount of labor (LA + LC)| = H/m, depends solely on the number of workerhouseholds and the parameter capturing the disutility of adult labor.5 The remainingvariables are straightforward to derive from the expressions in Table 1.

Uniform Tariff Rate

In a first step let us analyze a policy where the North levies a uniform ad valorem tariffon all South exportables. Since the purpose of the tariff is a reduction in child labor,the tariff rate is assumed as increasing in the amount of child labor in the South. Mostimportantly, however, note that the same tariff rate will be applied to all varieties irres-pective of how much child labor is incorporated in a specific good i. In this case thetariff rate t is no longer an index defined over the firm-specific tariff rates ti, but t turnsout to be a policy parameter directly controlled and set by the North. The implicationsof the introduction of (or a rise in) the tariff rate t are described in

Proposition 2. Suppose that the North does not distinguish between firm-specific tariffrates but levies a uniform rate t on all South exportables. Then a higher tariff rate (i) has no effect on child labor LC, adult labor LA, output Y, the child wage wC, andthe adult wage wA, (ii) leads to an increase in the real exchange rate q, and, thus, (iii)to a decline in both worker and entrepreneur household utility.

Proof. For = 0, we get wC = wA from equation (17). Using this result we can calcu-

late from equations (18), (19), (15), (16), and

(17). Property (ii) follows from (21) by derivation. Property (iii) is established by inserting the equilibrium levels of consumption etc. into the utility functions ofthe worker and entrepreneur households and computing the partial derivatives as

and

From the point of view of reducing child labor in the South, a uniform tariff ratelevied by the North is a failure.6 South children do not work less, but only consumeless, so a uniform tariff is bad for them. And even worse, due to part (iii) of Proposi-tion 2, such an instrument lowers utility of all households in the South. The tariff leadsto an equiproportionate increase in the consumer price of all South goods in North.In particular, the relative price between any two South varieties does not change. Nosingle South firm i has an incentive to substitute adult labor for child labor, since sucha substitution does not serve as an instrument to reduce the relative price of good i inthe North and, thus, to attract additional product demand. In other words, the uniformtariff leaves the optimal factor combination as it is. This holds true even if the tariffrate is announced to decline because of a lower input of aggregate child labor. Suchan announcement is in vain, since from a firm’s point of view, aggregate variables areconstant and can not be influenced.

As mentioned, a higher tariff reduces the demand for South goods developed by theNorth. On impact, we observe a decline in South output and, thus, a decline in bothadult and child labor. The reduction in Y lowers South’s imports too, however, onimpact South faces a trade account deficit. To restore a balanced trade account, thereal exchange rate has to increase. North goods get more expensive, so that South and

∂∂

∂∂

∂∂q

∂q∂

Ut

UC

Ct

j j

j

j= <*

*.0

∂∂

∂∂

∂∂q

∂q∂

Ut

UC

Ct

h h

h

h= <*

*0

∂∂

∂∂

∂∂

∂∂

∂∂

Lt

Lt

Yt

wt

wt

A C A C

= = = = = 0

′ti

′=ti 0



North consumer switch from North to South goods.The demand for South goods startsto rise. The new equilibrium is reached at the initial steady state, output and employ-ment move back to their free-trade levels. Income in terms of South goods and, thus,consumption of South goods by South households is unaltered, however, because ofmore expensive North goods, consumption of these goods and, thus, the utility levelsof all households decline.

Firm-Specific Tariff Rate

Suppose now that the North switches from the uniform tariff rate to a firm-specificrate, the tariff base being the amount of child labor incorporated in the production ofgood i. The results of such an ex ante revenue-neutral switch are summarized in

Proposition 3. If the North switches from a uniform to a firm-specific tariff rate, where

then (i) South child labor LC decreases, (ii) South adult labor LA increases,

(iii) the total amount of South labor, LA + LC, increases, (iv) South output Y increases,(v) both the adult wage wA and the child wage wC decrease, and (vi) utility of workerhouseholds decreases.

Proof. See text.

