Trade Policy, Market Leaders and Endogenous Competition Intensity

It is well known that tariff policy can alleviate the negative consequences of breaching intellectual property rights by foreign firms. Yet, the positive effect of tariff protection is thought to be the benefit firms get at the expense of consumers (at least in the short run). Using a set-up in which the intensity of market competition is endogenous, we argue that consumers can benefit from tariffs even in the short run. A high level of tariff protection alters the firms’ cost efficiency distribution and induces tougher market competition. Consumers benefit from the tariff policy, and governments that assign a high enough weight to the consumer surplus set positive tariff levels. Under protection the innovation level remains the same as under free trade but the average industry efficiency increases.