Working Paper: NBER ID: w30394
Authors: Svetlana Demidova; Takumi Naito; Andrés Rodríguez-Clare
Abstract: To provide sharp answers to basic questions in international trade, a standard approach is to focus on a small open economy (SOE). Whereas the classic tradition is to define a SOE as an economy that takes world prices as given, in the new trade literature it is defined instead as one that takes foreign-good prices and export demand schedules as given. We develop a gravity model that nests all its standard microfoundations and show how to take the limit so that an economy that becomes infinitesimally small behaves like a SOE. We then derive comparative statics and optimal policy for the SOE. Ignoring standard tax indeterminacies, optimal policy is characterized by export taxes and import tariffs equal to the (inverse) foreign demand and supply elasticities, respectively, and employment subsidies determined by the scale elasticity (under perfect competition) or markups (under monopolistic competition).
Keywords: No keywords provided
JEL Codes: F10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| foreign productivity (O49) | trade flows (F10) |
| trade flows (F10) | wages (J31) |
| foreign productivity (O49) | wages (J31) |
| export demand (F10) | wages (J31) |
| trade elasticities (H30) | optimal tariff (H21) |