Alasdair Smith

Strategic Investment, Multinational Corporations and Trade Policy

This paper presents a model of the multinational corporation focusing on a foreign firm which wishes to operate in a particular country. The firm must choose between direct investment and production in the country and production of the product elsewhere, followed by its export into the country concerned. The paper considers how government policy may influence this choice. Foreign direct investment may serve as a deterrent to entry, in the style of Dixit (1980). The effects of trade policy on foreign direct investment are very different in this oligopolistic model than in a competitive model. Depending on the nature of the oligopolistic equilibrium, tariffs may or may not induce foreign direct investment, they may or may not change the market structure, and they may have pro- or anti-competitive effects. In particular, it is possible for a tariff to deter foreign direct investment, contrary to the conventional wisdom.

Trade and industrial policy under imperfect competition

Trade and industry Anthony Venables and Alasdair Smith The textbook model of international trade is set in a world of perfectly competitive markets where products are homogenous and economies of scale are absent. Yet empirical evidence of two-way trade in similar products and of the importance of scale economies suggests this model is unrealistic. This paper examines the implications of imperfect competition for trade and industrial policy and evaluates the robustness of the conventional recommendation of free trade. Although policy design should be sensitive to the degree of competition, some general and intuitive principles emerge. Good policies target and promote activities which imperfect competition had previously overrestricted. Since trade affects the degree of competition in domestic and foreign markets, it is important that trade, industrial, and anti-trust policy should be complementary. To quantify these insights, the paper develops empirical models of two industries, refrigerators and footwear, which are then used to compare the effects of trade policy (tariffs or export subsidies), with or without foreign retaliation, and industrial policy (a production subsidy). Free trade is rarely the best policy. Whilst some forms of subsidy benefit some or even all countries, reciprocal tariffs are likely to harm the world economy. A strong rationale remains for negotiated and reciprocal reductions in trade barriers.

Capital theory and trade theory

Publisher Summary In a major survey of the theory of international trade, dynamic trade theory calls for further, systematic analysis and synthesis, and notes the negligible dent made so far by intermediate and capital goods in the theoretical models employed by analysts of international trade. This chapter surveys the progress that has now been made in incorporating capital goods into trade theory and discusses the dynamic models of trade and growth. Within this model, it is possible to develop a treatment of welfare economics that broadly follows the well-known static theory of the gains from trade although with some important features peculiar to intertemporal theory. Few positive-economic results are obtainable within such a general model. The chapter also provides two alternative ways of simplifying the general model so as to obtain useful results: reducing the number of goods, factors, and time-periods ill the model, or considering only steady states. Results in particular cases, which turn out to be similar to the standard results in models without capital, may not be sufficient to show that capital makes no difference. The chapter provides steady-state analysis: when a comparative dynamic result in steady state is formally very similar to a comparative static result in a timeless model it tempts to give the former result the same title as the latter, but such terminology may sometimes be misleading.

Intergenerational transfers as social insurance

Abstract In an overlapping-generations model with stochastic population changes, a social security scheme with a fixed level of payments to the retired can be interpreted as providing social insurance against the risks of demographic change.

The political economy of Eastern European trade with the European Community: why so sensitive?

EC trade with Eastern Europe Jim Rollo and Alasdair Smith Despite agreements to open trade with Eastern Europe, the European Community has retained a substantial degree of protection against imports of ‘sensitive’ products, notably agricultural products, textiles and clothing, and steel. This article investigates how sensitive these products really are. It is true that the targeted products are important to the EC economy, particularly in the poorer or declining regions. Yet trade with Eastern Europe only amounts to a very small proportion of the size of these sectors. When a large increase in imports is simulated, the overall effects on the Community are not insignificant, but are well within the range of the normal experience of economic change. Even without taking into account the fact that Eastern markets for EC goods would also grow, trade liberalization is welfare-increasing, particularly far Eastern Europe. Thus ‘contingent protection’, which may seriously deter investment in Eastern Europe, may simply be protectionism in any sector in which Eastern Europe is successful.

Some simple results on the gains from trade, from growth and from public production

Abstract A simple compact but general revealed-preference type of argument is used to derive results on the gains from trade, from terms of trade changes, and from exogenous resource growth. The approach extends to the welfare evaluation of public sector production. The relation between the sufficiency conditions for welfare improvement derived from this approach and the necessary and sufficient conditions derived in an alternative approach are briefly discussed. Most of the argument is conducted in the context of a representative-individual economy, though it is shown to extend in an essentially unchanged way to cases where redistribution is an issue.

The Accession of the UK to the EC: A Welfare Analysis

This article provides a decomposition of the welfare impact on the UK arising from the changes in manufacturing trade consequent upon joining the EC. The methodology employed is that of computable general equilibrium (CGE) modelling, where the underlying model is based on trade under imperfect competition with firms producing under conditions of increasing returns to scale. CGE models can be seen as providing numerical illustrations of theory, or as empirical tools providing estimates of policies. A second aim of this article is then to asses the extent to which CGE models can be used as serious tools of policy analysis. We examine this by assessing the success of the model in replicating counterfactual outcomes. The results indicate (i) that the model does reasonably well in replicating complex reality and that such models can be empirically useful; (ii) that a substantial portion of the welfare impact is attributed to distortions associated with imperfect competition, and that the impact is potentially quite large.

Tax reform and temporary inefficiency

Abstract If any type of direct income redistribution is permitted, a very weak condition ensures that it will not be desirable or necessary to permit production inefficiency in the process of a Pareto- improving tax reform. Inefficiency arises in models which make an implausible set of assumptions about the range of policies available to the government.

Constrained Optimal Trade Policy for Imperfectly Competitive Industries

Much of the literature on trade policy under oligopoly is concerned with establishing the welfare effects of small changes in some particular policy instrument, such as export subsidies or import tariffs. The welfare effects of these instruments are derived from their effects on the economy’s terms of trade, and on the scale of operation of ‘distorted’ domestic activities. Typically the literature makes little attempt to distinguish whether a policy is changing welfare through the terms of trade or through distortions. Furthermore, there has been little exploration of the interaction between different policy instruments. For example, how is the case for trade policy altered if other policy instruments are being used to manage domestic distortions? This approach is in marked contrast to the theory of policy developed for perfectly competitive economies. Here the method is to isolate the effects of policy on terms of trade and on distortions, and consequently to derive a theory of policy targeting. Trade policy should be used to manipulate the terms of trade and other instruments used to counter domestic distortion.