601-mb-2004 - Review of International Economics, 12(3),...

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Tariff Wars and Trade Deals with Costly Government John Burbidge and Gordon Myers* Abstract The authors study a simple model of tariff wars and trade deals in which government revenue collection and disbursement uses resources. The introduction of costly governments leads to lower non-cooperative tariffs, the possibility that a less costly government may win a tariff war, and fully cooperative trade deals where countries lower tariffs but do not eliminate them, even with lump-sum taxes and transfers. 1. Introduction The standard theoretical model of non-cooperative tariff determination leads to the familiar tariff-war results (Johnson, 1953). Some authors, including Krugman (1993), have argued that this standard theoretical result may be inconsistent with observa- tion—non-cooperative tariffs appear to be set more “cooperatively”—that is, lower. On the other hand, the traditional customs-union literature presumes free trade within each customs union. Here the reality is that tariffs appear to be set less cooperatively— that is, higher. Even for members of trade blocs, “cooperation” appears to be limited in the sense that trade deals while characterized by reciprocal reductions in tariffs are not characterized by the elimination of tariffs on all goods and services.This is also the case for the GATT under the auspices of the WTO which furnishes many examples of such trade arrangements.This short paper provides a simple explanation for lower non- cooperative tariffs and higher cooperative tariffs. 1 Clearly the operation of a government requires resources. So we begin with a stan- dard trade model and assume, for example, that hiring a customs ofFcer costs resources. We show that this simple extension yields two results in the tariff-war model. 2 ±irst, the introduction of a costly government may lower that country’s non- cooperative tariff. The logic is that one of the beneFts of a tariff is the revenue raised, and since an increase in the cost of government reduces the net revenue for a given tariff it also reduces the optimal tariff (Result 1). Now consider two countries that differ in their costs of government. The country with the less costly government can win a tariff war in the sense that it is better off at the non-cooperative equilibrium than at the laissez faire free-trade allocation. Here the idea is that the country with lower costs will face a lower non-cooperative tariff the more costly is the opposing country’s government (Result 1); consequently the less costly country can win the tariff war (Result 2). Review of International Economics, 12(3), 543–549, 2004 *Burbidge: Department of Economics, University of Waterloo, Waterloo, ON, N2L 3G1, Canada. Tel: 519- 888-4567 ext. 7204; ±ax: 519-725-0530; E-mail: jburbidg@watarts.uwaterloo.ca. Myers: Department of Eco- nomics, Simon ±raser University, Burnaby, BC, V5A 1S6, Canada. Tel: 604-291-3409; ±ax: 604-291-5944; E-mail: gmmyers@sfu.ca. The Frst draft of this paper was written while Burbidge was visiting the Univer- sity of Western Ontario. He is grateful to this institution for its hospitality and Fnancial support. In addi-
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601-mb-2004 - Review of International Economics, 12(3),...

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