Trade Policy: Home Market Effect Versus Terms-of-Trade Externality

57 Pages Posted: 6 Mar 2013

See all articles by Alessia Campolmi

Alessia Campolmi

Universitat Pompeu Fabra

Harald Fadinger

University of Vienna

Chiara Forlati

Ecole Polytechnique Fédérale de Lausanne

Date Written: December 2012

Abstract

We study trade policy in a two-sector Krugman (1980) trade model, allowing for production, import and export subsidies/taxes. We consider non-cooperative and cooperative trade policy, first for each individual instrument and then for the situation where all instruments can be set simultaneously, and contrast those with the efficient allocation. While previous studies have identified the home market externality, which gives incentives to agglomerate firms in the domestic economy, as the driving force behind non-cooperative trade policy in this model, we show that this, in fact, is not the case. Instead, the incentives for a non-cooperative trade policy arise from the desire to eliminate monopolistic distortions and to improve domestic terms of trade. As a consequence, terms-of-trade externalities remain the only motive for international trade agreements in the Krugman (1980) model once a complete set of instruments is available.

Keywords: Home Market Effect, Terms of Trade, Tariffs and Subsidies

JEL Classification: F12, F13, F42

Suggested Citation

Campolmi, Alessia and Fadinger, Harald and Forlati, Chiara, Trade Policy: Home Market Effect Versus Terms-of-Trade Externality (December 2012). Center for Fiscal Policy, EPFL, Chair of International Finance (CFI) Working Paper No. 02-2013, Available at SSRN: https://ssrn.com/abstract=2228125 or http://dx.doi.org/10.2139/ssrn.2228125

Alessia Campolmi

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain

Harald Fadinger

University of Vienna ( email )

Bruenner Strasse 72
Vienna, Vienna 1090
Austria

Chiara Forlati (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Station 5
Odyssea 1.04
1015 Lausanne, CH-1015
Switzerland

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