Optimal Reciprocal Import Tariffs Under Variable Elasticity of Substitution

Abstract

We explore the impact of reciprocal, specific or ad valorem, import tariffs on welfare among N symmetric countries (a free-trade agreement)—using the standard Krugman’s one-sector trade model, with unspecified variable-elasticity preferences (mostly under decreasing elasticity of utility). Without transport costs, any tariff is harmful, a specific import subsidy (export tariff) can be welfare-improving, whereas ad valorem tariffs or subsidies are always harmful. Under transport costs, a small ad valorem tariff can be beneficial; moreover, under sufficiently high transport costs, both kinds of tariffs can be become beneficial. The reason is mitigated distortion: excessive entry under decreasingly elastic utility.