The switch from a uniform to a firm-specific tariff rate creates an incentive to reduce child labor. This incentive holds for each single firm. Because of the lowerexport demand via a higher firm-specific tariff rate the marginal revenue of a childlaborer now falls short of the marginal revenue of an adult laborer. This firm-leveleffect carries over to the general equilibrium context, i.e., aggregate child labor demand decreases. In the new equilibrium, the adult wage wA will be larger than thechild wage wC (see equation (17)). The increase in the wA/wC-ratio in turn forces the supply of child labor down. Supply and demand move in the same direction, sothat the equilibrium level of child labor goes down as established in part (i) of Propo-sition 3. The new equilibrium level of child labor is given by (19). On the other hand,a higher wA/wC-ratio raises the supply and, thus, the equilibrium level of adult labor(see (18)).

In terms of reducing child labor (forcing schooling) in the South, the firm-specifictariff rate is indeed a suitable instrument. But is it a desirable instrument too? Thisremains unclear since up to now we have not carried out a welfare analysis, and wetherefore cannot exclude the case where a reduction in child labor goes hand in handwith a worsening in the level of children (worker household) utility. To address thisproblem, we have to derive an expression for the wage income of worker households.

In a first step let us turn to the total amount of labor. By combining (18) and (19)we yield

(24)

The comparison of (24) with (LA + LC) | = H/m proves part (iii) of Proposition 3. Pro-vided that child labor does not vanish, but LC > 0 holds even in the new equilibrium,the second term in the brackets on the right-hand side of (24) is positive. The increase

′=ti 0

L Lw w

wLH

HA Ct

A C

A

C

i+( ) = + −

′>0

1m

.

∂∂

tL

i

iC

> 0,



in adult labor is larger than the decrease in child labor, aggregate employmentincreases. The increase in aggregate employment leads to an increase in South outputY (see equation (15)). Inserting (15) into the adult labor demand function (16) imme-diately reveals that due to diminishing returns of labor the adult real wage wA

decreases. Moreover, a lower adult wage combined with a rise in the wA/wC-ratioimplies that the child wage wC declines even more than wA.These results establish parts(iv) and (v) of Proposition 3.

By using (18) and (19), the income of worker households can be derived as pro-portional to the adult wage:

(25)

Worker households face a decline in real income, the increase in adult labor LA doesnot compensate the decrease in wA, wC and LC.7 Determining the change in the utilitylevel of worker households is a little bit complex since in addition to consumption ofSouth and North goods schooling of the children and the disutility of adult labor hasto be observed. As just derived, real worker income declines so does consumption ofSouth goods. If North goods get more expensive via a higher real exchange rate q,consumption of North goods will be reduced too. If the real exchange rate falls,8 weobserve a negative income and a positive price effect. For most plausible parameterconstellations the negative income effect dominates, worker households have to reducethe consumption of North goods. The third negative impact on worker utility is theincrease in adult labor. The only positive impact is the increase in schooling, but thisdoes not compensate the negative effects. To sum up, the firm-specific tariff ratereduces child labor, but it deteriorates the well-being of worker households and, thus,deteriorates the well-being of children. Worker households (children) loose twice,firstly at the introduction of a uniform tariff and secondly at the switch to a firm-specific rate. The consequences for the entrepreneur households are described in

Proposition 4. If the North switches from a uniform to a firm-specific tariff rate, thenutility of entrepreneur households increases.

Proof. See text.

Entrepreneur households are unambiguously better off. Their income, consisting of pure profits, goes up because of a higher Y and a lower wage bill. This in turn leads to increased consumption of South goods. If the relative price of North goods,i.e., the real exchange rate, falls, both the price and the income effect drive up consumption of North goods and, thus, utility of entrepreneur households. If, however,the real exchange rate increases, the price and the income effect run in opposite directions. However, the net effect can be signed unambiguously. By combining (16), (21) and (25), entrepreneur consumption of North goods can be expressed as

The lower tariff rate t (which is due to the

lower LC) raises the first multiplicand, the higher aggregate employment raises the second multiplicand. Consequently, the positive income effect always domi-nates the negative price effect. Despite the higher price the consumption of Northgoods by entrepreneur households increases. All in all, a switch from a uniform to afirm-specific tariff rate leads to rise in the consumption and, thus, to a rise in the utility

JCY

tH

L Lj A C* * *

.=−( ) =

+−

+

11

1g p

qd

mak

w L w LH

wA A C C A+ = ⋅m

.



