Distributing the Gains from Trade With Incomplete Information
Tracy R. Lewis
We argue that the incomplete information which the government has about
domestic agents means that tariffs become an optimal instrument to protect
them from import competition. We solve for the optimal government policies.
subject to the political constraint of ensuring Pareto gains from trade, the
incentive compatibility constraint, and the government's budget constraint. We
find that the optimal policies take the form of nonlinear tariffs, so that both
buyers and sellers of the import face an effective price which exceeds its
world level. We find that the tariffs are never complete, in the sense of
bringing prices (or all individuals back to their initial level. Rather, it will
always be possible to make some individuals strictly better off than at the
initial prices, while ensuring that no persons are worse off.
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