Template-Type: ReDIF-Paper 1.0
Author-Name: Alessia Campolmi
Author-X-Name-First: Alessia
Author-X-Name-Last: Campolmi
Author-Email: campolmia@ceu.hu
Author-Workplace-Name: Central European University and Magyar Nemzeti Bank, Hungary
Author-Name: Harald Fadinger
Author-X-Name-First: Harald
Author-X-Name-Last: Fadinger
Author-Email: harald.fadinger@univie.ac.at
Author-Workplace-Name: University of Vienna, Austria
Author-Name: Chiara Forlati
Author-X-Name-First: Chiara
Author-X-Name-Last: Forlati
Author-Email: chiara.forlati@epfl.ch
Author-Workplace-Name: École Polytechnique Fédérale de Lausanne, Switzerland

Title: Trade policy: home market effect versus terms of trade externality

Abstract: We study trade policy in a two-sector Krugman-type trade model with home market effects. We conduct a general analysis allowing for three different instruments: tariffs, export taxes and production subsidies. For each instrument, we consider unilateral trade policy without retaliation. When carefully disentangling the different effects that determine policy makers’ choices and modeling general equilibrium effects of taxes/tariffs, we find – contrary to the results of previous studies – that production subsidies are always inefficiently low and driven by the incentives to improve the (welfare relevant) terms of trade. In the cases of tariffs and export taxes results depend crucially on whether the free trade allocation is efficient. When starting from an allocation that is distorted because of monopolistic competition, the home market effect (and in the case of export taxes also the desire to correct for the monopolistic inefficiency) induces policy makers to set a tariff (an export subsidy). However, when monopolistic distortions are corrected, terms of trade effects dominate the choice of trade policy and lead to an import subsidy (an export tax).

Length: 43 pages
Creation-Date: 2010
File-URL: http://www.mnb.hu/letoltes/wp-2010-6-final.pdf
File-Format: Application/pdf

Number: 2010/6
Classification-JEL: F12, F13, F42
Keywords: home market effect, terms of trade, tariffs and subsidies
Handle: RePEc:mnb:wpaper:2010/6