Tariffs and Declining-Cost Industries

Abstract

Recently Corden [1] explored some implications of assuming increasing returns and monopoly in an import-competing industry. The models chosen are relevant to considering the effects of tariffs and subsidies in a young industrializing economy which plays a relatively minor role in world trade. The main conclusions of the Corden analysis are that (1) tariffs cannot lead to a social optimum; (2) if the country produces the good, it must do so at marginal cost pricing which requires that the industry be subsidized; and (3) the social optimum cannot result from subsidizing imports. This paper is a limited attempt to determine how tariffs and subsidies affect decreasing-cost, import-competing industries where the economy under consideration plays a relatively major role in world trade. The approach is similar to that used by Corden in that it is partial equilibrium analysis. Subject to all the limitations of partial analysis, among the conclusions (where the import-competing industry is of a decreasingcost nature) are (1) an optimum tariff can exist such that through subsidization there will be domestic production and imports, not all of one or the other; (2) the imposition of tariffs may actually cause prices in the import-competing industry to fall; (3) in other cases it is possible to achieve a social optimum by producing all of the good domestically and subsidizing domestic production; and (4) a social optimum can be achieved by subsidizing imports. In the first case considered, the free-trade price is such that in the absence of barriers to trade all of the good consumed domestically is imported. Thus, the good is not produced by a monopoly in the importing country. It is shown in Figure 1 that a tariff can lead to a net welfare gain and that an optimum tariff exists. The demand schedule in the importing country is AR; the average and marginal cost curves are ACd and MCd.2 It is assumed that the cost curves reflect both private and social costs. To be consistent with Corden's analysis, the possibility