level of South entrepreneurs. They are the winners of such a policy switch. They areable to reclaim at least part of the utility loss they face by the introduction of a uniformtariff rate. Even as a model-specific result, this presents an interesting example of howwell-meaning policy initiatives have unintended consequences: in this case, a trademeasure imposed by the altruistic North makes the supposed exploiters of child laborbetter off while hurting their victims.9

5. Discussion

Our analysis suggests that the GSP scheme mentioned in the introduction does moreharm than good. In particular, excluding certain sectors where the conditions for granting additional tariff preferences are not fulfilled reduces child labor, but fails toimprove the children’s well-being. This is bad news for policymakers, thus the questionof robustness arises. First of all, this result crucially hinges on the assumption that ourfirm-specific tariff is a good approximation for the sector-specific tariff of the GSP. Onlyif a sector consists of very few firms (to put it to the extreme: one firm), we will observean incentive to switch from child to adult labor at the micro level.The GSP of the Euro-pean Union, for instance, distinguishes between roughly 1100 sectors and 3700 products(Annex IV of the Council Regulation (EC) No 2501/2001). Given these numbers wethink the framework is not at odds with reality. But, what if the incentive to switch toadult labor indeed dilutes/vanishes because of too many firms belonging to the samesector? In this case the introduction of a (an increase in the) sector-specific tariff ratelowers North’s demand for these products leading to lower output and a decrease in bothadult and child labor used in this sector. Provided that the sector is small in relation tothe macro level, no adjustment of the real exchange rate takes place (partial equilib-rium). If all sectors face such a tariff (symmetric general equilibrium), we will be back ina world with a uniform tariff, all results of section 4 apply.

The tariff function ti( ) is assumed to be continuously differentiable in , i.e., evena small increase in the amount of child labor leads to an increase in the tariff rate. Asmentioned above, we neglect all problems arising from measuring the amount of childlabor incorporated in a product. This is, of course, a heroic assumption given the infor-mational complexities and logistical difficulties to implement such a tariff. A morepractical approach would be the definition of just a few tariff brackets, the easiest casebeing a zero tariff for a “child labor free” product and a positive tariff for a product“produced with child labor” regardless of how much child labor the product contains.To justify our assumption we refer to a more sophisticated model with uncertainty,where ti( ) is a random variable. In such a framework, the expected tariff equals theprobability of being found employing children times the tariff rate for a child laborproduct. If—realistically—the probability of being detected is continuously increasingin the number of children, the expected tariff is continuously increasing in . Ourtariff function serves as a short-cut for such a more complex approach.

How does our firm-specific tariff relate to alternative policy instruments like an outright ban on the import of child labor products, a labeling scheme or a fine foremploying children levied by the South government (for an analysis of a fine, see Basu,2005)? Driving force of our results is the wedge between the child wage and the adultwage at the firm-level. Such a wedge always arises when the marginal revenue of achild laborer is lower than the marginal revenue of an adult laborer. In our framework,this is due to lower product demand caused by a higher tariff. But the underlying prin-ciple is more general. Any instrument which, at the firm-level, drives a wedge betweenthe demand for child labor products and adult labor products sets into motion the

LiC

LiC

LiCLi

C



described mechanisms. Thus, we expect that these instruments have, at least quali-tatively, the same effects on the child wage, the amount of child labor, etc. Furtherresearch is needed on this issue, but our framework may serve as a benchmark.

Let us have a closer look at the labeling issue. Starting point of our analysis was thepremise that North consumers value not only the final product, but the process as well.Since this constitutes a willingness to pay relatively higher prices for “child labor free”products, a product labeling scheme may serve as a superior instrument. Establishinglabor standards through a labeling scheme is—at least at first sight—the most naturalstrategy. Freeman (1994) forcefully expressed this view: tell the consumer how the product is made and let him decide. However, such a market solution rests on theassumptions of perfect information and labor standards as private good. In a worldwith imperfect and asymmetric information and costly monitoring each producer willclaim to have a “child labor free” product. Engel (2004) addresses this problem andshows how an optimal labeling scheme can be implemented under these circumstances.Our framework addresses the second issue. Only if each consumer cares about childlabor incorporated in the goods s/he consumes, labor standards take the form of aprivate good and a labeling scheme will be appropriate. In this case a labeling schemewould be a perfect substitute for our firm-specific tariff. If, however, consumers areinterested in child labor incorporated in aggregate consumption, a standard is more apublic good. Accordingly, there will be no price premium for a child labor free productand, thus, no incentive to switch to adult labor. A firm-specific tariff overcomes thisproblem, it creates such an incentive by rewarding each firm via a lower tariff rate forits product. We do not take a stand whether a standard is a private or public good, butclaim that the firm-specific tariff is more general in the sense that it works irrespectiveof the feature of this good.

