Shortages of Critical Goods in a Global Economy: Optimal Trade and Industrial Policy

This paper studies optimal trade and industrial policy in response to shortages of critical goods following global shocks. We develop a dynamic open-economy model with essential and non-essential goods, heterogeneous households, and incomplete financial markets. When global demand for essential goods rises, households fail to internalize how their borrowing choices affect aggregate interest rates, leading to excessive discounting of future returns and underinvestment. Trade amplifies shortages as producers reallocate supply toward exports. Calibrated to the U.S. during COVID-19, the model shows that export taxes, import subsidies, and production subsidies mitigate shortages, increase welfare, and align with observed cross-country policy responses.