TRADE POLICIES AND WELFARE IN A HARRIS-TODARO ECONOMY

This paper uses the HT model to analyze optimal trade policies of a small open labor-surplus economy with intersectoral capital mobility. An increase in the price of the importable increases the capital rental but decreases the rural wage, regardless of the factor intensities of traded goods. It is shown that an important tariff is welfare-reducing and the optimal tariff is negative. However, if a production subsidy is used, the optimal production subsidy on the importable is negative and the optimal tariff is zero. The analysis has two important implications on trade policies. First, when LDCs lack other revenue sources to finance production subsidies, an import tariff raises government revenue but reduces domestic welfare. Thus, an optimal policy is an import subsidy (a negative import tariff), or equivalently, an equal export subsidy. Second, if revenues can be generated, the optimal policy is not an export subsidy, but a production subsidy on the exportable (which is equivalent to a production tax on the importable). Production subsidy is superior to export subsidy, even though the latter promotes export more directly. -from Authors