Shortages of Critical Goods in a Global Economy: Optimal Trade and Industrial Policy

Abstract

This paper studies international trade policy during a pandemic. We consider a multi-sector small open economy model with essential and non-essential goods. Essential goods provide utility relative to a reference consumption level, and a pandemic consists of an increase in this reference level along with higher import and export prices of these goods. The economy produces domestic varieties of both types of goods subject to sectoral adjustment costs, and varieties are traded internationally subject to trade barriers. We find that trade provides limited relief to the increased demand for essential goods: import prices increase, limiting access, while domestic producers reallocate domestic sales toward exports. We find that international trade policy changes can mitigate these effects. The optimal unilateral trade policy response to the pandemic is to subsidize imports of essential goods while taxing exports, leading to increased consumption of essential goods in the short-run. These findings are consistent with evidence on changes in trade barriers across countries during the COVID-19 pandemic.