An Example of Procompetitive Trade Policies
The procompetitive effects of trade policies are analyzed in a foreign duopoly model of vertical product differentiation. A uniform tariff policy complying with the Most Favored Nation (MFN) clause is welfare superior to free trade because of a pure rent-extracting effect. A nonuniform tariff policy yields an even higher level of social welfare because of procompetitive effects. The optimalpolicyissensitivetofirms’ cost asymmetries: if these are high, imports of low quality are subsidized and imports of high quality face a tariff; otherwise, both imports face a tariff. Regional Trade Agreements (RTAs) are examples of such nonuniform tariff policies. They yield higher welfare than free trade because they are procompetitive; moreover, a RTA with a lowquality producing country yields larger gains than a RTA with a high-quality producing country because the former enables the importer to extract foreign rents.
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