Differential tariffs, growth, and welfare in a small open economy

This paper analyzes the effects of consumption and investment tarrifs on gr owth and welfare. With endogenous laber supply, consumption tariffs are not growth-neutral. Instead, an increase in either tariff reduces both the sho rt-run growth rates of key economic variables such as GDP, consumption, and foreign debt, and their common long-run equilibrium growth rate. Numerical simulations suggest that the investment tariff has a more adverse effect o n growth rates and welfare than does a comparable consumption tariff. Accor dingly, a revenue-neutral substitution of a consumption tariff for an inves tment tariff is both growth-enhancing and welfare-improving. The second-bes t and first-best optimal tariffs are characterized and shown to involve the heavy subsidization of investment. (C) 2000 Elsevier Science B.V. All righ ts reserved. JEL classification: E62; F43; O20.