In Discussion Paper No. 1037, Research Fellow Christian Keuschnigg and Wilhelm Kohler assess the &nbspconsequences &nbspof commercial &nbsppolicy in an intertemporal computable general equilibrium model of an imperfectly competitive, small open economy. Specifically, they combine an overlapping generations model of aggregate savings with capital accumulation by forward-looking investors &nbspand production under monopolistic competition and increasing returns to scale.

Quantitatively evaluating the effects of several commercial policy scenarios on the Austrian economy, the authors produce a number of insights. First, trade liberalization is clearly expansionary: even if unilateral tariff cuts are not repeated abroad, the home economy experiences both an investment boom and rising employment and output, while export subsidies tend to be even more expansionary and may be self-financing. Second, under monopolistic competition, the expansionary effects and associated welfare increases get magnified. Third, although all generations participate in the efficiency gains, the gains are generationally uneven. Last, the dynamic adjustment of the economy to its long-run equilibrium position involves heavy initial worsening of the trade balance and an increase in foreign indebtedness in terms of imported goods. This implies rather large overshooting in the net asset position, associated with a transitory savings shortfall. These results highlight a simple point of which commercial policy-makers may not always be fully aware: foreign indebtedness in and of itself is devoid of any welfare significance. It may simply be the result of the dynamics of welfare-improving expansion of the home economy.

Commercial Policy and Dynamic Adjustment Under Monopolistic Competition
Christian Keuschnigg and Wilhelm Kohler

Discussion Paper No. 1037, November 1994 (IT)