Last but not least let us mention some limitations of our framework. For instance,we have assumed that for the children concerned the alternative to working (in thetradable sector) is better education or schooling.Actually, the alternative could be evenworking in a nontradable sector under worse conditions (Dessy and Pallage, 2005).Furthermore, our model has abstracted from positive externalities resulting frominvestment in human capital which might provide a stronger justification for combat-ting child labor. Finally, nothing has been said about the redistribution of tariff revenues. It would be interesting to see what will happen, if they are transferred fromindustrial to developing countries.

6. Conclusions

We have presented an imperfect competition model of a small open developingcountry to examine the effects of trade sanctions on the incidence of child labor. Twogeneral conclusions can be drawn from our paper. First, trade sanctions will be moreeffective, if they are applied on a more disaggregated level. This conclusion has beenreached by comparing the effects of a uniform tariff imposed on developing countries’exports and a firm-specific tariff linked to the use of child labor by each firm. Second,due to unintended consequences a well-meaning policy initiative may cause more harmthan good. While a firm-specific tariff is a suitable means to reduce child labor, it is nota reliable mechanism to improve the well-being to the children concerned. Instead, thesupposed exploiters of child labor, i.e., the entrepreneurs, benefit by accruing higherprofits. Our analysis does not suggest that trade sanctions aimed at combating childlabor must always be a failure, but it suggests that a variety of factors have to be exam-ined carefully before using such an instrument.



References

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———, “A Note on Multiple General Equilibria with Child Labor,” Economics Letters 74(2002):301–8.

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Becker, Gary, A Treatise on the Family, Cambridge, MA (1981).Brown, Drusilla K., Alan V. Deardorff, and Robert M. Stern, “Child Labor: Theory, Evidence,

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Dessy, Sylvain E. and Stéphane Pallage, “Child Labour and Coordination Failures,” Journal ofDevelopment Economics 65 (2001):469–76.

———, “A Theory of the Worst Forms of Child Labour,” Economic Journal 115 (2005):68–87.

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Edmonds, Eric V. and Nina Pavcnik,“Child Labor in the Global Economy,” Journal of EconomicPerspectives 19 (2005a):199–220.

———, “The Effect of Trade Liberalization on Child Labour,” Journal of International Eco-nomics 65 (2005b):401–19.

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Notes

1. Our framework builds on the closed-economy model of Layard et al. (1991) and the open-economy model of Michaelis and Pflüger (2000).2. By following the Becker-approach we abstract from any intra-family bargaining. For modelsinvolving such a bargain see Gupta (2000) and Banerjee (2004).3. We neglect all problems arising from the (im)possibility of verifying the amount of child laborincorporated in each variety.4. The North is assumed to use the tariff revenue to finance a public good.5. In order to ensure LA ≥ 0 and LC ≥ 0 in the initial equilibrium, we assume 1 ≥ m − r ≥ 0.6. The neutrality result is clearly specific to our framework. As mentioned in the introduction,by incorporating credit constraints, adult unemployment, a nontradables sector or the like,child labor can go either way. Furthermore, if the elasticity of substitution between North andSouth goods were not restricted to unity as in the Cobb–Douglas case, the real-exchange-rateelasticity of exports and imports would be different from unity and we would expect a non-neutrality result.7. If we assume that adult labor is supplied inelastically as in Basu and Van (1998), a firm-specific tariff lowers the aggregate labor supply and, thus, raises the adult wage. In this case, itis possible that the loss of income resulting from reduced child labor will be dominated by theincrease in the adult labor income. We are able to show, however, that a sufficient condition fora decline in the income of worker households is a + r > 1.8. As can be seen from the trade account (21), the increase in Y has a positive impact on q,whereas the decline in the tariff rate t lowers q. The net effect is unclear.9. We thank a referee for expressing the redistribution effect in such an intuitive way.



Trade Sanctions and the Incidence of Child Labor

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