Protection and the Optimal Tariff

Abstract

A simple diagrammatic device, featuring the foreign offer curve and several alternative home income-consumption loci, is presented to illustrate those cases in which the Metzler tariff paradox may arise. In this paradoxical outcome, a tariff lowers the relative domestic price of importahles. It is shown thai the imposition of an optimal tariff may lead to such an outcome, even though the existence of an optima! tariff is often cited as a condition sufficient to rule out various paradoxes in trade theory, including the Metzler tariff paradox. The theory of international trade is noted for several paradoxical outcomes that may emerge when a trade equilibrium is disturbed from an initial, free-trade, competitive level: Growth in production possibilities in one country may so depress the country's terms of trade as to lower real income. In similar fashion a gift from abroad may, in a multi-country trading world, lower home welfare. And the imposition of a small tariff may lower the world price of imports sufficiently to cause the relative domestic price of imports to decline, the celebrated Metzler paradox. As argued by Bhagwati and others, paradoxes such as these can be avoided if a country levies an optimal tariff. Specifically, if such a tariff is in place, (i) growth at home or a gift from abroad must raise aggregate welfare, and (ii) a further rise in the tariff rate must serve to protect local import-competing industries. Thus the optimal tariff is associated with the absence of such paradoxical possibilities. However, such a broad conclusion still leaves open the question of whether the move from free trade to an optimal tariff must itself be protective, even though it is established that further increases in the tariff rate raise domestic import prices. The purpose of this note is to illustrate that the Metzler paradox may indeed emerge with an optimal tariff. Furthermore, the simple graphical construction used to illustrate this result focuses on the home country's income-consumption locus in a manner which reveals how the possibility * Department of Economics, University of Rochester, U.S.A. Research support has been provided by the National Science Foundation Grant #SES-851069F. This content downloaded from 40.77.167.15 on Sun, 28 Aug 2016 04:50:12 UTC All use subject to http://about.jstor.org/terms Journal of International Economic Integration of a Metzler tariff paradox is sensitive to the height of the tariff. A sufficiently high rate of protection can always serve to raise the relative price of imports behind the tariff wall. The argument is based on the accompanying offer curve diagram. I have assumed that the slope of ray OF depicts the initial terms of trade and that the foreign offer curve, OR* is inelastic at equilibrium point F. The diagram differs from those traditionally shown in that it is designed to represent three alternative taste patterns for the home country. They all share indifference curve y0 tangent to ray OF at the initial equilibrium, but differ in the values for the home marginal propensity to consume. Three alternative income-consumption curves are drawn, each corresponding to a different set of tastes. Thus the steepest curve, 1, is associated with a taste pattern heavily biased towards importables-a high value for m, the home marginal propensity to consume. Curve 3, by contrast, reflects a low marginal propensity to consume. With such a tast pattern indifference curves have the same slope as y0 at F everywhere along curve 3. An intermediate case is shown by income-consumption curve 2. Each income-consumption curve is associated with a different home offer curve, not drawn, with each offer curve passing through point F. This content downloaded from 40.77.167.15 on Sun, 28 Aug 2016 04:50:12 UTC All use subject to http://about.jstor.org/terms