The optimal tariff structure and foreign penetration

Abstract

This study investigates tariff policies as a means of improving economic welfare. The government sets the tariff so as to maximize domestic welfare against foreign penetration. We examine the relationship between the optimal tariff structure and the degree of penetration. We find that the optimal tariff rate is non-monotonically related with the degree of penetration (inverse U-shape). We also show that intermediate degrees of foreign penetration are harmful for economic welfare.

Keywords:

• Tariff policy
• foreign penetration
• strategic trade policy
• international competition

Acknowledgements

I am grateful to Hong Hwang, Toshihiro Matsumura, and the participants of the conference for their helpful comments. I also thank anonymous referees of this journal for helpful suggestions.

Notes

No potential conflict of interest was reported by the author.

This study was presented at the Joint Conference on Industrial Organization (by National Taiwan University and University of Tokyo). Postdoctoral Fellow for Research Abroad of the Japan Society for the Promotion of Science.

1 See Dixit (1984), Brander and Spencer (1985), Venables (1987), Sertel (1988), and Brander et al. (1995). Recently, Etro (2011, 2014, 2015) provided an approach to strategic trade policy under the assumption that the number of firms is determined endogenously.

2 Foreign penetration can be regarded as the dynamic process, but we focus on comparative statics with respect to the proportion of foreign firms. We ignore the strategic aspect due to the dynamic processes.

3 Cato and Matsumura (2015) examine the relationship between tariff policy and partial privatization. Cato and Matsumura (2012) and Wang and Lee (2013) consider the long-run effects of foreign penetration on privatization policies.

4 We assume that there is at least one foreign firm (). If there is no foreign firm, any tariff rate can be optimal.

5 It is easy to check that .

6 Note that the government does not care about m foreign firms’ profits when it chooses the tariff rate. Then, there exists a difference between the authentic domestic economic welfare and the government’s objective.

7 A similar approach is employed by Lin and Matsumura (2012), who assume that the ownership of a privatized public firm is transferred to the foreign investors with compensation.

8 Suppose that , , , and . Then, we have

This function has two critical points between 1 and n: the local minimum and the local maximum.

Additional information

Funding

This study was financially supported by Grant-in-Aids for Young Scientists (B) from the Japan Society for the Promotion of Science (JSPS) (MEXT/JSPS KAKENHI [grant number: 26870477]). This paper was also supported by Postdoctoral Fellowship for Research Abroad of JSPS.