DP856 Phasing in and Phasing Out Protectionism with Costly Adjustment of Labour

Author(s): Larry Karp, Thierry Paul
Publication Date: December 1993
Keyword(s): Adjustment Costs, Dynamic Tariffs, Markov Perfection, Time Inconsistency
JEL(s): F13, J20, J24
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=856

We study the dynamics of optimal trade policy in a model with costly inter-sectoral adjustment of labour, where migrants pay less than the marginal social cost of migration. If workers have rational expectations, a future tariff has an announcement effect on the current migration decision. If the government is able to commit itself to future policy, the optimal trajectory involves phasing in and then phasing out protection of the dying sector. This contrasts with recommendations of gradual liberalization. Without the ability to make commitments, the equilibrium policy begins with and maintains free trade.