Trade policy: home market effect versus terms of trade externality
Harald Fadinger and
Chiara Forlati ()
No 2010/6, MNB Working Papers from Magyar Nemzeti Bank (Central Bank of Hungary)
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).
Keywords: home market effect; terms of trade; tariffs and subsidies (search for similar items in EconPapers)
JEL-codes: F12 F13 F42 (search for similar items in EconPapers)
Pages: 43 pages
New Economics Papers: this item is included in nep-int
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Journal Article: Trade policy: Home market effect versus terms-of-trade externality (2014)
Working Paper: Trade Policy: Home Market Effect versus Terms-of-Trade Externality (2012)
Working Paper: Trade Policy: Home Market Effect versus Terms-of-Trade Externality (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:mnb:wpaper:2010/6
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