Rules and Discretion in Trade Policy

Abstract

We argue that the second-best nature of trade-policy suggests that the issue of time consistency will be an important consideration in determining the extent and efficacy of such intervention. If production decisions are made prior to consumption decisions, governments with sufficient policy discretion will be tempted to surprise producers with policies other than those announced in an effort to separate the consumption tax aspect from the production subsidy dimension of a tariff. This leads optimal trade policy to be time-inconsistent in a wide range of environments. We explore this idea and illustrate the results with specific examples.

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