Chapter 14 Tariff Policy and Foreign Economic Aid for the Economy with a Monopolistically Competitive Nontraded Industry and Capital Inflow

Purpose – This chapter examines whether a small open economy in the presence of a nontraded good produced under a monopolistically competitive market and foreign capital inflow can raise its national welfare by adopting trade liberalization coupled with foreign economic aid. Methodology/approach – The chapter employs a general equilibrium, comparative static analysis of a small open economy involving two factors and two industries. Findings – It is shown that an import tariff can raise the welfare of a country or impoverish it, depending on the production and trade structures and preferences of the country, but foreign economic aid is always welfare enhancing. Thus, even when a tariff reduction reduces national welfare, the government still has an incentive to adopt the policy combination of trade liberalization and foreign economic aid. Originality/value of paper – The results obtained explain a widely recognized fact that economic aid by developed donor countries, trade liberalization and capital market liberalization typically take place simultaneously in developing recipient countries.