Journal Article

Choosing between Protectionism and Free Trade in an Uncertain World

We develop a 2x2x2 general equilibrium model of trade with imperfect capital mobility, uncertain productivity in one sector, and risk-neutral producers chosing the capital allocation before uncertainty resolves. Without government intervention, the allocation of production is more export-oriented than what risk-averse consumers prefer. National welfare maximization hence justifies the use of trade policy. With uncertainty in both countries, a trade-off exists between trade as insurance against domestic shocks, and protection as insurance against foreign shocks. We find that the optimal trade policy depends not just on a country's comparative advantage, but also on the size and the correlation of the domestic and foreign shocks it experiences. Our results are consistent with persistent protection in sectors such as agriculture.


Peter Debaere
Toni Glaser


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