Trade policy: home market effect versus terms of trade externality
AbstractWe study trade policy in a two-sector Krugman-type trade model with home market effects. We conduct a general analysis allowing for three different instruments: tariffs, export taxes and production subsidies. For each instrument, we consider unilateral trade policy without retaliation. When carefully disentangling the different effects that determine policy makers’ choices and modeling general equilibrium effects of taxes/tariffs, we find – contrary to the results of previous studies – that production subsidies are always inefficiently low and driven by the incentives to improve the (welfare relevant) terms of trade. In the cases of tariffs and export taxes results depend crucially on whether the free trade allocation is efficient. When starting from an allocation that is distorted because of monopolistic competition, the home market effect (and in the case of export taxes also the desire to correct for the monopolistic inefficiency) induces policy makers to set a tariff (an export subsidy). However, when monopolistic distortions are corrected, terms of trade effects dominate the choice of trade policy and lead to an import subsidy (an export tax).
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Bibliographic InfoPaper provided by Magyar Nemzeti Bank (the central bank of Hungary) in its series MNB Working Papers with number 2010/6.
Length: 43 pages
Date of creation: 2010
Date of revision:
home market effect; terms of trade; tariffs and subsidies;
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, 2009. "Trade Policy: Home Market Effect versus Terms-of-Trade Externality," CEU Working Papers 2012_3, Department of Economics, Central European University, revised 01 Dec 2011.
- F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies
- F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
- F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
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- 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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