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Tariffs as Insurance: Optimal Commercial Policy When Domestic Markets Are Incomplete

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  • Jonathan Eaton
  • Gene M. Grossman

Abstract

Free trade is not optimal for a small country that faces uncertain terms of trade if some factors are immobile - ex post, and markets for contingent claims are incomplete. The government can improve social welfare by using commercial policy that serves as a partial substitute for missing insurance markets. Using a combination of analytical and simulation techniques we demonstrate that optimal policy for this purpose will often have an anti-trade bias. We also show that the usual preference by economists for factor or product taxes and subsidies over tariffs and export subsidies may not be justified in this context.

Suggested Citation

  • Jonathan Eaton & Gene M. Grossman, 1981. "Tariffs as Insurance: Optimal Commercial Policy When Domestic Markets Are Incomplete," NBER Working Papers 0797, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0797
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    1. Eaton, Jonathan & Rosen, Harvey S., 1980. "Labor supply, uncertainty, and efficient taxation," Journal of Public Economics, Elsevier, vol. 14(3), pages 365-374, December.
    2. Eaton, Jonathan, 1979. "The Allocation of Resources in an Open Economy with Uncertain Terms of Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(2), pages 391-403, June.
    3. Newbery, David M, 1989. "The Theory of Food Price Stabilisation," Economic Journal, Royal Economic Society, vol. 99(398), pages 1065-1082, December.
    4. Thomas J. Rothenberg & Kenneth R. Smith, 1971. "The Effect of Uncertainty on Resource Allocation in a General Equilibrium Model," The Quarterly Journal of Economics, Oxford University Press, vol. 85(3), pages 440-459.
    5. Grossman, Gene M & Shapiro, Carl, 1982. "A Theory of Factor Mobility," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 1054-1069, October.
    6. John S. Flemming & Stephen J. Turnovsky & Murray C. Kemp, 1977. "On the Choice of Numeraire and Certainty Price in General Equilibrium Models of Price Uncertainty," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 573-583.
    7. Kydland, Finn, 1977. "Equilibrium solutions in dynamic dominant-player models," Journal of Economic Theory, Elsevier, vol. 15(2), pages 307-324, August.
    8. Jonathan Eaton & Harvey S. Rosen, 1980. "Optimal Redistributive Taxation and Uncertainty," The Quarterly Journal of Economics, Oxford University Press, vol. 95(2), pages 357-364.
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