The Choice of Optimal Protection under Oligopoly: Import Tariff v. Production Subsidy

Abstract

Up to now, researchers in international economics have tried to identify the optimal policy from the point of view of the chosen target, based on the assumption of a small price-taking country. In that sense we have to note Bhagwati’s (1971) remarkable concept of duality relationships between the analysis of policy rankings under distortions and the analysis of policy rankings for non-economic objectives. For example, in the presence of a domestic distortion, as well as when a government protects the output of an importcompeting industry as the target, an import tariff policy is not necessarily the optimal measure (Bhagwati and Ramaswami, 1963; Bhagwati et al., 1969; Kemp and Negishi, 1969; Bhagwati, 1971). In other words, there are domestic distortions, which can be due to production and consumption externalities in product markets. Also, factor market distortions can exist in several forms, such as sector-specific sticky wages, an economywide minimum wage restriction and so on. In the presence of domestic distortions, the importing (home) country may prefer to use a tax-cum-subsidy policy designed to weaken the distortions directly. If the government chooses the import tariff policy, that policy may distort the other product markets and the factor markets. Thus, based on the assumption of a small price-taking country, the research literature has shown that the optimal policy