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Trade Policy: Home Market Effect versus Terms-of-Trade Externality

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  • Alessia Campolmi
  • Harald Fadinger
  • Chiara Forlati

    ()
    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Abstract

We study trade policy in a two-sector Krugman (1980) trade model, allowing for production, import and export subsidies/taxes. We consider non-cooperative and cooperative trade policy, first for each individual instrument and then for the situation where all instruments can be set simultaneously, 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 not the case. Instead, the 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, terms-of-trade externalities remain the only motive for international trade agreements in the Krugman (1980) model once a complete set of instruments is available.

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Bibliographic Info

Paper provided by Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne in its series Working Papers with number 201302.

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Length: 57 pages
Date of creation: Feb 2009
Date of revision: Dec 2012
Handle: RePEc:cif:wpaper:201302

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Keywords: Home Market Effect; Terms of Trade; Tariffs and Subsidies;

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  1. Gros, Daniel, 1987. "A note on the optimal tariff, retaliation and the welfare loss from tariff wars in a framework with intra-industry trade," Journal of International Economics, Elsevier, vol. 23(3-4), pages 357-367, November.
  2. Grossman, Gene & Helpman, Elhanan, 1993. "Protection for Sale," CEPR Discussion Papers 827, C.E.P.R. Discussion Papers.
  3. 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.
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  5. Flam, Harry & Helpman, Elhanan, 1987. "Industrial policy under monopolistic competition," Journal of International Economics, Elsevier, vol. 22(1-2), pages 79-102, February.
  6. Grossman, G.M. & Helpman, E., 1993. "Trade Wars and Trade Talks," Papers 1-93, Tel Aviv.
  7. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  8. Kyle Bagwell & Robert W. Staiger, 2009. "Delocation and Trade Agreements in Imperfectly Competitive Markets," NBER Working Papers 15444, National Bureau of Economic Research, Inc.
  9. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  10. Kyle Bagwell & Robert W. Staiger, 1997. "An Economic Theory of GATT," NBER Working Papers 6049, National Bureau of Economic Research, Inc.
  11. Venables, Anthony J, 1987. "Trade and Trade Policy with Differentiated Products: A Chamberlinian-Ricardian Model," Economic Journal, Royal Economic Society, vol. 97(387), pages 700-717, September.
  12. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
  13. Ralph Ossa, 2011. "A “New Trade” Theory of GATT/WTO Negotiations," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 122 - 152.
  14. Dixit, Avinash, 1985. "Tax policy in open economies," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 6, pages 313-374 Elsevier.
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Cited by:
  1. Paul R. Bergin & Giancarlo Corsetti, 2013. "International Competitiveness and Monetary Policy: Strategic Policy and Coordination with a Production Relocation Externality," NBER Working Papers 19356, National Bureau of Economic Research, Inc.

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