Optimal Tariffs

Entry for the New Palgrave, 2^nd Edition

Nuno Limão

University of Maryland
December 2006

Abstract

Optimal tariffs are trade taxes that allow a country to exploit its market power in international trade. A country can improve its terms-of-trade and welfare by unilaterally restricting its exports if it faces a downward-sloping demand for them or restricting its imports if it faces an upward sloping foreign export supply. The terms-of-trade argument against unilateral free trade is over 150 years old but it remains central to modern theories that explain trade agreements and their rules. This, along with recent evidence that prior to such agreements countries exploit their market power in trade, indicates that optimal tariffs may be an important positive theory of protection.