Working Paper: NBER ID: w4179
Authors: Florencio Lopez-de-Silanes; James R. Markusen; Thomas F. Rutherford
Abstract: Conventional analysis in the trade-industrial-organization literature suggests that, when a country has some market power over an imported good, some small level of protection must be welfare improving. This is essentially a terms-of-trade argument that is reinforced if the imported goods are substitutes for domestic goods produced with increasing returns to scale, goods that are initially underproduced in free-trade equilibrium. This paper notes that this result may not hold when (1) the imports are intermediates used in a domestic increasing-returns industry, and/or (2) the intermediates are complements for domestic inputs produced with increasing returns. We then demonstrate such an outcome with respect to Mexican protection against imported auto parts using an applied general-equilibrium model of the North American auto industry.
Keywords: trade policy; intermediate goods; welfare effects; general equilibrium model; auto industry
JEL Codes: F12; F13; D43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Protectionist policies (F13) | welfare improvement (I38) |
| Market power over imported good (F10) | welfare improvement (I38) |
| Imported intermediates in domestic increasing-returns industry (F12) | welfare reduction (I38) |
| Complementarity between domestic and imported intermediates (F10) | negative welfare effect (D62) |
| Tariff on imported auto parts (L62) | welfare reduction in Mexico (I38) |
| Higher prices for imported intermediates (F14) | reduction in output of final goods (E23) |
| Derationalization effect dominates terms-of-trade effect (F16) | welfare reducing (I38) |
| Removal of protection on auto parts (L62) | welfare gain in Mexico (D69) |
| Removal of parts protection (Y60) | expansion of Mexican auto production and exports (F10) |
| Protection (D18) | scale effect outweighs expenditure switching effect (D12) |