Second-best policy for international trade and investment
Journal of International Economics , Volume 14 - Issue 3-4 p. 313- 320
This paper investigates second-best commercial policy for an open economy, within the two-commodity two-factor model of a two-country world, where the first-best strategy is known to require taxes (subsidies) on both international trade in commodities and foreign investment via capital movements. As the analysis shows, when either of these policy instruments is prohibited, the other instrument generally must be complemented by a tax (subsidy) in consumption or production if a second-best (rather than third-best) equilibrium is desired. The paper derives, moreover, precise conditions for determining the second-best package of policies.