Optimal public policies in small open economies
Creators: name: Turunen, Arja Helena
Publisher: name: University of British Columbia
Year: 2010

description: Until recently, proofs establishing the existence of gains from trade have used the assumption that the government can alter the distribution of income by a set of lump sum transfers , i.e ., the government has at its disposal a set of household specific transfer instruments. However, recent work has been devoted to situations where these transfer instruments are inadmissible. Dixit and Norman (1980: 79-80) demonstrate that a government that can alter all domestic commodity taxes can ensure that no individual is made worse of by moving from autarky to free trade. It turns out, however, that this Dixit and Norman proof of the gains from trade shows only that the autarky equilibrium can be replicated under free trade and not that positive gains will occur. One of the purposes of this thesis is to investigate the problem of the gains from trade when a variety of tax and transfer instruments are available. It is fruitful to regard the problem of the gains from trade as a policy reform question: can the government in the home country find a small (differential) perturbation in the country's initial international trade prohibitive tariffs which, accompanied with a suitable (differential) perturbation in the country's commodity tax structure, results in a strict Pareto improvement? In order to answer the question, a model for the production side of an economy is presented in Chapter 2. It is established that, under some very weak conditions, there are (differential) tariff perturbations that improve the country's initial net balance of trade. In Chapter 4, it is shown that these productivity gains can be distributed to the consumers in the economy in a strict Pareto improving way by suitably adjusting the country's initial commodity tax rates. The principal tool for establishing these results is a duality theorem: Motzkin's Theorem. Chapter 3 develops two approximative formulae for measuring the productivity gain accruing from a change of tariffs. Some examples of strict Pareto improving perturbations in commodity taxes and tariffs are given in Chapter 7. These include proportional and uniform reductions of tariffs as well as a change toward uniformity in the country's initial tariff structure. Next, the government is assumed to be able to adjust only the home country's initial vectors of tariffs and lump sum transfers but not the vector of commodity taxes. Conditions for strict Pareto improving tariff and transfer perturbations to exist are developed. In Chapter 9 it is shown that neither the existence of strict gains from trade under commodity taxation or under lump sum compensation necessarily implies the other. Examples of strict Pareto improving changes in tariffs, taxes and transfers are given in Chapter 10. These include proportional reductions of tariffs and/or taxes and movements toward uniformity in the tax rates for domestic and tradable commodities. The role of normality of commodities in consumption in policy recommendation results is also discussed. Chapter 11 develops sufficient conditions for a perturbation in the home country's tax structure, which causes international trade, to be strict Pareto improving. In Chapter 12 the goal of the government is to choose a policy that reduces the level of economic inequality associated with the initial observed equilibrium in the economy. It is shown that inequality reducing perturbations in commodity taxes and tariffs exist, if the preferences and initial commodity endowments of the consumers satisfy certain conditions.