Chapter 7: Trade Policy

In the competitive circumstance, free trade brings about a Pareto-efficient resource allocation in the world economy. Despite this remarkable theoretical result, the government of each individual country, in reality, often adopts interventional trade policies and somehow tries to affect the world resource allocations in favor of the country itself. Of course, the government of a country may have various “good” reasons for trade intervention. For example, the government may want to protect the domestic firms against harsher competition with foreign firms who can supply cheaper goods to the domestic market; to gain time to foster a new prospective industry that has just come into existence (i.e., an infant industry) until it becomes a mature well-established industry; to secure the health and safety of its nationals from those foreign food products that do not meet the appropriate sanitary/phytosanitary standards in the country, and so on. To see if those and other reasons for trade intervention can be theoretically justified or not, we have to get a good understanding of the effects of various trade policies and the way how they work. In this chapter, we first examine trade policies in the competitive circumstance. Our main focus will be on tariffs. The similarities and differences between tariffs and other policy measures will also be discussed. Then, we move on to the examination of trade policies in some imperfectly competitive circumstances. We discuss the so-called strategic trade policy arguments.