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Trade policy: Home market effect versus terms-of-trade externality

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  • Campolmi, Alessia
  • Fadinger, Harald
  • Forlati, Chiara
Abstract
We study trade policy in a two-sector Krugman (1980) trade model, allowing for wage, import and export subsidies/taxes. We study non-cooperative trade policies, first for each individual instrument and then for the situation where all instruments can be set simultaneously, and contrast those with the efficient allocation. We show that in this general context there are four motives for non-cooperative trade policies: the correction of monopolistic distortions; the terms-of-trade manipulation; the delocation motive for protection (home market effect); the fiscal-burden-shifting motive. The Nash equilibrium when all instruments are available is characterized by first-best-level wage subsidies, and inefficient import subsidies and export taxes, which aim at relocating firms to the other economy and improving terms of trade. Thus, the dominating incentives for non-cooperative trade policies are the fiscal-burden-shifting motives and terms-of-trade effects.

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  • Campolmi, Alessia & Fadinger, Harald & Forlati, Chiara, 2014. "Trade policy: Home market effect versus terms-of-trade externality," Journal of International Economics, Elsevier, vol. 93(1), pages 92-107.
    • Handle: RePEc:eee:inecon:v:93:y:2014:i:1:p:92-107
    DOI: 10.1016/j.jinteco.2013.12.010
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    3. Nocco, Antonella & Ottaviano, Gianmarco I.P. & Salto, Matteo, 2019. "Geography, competition, and optimal multilateral trade policy," Journal of International Economics, Elsevier, vol. 120(C), pages 145-161.
    4. Stéphane Auray & Devereux Michael B. & Aurélien Eyquem, 2020. "Trade Wars, Currency Wars," Post-Print halshs-03031833, HAL.
    5. Arnaud Costinot & Andrés Rodríguez‐Clare & Iván Werning, 2020. "Micro to Macro: Optimal Trade Policy With Firm Heterogeneity," Econometrica, Econometric Society, vol. 88(6), pages 2739-2776, November.
    6. Bagwell, Kyle & Lee, Seung Hoon, 2020. "Trade policy under monopolistic competition with firm selection," Journal of International Economics, Elsevier, vol. 127(C).
    7. Paul R. Bergin & Giancarlo Corsetti, 2020. "Beyond Competitive Devaluations: The Monetary Dimensions of Comparative Advantage," American Economic Journal: Macroeconomics, American Economic Association, vol. 12(4), pages 246-286, October.
    8. Ariel Weinberger & Luca Macedoni, 2023. "International Spillovers of Quality Regulations," Working Papers 2023-10, The George Washington University, Institute for International Economic Policy.
    9. David De Remer, 2013. "The Evolution of International Subsidy Rules," Working Papers ECARES ECARES 2013-45, ULB -- Universite Libre de Bruxelles.
    10. Stéphane Auray & Michael B. Devereux & Aurélien Eyquem, 2024. "The Demand for Trade Protection over the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 56(4), pages 865-898, June.
    11. Paul R. Bergin & Giancarlo Corsetti, 2013. "International Competitiveness and Monetary Policy: Strategic Policy and Coordination with a Production Relocation Externality," NBER Working Papers 19356, National Bureau of Economic Research, Inc.
    12. Kohl, Miriam & Richter, Philipp M., 2023. "Unilateral tax policy in the open economy," Journal of International Economics, Elsevier, vol. 145(C).
    13. Takatsuka, Hajime & Zeng, Dao-Zhi, 2016. "Nontariff protection without an outside good," International Review of Economics & Finance, Elsevier, vol. 41(C), pages 65-78.
    14. Kyle Bagwell & Robert W. Staiger, 2016. "The Design of Trade Agreements," NBER Working Papers 22087, National Bureau of Economic Research, Inc.
    15. Gene M. Grossman & Phillip McCalman & Robert W. Staiger, 2021. "The “New” Economics of Trade Agreements: From Trade Liberalization to Regulatory Convergence?," Econometrica, Econometric Society, vol. 89(1), pages 215-249, January.
    16. Vincent Rebeyrol, 2023. "Protection Without Discrimination," The Economic Journal, Royal Economic Society, vol. 133(655), pages 2807-2827.
    17. Allan Sørensen, 2022. "Spillovers from foreign business conditions," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 158(3), pages 779-814, August.
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    19. Luca Macedoni & Ariel Weinberger, 2021. "Quality Misallocation, Trade, and Regulations," CESifo Working Paper Series 9041, CESifo.
    20. Antonella Nocco & Gianmarco I. P. Ottaviano & Matteo Salto & Atsushi Tadokoro, 2024. "Leaving the global playing field through optimal non-discriminatory corporate taxes and subsidies," CEP Discussion Papers dp1992, Centre for Economic Performance, LSE.
    21. Fadinger, Harald & Campolmi, Alessia & Forlati, Chiara, 2018. "Trade and Domestic Policies under Monopolistic Competition," CEPR Discussion Papers 13219, C.E.P.R. Discussion Papers.
    22. David De Remer, 2013. "Domestic Policy Coordination in Imperfectly Competitive Markets," Working Papers ECARES ECARES 2013-46, ULB -- Universite Libre de Bruxelles.
    23. David R. DeRemer, 2016. "The Principle of Reciprocity in the 21st Century," CERS-IE WORKING PAPERS 1613, Institute of Economics, Centre for Economic and Regional Studies.

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    More about this item

    Keywords

    Home market effect; Terms of trade; Tariffs and subsidies;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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