Abstract
The welfare loss calculated by Romer (J Dev Econ 43:5-38, 1994) under the assumption that certain import varieties disappear a result of increased protection are an order of magnitude larger than those obtained by any other investigator. In this paper, we will argue that the key source of Romer’s result is the total absence of domestic varieties of the differentiated product. Once we allow the differentiated product to be produces at home, the results change dramatically. This allows for the realistic possibility that domestic production substitutes for imports once tariffs are imposed.
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Notes
Reviewing the work of Janssen (1961), Mundell (1962, p. 622) went on to state, “On a more philosophical level, there have appeared in recent years studies purporting to demonstrate that...gains from trade and the welfare gains from tariff reduction are almost negligible. Unless there is thorough theoretical re-examination of the validity of the tools on which these studies are founded...someone inevitably will draw the conclusion that economics has ceased to be important!” Reacting to the estimates by Johnson (1965), Bhagwati (1968) wrote in a similar vein and went on to offer an example in which an export subsidy that turned an importable into exportable led to halving of the national income. Balassa (1971) also applied the idea of X-efficiency to measuring the cost of protection to five developing countries.
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Acknowledgments
The authors would like to gratefully acknowledge comments of an anonymous referee. All errors are our own.
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Mukerji, P., Panagariya, A. Cost of Protection: A Second Look at the Romer Variety Effect. Open Econ Rev 22, 463–477 (2011). https://doi.org/10.1007/s11079-009-9135-7
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DOI: https://doi.org/10.1007/s11079-009-9135-7