2 management - School of International Business and ...

157 The Puzzle of Globalization
maximized if the tariff rate leads to an import price that equals the autarky price (prohibitive tariff).
The large country case (Box 2b) implies that the world market price reacts to the introduction of
a tariff. Instead of bearing the full tariff the large import country is able to shift parts of the tariff to
the trading partner. The exporters reduce their price compared to the free trade situation in order
to keep their market position in the tariff imposing large country as far as possible. Similar to
the small country case there exists no world market price; again, the volume of trade decreased
compared to the free trade situation. The distribution of the tariff between both countries depends
on the elasticity of supply and demand. The tariff imposing large country will be exposed to a
smaller part of the tariff if its supply and demand elasticity is high and the respective elasticity in
the other country is low. The effect on the large country’s welfare tends to be positive. Anyhow,
the final result depends on the reaction of the import volume on the allocation of the tariff between
both countries. The large country can determine the tariff rate that maximizes the welfare under
given supply and demand elasticity. The Optimal Tariff Theory [Johnson, 1954/55] explains the
condition that leads to an improvement of the welfare of the tariff imposing country. The tariff is
optimal when the gain from the improvement of the terms of trade offsets the loss of the lower
trade volume.
The comparison between both cases shows that firstly the large country is exposed to lower loss-
es than the small country. Secondly, the former has the chance to avoid negative welfare effects
by choosing an optimal tariff. If the supply and demand elasticity is high in the domestic market
and low in the foreign market, the tariff imposed by the large country reduces significantly the
price in the exporting country.
Even for a large country, the optimal tariff strategy does not result in net welfare gains if the
exporters are able to shift their part of the tariff to domestic consumers. This scenario requires
a strong domestic market position. If the import country substitutes the tariff by quantitative re-
strictions (e.g. import quota), it is able to level out the aforementioned price policy of the exports.
The smaller the quota, the more the domestic price in the import country increases. Compared to
the tariff, the government does not generate direct revenues except when auctioning the quota at
its full price. In the latter case the government receives the quota rent which is equivalent to the
tariff. When giving the quota rights to domestic imports, the benefits remain in the country. The
net welfare effect can be positive or negative depending on the relation between loss of efficien-
cy, revenues and distribution of revenues. The more restrictive the quota, the more probable is a
negative welfare effect.
Independent from the type of trade barriers the global welfare effects are negative compared with
the free trade situation.