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Optimal trade policy with monopolistic competition and heterogeneous firms

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Abstract
This paper derives optimal trade and domestic taxes for a small open economy containing a monopolistically competitive (MC) sector in which firms may have heterogeneous productivity levels. Analysis encompasses cases in which the domestic MC sector is able to expand or contract flexibly, or is constrained to be of fixed size. In the former case domestic protection can bring gains by increasing the number of product varieties on offer; these gains (and the corresponding rates of domestic subsidy or of import tariffs) are reduced by heterogeneity of foreign exporters some of whom may withdraw from the market. In the latter case gains from protection arise from terms-of-trade effects; since various margins of substitution are switched off, only the relative values of domestic taxes, import tariffs and export taxes matter. In general, policies work through both a terms-oftrade and a variety effect, and the paper shows how the relative importance of each depends on the structure of the economy.

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  • Haaland, Jan I. & Venables, Anthony J., 2014. "Optimal trade policy with monopolistic competition and heterogeneous firms," Discussion Paper Series in Economics 33/2014, Norwegian School of Economics, Department of Economics.
    • Handle: RePEc:hhs:nhheco:2014_033
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    Cited by:

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    3. Takatsuka, Hajime & Zeng, Dao-Zhi, 2016. "Nontariff protection without an outside good," International Review of Economics & Finance, Elsevier, vol. 41(C), pages 65-78.
    4. 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.
    5. Kohl, Miriam & Richter, Philipp M., 2023. "Unilateral tax policy in the open economy," Journal of International Economics, Elsevier, vol. 145(C).
    6. Fadinger, Harald & Campolmi, Alessia & Forlati, Chiara, 2018. "Trade and Domestic Policies under Monopolistic Competition," CEPR Discussion Papers 13219, C.E.P.R. Discussion Papers.
    7. Hassan Molana & Catia Montagna, 2016. "Selection, Trade, and Employment: The Strategic Use of Subsidies," Dundee Discussion Papers in Economics 296, Economic Studies, University of Dundee.
    8. Taylor, Alan M. & Caliendo, Lorenzo & Feenstra, Robert & Romalis, John, 2021. "A Second-best Argument for Low Optimal Tariffs," CEPR Discussion Papers 15697, C.E.P.R. Discussion Papers.
    9. 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.
    10. Allan Sørensen, 2020. "Export promotion and intra‐industry reallocations," Review of International Economics, Wiley Blackwell, vol. 28(2), pages 303-319, May.
    11. Gaubert, Cecile & Itskhoki, Oleg & Vogler, Maximilian, 2021. "Government policies in a granular global economy," Journal of Monetary Economics, Elsevier, vol. 121(C), pages 95-112.
    12. Ziran Ding, 2022. "Firm heterogeneity, variable markups, and multinational production: A review from trade policy perspective," Journal of Economic Surveys, Wiley Blackwell, vol. 36(5), pages 1311-1357, December.
    13. Hajime Takatsuka & Dao‐Zhi Zeng, 2022. "Mobile capital, optimal tariff, and tariff war," Review of International Economics, Wiley Blackwell, vol. 30(1), pages 166-204, February.
    14. Gry Ostenstad & Wessel N. Vermeulen, 2015. "The impact of windfalls: Firm selection, trade and welfare," OxCarre Working Papers 162, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    15. Atsushi Tadokoro, 2020. "Tariff policies, variable markups, and within-sector missallocation," Discussion Papers in Economics and Business 20-16, Osaka University, Graduate School of Economics.
    16. Rishi R. Sharma, 2018. "Optimal tariffs with inframarginal exporters," Review of International Economics, Wiley Blackwell, vol. 26(4), pages 768-783, September.
    17. Demidova, Svetlana, 2017. "Trade policies, firm heterogeneity, and variable markups," Journal of International Economics, Elsevier, vol. 108(C), pages 260-273.
    18. Timini, Jacopo & Conesa, Marina, 2019. "Chinese Exports and Non-Tariff Measures: Testing for Heterogeneous Effects at the Product Level," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 34(2), pages 327-345.
    19. Caliendo, Lorenzo & Feenstra, Robert C. & Romalis, John & Taylor, Alan M., 2023. "A second-best argument for low optimal tariffs on intermediate inputs," Journal of International Economics, Elsevier, vol. 145(C).
    20. Lorenzo Caliendo & Robert C. Feenstra & John Romalis & Alan M. Taylor, 2023. "Tariff Reductions, Heterogeneous Firms, and Welfare: Theory and Evidence for 1990–2010," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 71(4), pages 817-851, December.
    21. Hassan Molana & Catia Montagna, 2018. "Competitive selection, trade, and employment: The strategic use of subsidies," Review of International Economics, Wiley Blackwell, vol. 26(5), pages 1154-1177, November.
    22. Bruno Larue, 2018. "Economic Integration Reconsidered," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 66(1), pages 5-25, March.
    23. Bo Gao & Bin Qiu, 2023. "Income distribution and unequal gains from trade," The World Economy, Wiley Blackwell, vol. 46(1), pages 236-255, January.
    24. Hernández Vega Marco A., 2021. "Tariffs and Macroeconomic Dynamics," Working Papers 2021-25, Banco de México.

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    More about this item

    Keywords

    Trade policy; monopolistic competition; heterogeneous firms; terms of trade; variety; productivity.;
    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

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