Ranking Production Subsidies and Import Tariffs under Different Scenarios

Abstract

Both a tariff and a production subsidy can be used to protect the import competing industry. Yeh (1971) has shown that if the country is large, a tariff will be superior to a production subsidy, assuming that the level of support required for the import competing industry is not greater than the one needed when the optimum tariff is in operation. Maintaining the hypothesis that exporters do not react to importing country policies, the paper shows that tariffs and subsidies can always be ordered. Tariffs will remain superior to subsidies even if the support guaranteed to domestic producers exceeds that achieved under the optimum tariff. A tariff though is inferior to production subsidy only when the country wishes to produce a quantity significantly in excess of the optimum tariff production. However, this ranking is sensitive to the behaviour of trade partners. In fact, when foreign suppliers fix their export quantity at the free-trade equilibrium through whatever means, production subsidy is shown to be always superior to tariff.