Trade Policy: Home Market Effect versus Terms-of-Trade Externality
AbstractWe study trade policy in a two-sector Krugman (1980) trade model, allowing alternatively for production subsidies, import tariffs or export subsidies. For each instrument, we consider the unilateral trade policy without retaliation, the Nash solution and the cooperative solution and contrast those with the efficient allocation. While previous studies have identified the home market externality, which gives incentives to agglomerate firms in the domestic economy, as the driving force behind non-cooperative trade policy in this model, we show that this, in fact, is never the case. Instead, the prevailing incentives for a non-cooperative trade policy arise from the desire to eliminate monopolistic distortions and to improve domestic terms of trade. As a consequence, uncoordinated trade policies are not necessarily protectionist and allowing countries to set production or export subsidies strategically can be welfare improving compared to the free trade equilibrium. The implications are relevant: the Krugman (1980) model provides no rationale for prohibiting production and export subsidies.
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Bibliographic InfoPaper provided by Department of Economics, Central European University in its series CEU Working Papers with number 2012_3.
Date of creation: 01 Feb 2009
Date of revision: 01 Dec 2011
Other versions of this item:
- Alessia Campolmi & Harald Fadinger & Chiara Forlati, 2009. "Trade Policy: Home Market Effect versus Terms-of-Trade Externality," Working Papers 201302, Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne, revised Dec 2012.
- Alessia Campolmi & Harald Fadinger & Chiara Forlati, 2010. "Trade policy: home market effect versus terms of trade externality," MNB Working Papers 2010/6, Magyar Nemzeti Bank (the central bank of Hungary).
- F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
- F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
- F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Paolo Epifani & Gino Gancia, 2009.
"Openness, Government Size and the Terms of Trade,"
Review of Economic Studies,
Oxford University Press, vol. 76(2), pages 629-668.
- Paolo Epifani & Gino Gancia, 2005. "Openness, government size and the terms of trade," Economics Working Papers 915, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2008.
- Paolo Epifani & Gino Gancia, 2008. "Openness, Government Size and the Terms of Trade," IEW - Working Papers 359, Institute for Empirical Research in Economics - University of Zurich.
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