Choosing between Protectionism and Free Trade in an Uncertain World

Gerald Willmann, Peter Debaere and Toni Glaser

No 10625, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop a two-sector, two-factor general equilibrium model of international trade with imperfect short-term mobility of one factor that features uncertainty about sectoral productivity, and hence uncertainty about the terms of trade. Uncertainty resolves after the sectoral capital allocation has been decided. We show that the capital allocation chosen by producers need not be welfare maximizing if producers and consumers have differing attitudes to risk. In a small country facing uncertain terms of trade, risk-neutral producers specialize more in exporting than is preferred by risk-averse consumers. From a national welfare perspective this misallocation can justify the use of trade policy that deviates from free trade. In the general case with uncertainty in both countries, there exists a trade-of between trade as insurance against domestic shocks, and protection as insurance against foreign shocks. In our framework, the optimal trade policy of a country is thus very much a function of its particular circumstance: the nature of its comparative advantage and especially the size and correlation of domestic vs. international shocks that a country faces. The model we propose can explain the persistent protectionism especially in sectors such as agriculture.

Keywords: Trade; policy (search for similar items in EconPapers)
JEL-codes: F1 (search for similar items in EconPapers)
Date: 2015-05
New Economics Papers: this item is included in nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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