Trade liberalisation with costly adjustment
This paper discusses the welfare effects of trade in a Heckscher-Ohlin model of trade with costs of adjustment. The paper analyses the efficiency and the distributional effects of eliminating a tariff in a formerly protected sector. The tariff can be eliminated at the onset or after a while. In case of postponing the elimination of the tariff, the government may pre-announce the policy change or may not do it and surprise the private sector. It is shown that while large adjustment costs reduce the efficiency gains from trade liberalisation, small to moderate adjustment costs may raise the efficiency gains from a pre-announced liberalisation. The (net) adjustment costs reduce the welfare gains and losses of owners of production factors from a sudden unanticipated liberalisation. The policy risk is partially shifted towards owners of firms. The distributional effects of trade liberalisations are more complex when the policy is pre-announced. The adjustment costs may increase the gains and losses of owners of the production factors, for small and moderate levels. Also, the announcement that the tariff will be eliminated affects the value of the firms, and when the adjustment cost are not high it may raise rather than reduce the value of the firms in the formerly protected sector.
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