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Tariffs, Capital Accumulation, and the Current Account in a Small Open Economy


  • Partha Sen
  • Stephen J. Turnovsky


This paper analyze these effects of a tariff in an intertemporal optimizing model, emphasizing the role of capital accumulation. Three types of increases in the tariff rate are considered: (i) unanticipated permanent; (ii) unanticipated temporary; (iii) anticipated permanent. There are two main general conclusions to be drawn from the analysis. The first is that the introduction (or increase) of a tariff is contractionary, both in the short run and in the long run. In particular, employment is reduced both in the short run and in the long run, so that there is no significant intertemporal tradeoff, as obtained by previous authors. The fail in the long-run capital stock causes an immediate reduction in the rate of investment, which in turn leads to a current account surplus. While this response of the current account is in accordance with much (but not all) of the existing literature, the mechanism by which it is achieved, namely the decumulation of capital, has not been previously considered. Also, the fact that the declining capital stock is accompanied by an accumulation of foreign bonds means that the savings effect of the tariff is unclear, depending upon which influence dominates. This ambiguity of savings is, however, very different from those occurring in other studies. The second major conclusions stems from the fact that the steady state depended upon the initial stocks of the assets. As a consequence, a temporary tariff, by altering these initial conditions for some later date when the tariff is removed, leads to a permanent effect on the economy.

Suggested Citation

  • Partha Sen & Stephen J. Turnovsky, 1988. "Tariffs, Capital Accumulation, and the Current Account in a Small Open Economy," NBER Working Papers 2781, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2781
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    References listed on IDEAS

    1. Eichengreen, Barry J., 1981. "A dynamic model of tariffs, output and employment under flexible exchange rates," Journal of International Economics, Elsevier, vol. 11(3), pages 341-359, August.
    2. Maurice Obstfeld, 1982. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?," The Quarterly Journal of Economics, Oxford University Press, vol. 97(2), pages 251-270.
    3. Abel, Andrew B & Blanchard, Olivier J, 1983. "An Intertemporal Model of Saving and Investment," Econometrica, Econometric Society, vol. 51(3), pages 675-692, May.
    4. Sebastian Edwards, 1987. "Tariffs, Terms of Trade, and the Real Exchange Rate in an Intertemporal Optimizing Model of the Current Account," NBER Working Papers 2175, National Bureau of Economic Research, Inc.
    5. Charles Engel & Kenneth Kletzer, 1986. "Tariffs, Saving and the Current Account," NBER Working Papers 1869, National Bureau of Economic Research, Inc.
    6. Matsuyama, Kiminori, 1987. "Current account dynamics in a finite horizon model," Journal of International Economics, Elsevier, vol. 23(3-4), pages 299-313, November.
    7. Krugman, Paul, 1982. "The macroeconomics of protection with a floating exchange rate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 16(1), pages 141-182, January.
    8. Svensson, Lars E O & Razin, Assaf, 1983. "The Terms of Trade and the Current Account: The Harberger-Laursen-Metzler Effect," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 97-125, February.
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