Import Tariffs and Export Subsidies in the WTO: A Small-Country Approach

Abstract

This paper develops a simple small-country model to explain why the WTO prohibits export subsidies but allows import tariffs. Governments choose protection rates import tariffs/export subsidies) to maximize a weighted sum of social welfare and lobbying contributions. While transportation costs decrease due to the progress of trade liberalization and lower transportation costs, import-competing sectors decline but export industries grow. In the growing export industries, the surplus generated by protection is eroded by new entrants. Therefore, the rent that the governments gain from protecting the export sectors by using export subsidies is small. On the other hand, in the import-competing sectors, capital is sunk and no new entrants erode the protection rent. Therefore, the governments can get large political contributions from protecting these import-competing sectors. We show that under fast capital mobility, the governments with a high bargaining power are better off from a trade agreement that allows import tariffs but prohibits export subsidies.