Capital Movements and the Political Economy of trade Policy
Considering a time consistent policy in a two-period political economy model of trade policy, where foreign capital is endogenously determined, the tariff and the level of foreign capital would be higher with external debt than with foreign direct investment. As foreign direct investment is remunerated at the marginal productivity of capital, an increase of the tariff increases its remuneration, increasing also the welfare costs of the tariff. Foreign direct investment can lead to free trade.
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