The Optimal Tariff, Time Consistency and Immiserising Growth in a Large Country

Abstract

It is well-known that immiserising growth cannot occur in a large, non-distorted economy that employs its optimal tariff. However, if production decisions are made before tariffs are ir revocably set, then the conventional optimal tariff is not time-consistent. We show that if a large country employs its time-consistent optimal tariff, then ultra-import biased domestic growth can be immiserising both for the large country and for its foreign trading partners. We also show that if the large country employs its second-best domestic production tax on importables, then im miserising growth cannot occur. It is well-known that, under free trade, an outward shift in a large country's pro duction possibility frontier can lead to immiserising growth. It is also clear that, in the presence of domestic distortions, immiserising growth can occur for a small country. Finally, we know that immiserising growth cannot arise if the large country utilizes its optimal tariff and is not subject to domestic distortions. However, the determination of a large nation's optimal tariff, and the implications of economic growth for domestic welfare, are usually analyzed in an atemporal frame work in which production, consumption (trade) and tariff decisions are all made simul taneously. In reality, most productive activities require time and hence a nation will usually have to precommit to production decisions before consumption decisions are made. In a perfect foresight world in which the country can also credibly precommit to its optimal tariff, this precommitment to production activities, in advance of consump