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Should Smaller Countries Be More Protectionist? The Diversification Motive for Tariffs

James Gaisford and Olena Ivus

Review of International Economics, 2014, vol. 22, issue 4, 845-862

Abstract: This paper examines the diversification motive for tariffs under trade-related uncertainty when there is incomplete international and domestic risk sharing. In the context of a two-country Ricardian continuum-of-sectors model with shocks to foreign technologies or preferences, tariffs allow a country to mitigate external risk by diversifying across sectors. Given sufficiently high risk and risk aversion, the optimality of tariffs depends primarily on a country's ability to diversify, rather than its market power, such that small countries gain most.

Date: 2014
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