DISCRIMINATORY TARIFFS AND THE MOST FAVORED NATION CLAUSE. by Konstantine GATSIOS* and Evmorfia MAKANTASI** DISCUSSION PAPER No.

Transcription

1 ISCRIMINATORY TARIFFS AN THE MOST FAVORE NATION CLAUSE by Konstantne GATSIOS* and Evmorfa MAKANTASI** ISCUSSION PAPER No. 0 July 00 The scusson Papers n ths seres crculate manly for early presentaton and dscusson, as well as for the nformaton of the Academc Communty and all nterested n our current research actvty. The authors assume full responsblty for the accuracy of ths paper as well as for the opnons expressed theren. epartment of Economcs Athens Unversty of Economcs and Busness 76 Patsson Str., Athens 04 34, Greece Tel. (++30) Fax: (++30) * Professor, ept. of Economcs, Athens Unversty of Economcs and Busness. ** Ph.. Canddate, ept. of Economcs, Athens Unversty of Economcs and Busness.

2 ISCRIMINATORY TARIFFS AN THE MOST FAVORE NATION CLAUSE Konstantne GATSIOS* and Evmorfa MAKANTASI** epartment of Economcs, Athens Unversty of Economcs and Busness Abstract The am of ths paper s to shed lght on the mpact the degree of product dfferentaton has on dscrmnatory tarffs, on tarffs and on welfare. It s shown that under both tarff regmes, dscrmnatory and, the equlbrum levels of tarffs, outputs and profts are postvely related to the degree of product dfferentaton. The mportng country and the less cost effcent exporter are both worse off, whereas the more cost effcent country and the world as a whole are better off when the prncple s appled. However, all those welfare changes are lesser n magntude as the degree of product dfferentaton ncreases. Keywords: prncple; scrmnatory tarffs; Product dfferentaton; Welfare analyss. JEL Classfcaton: F; F3; F4. *e-mal: gatsos@aueb.gr **Correspondence Author e-mal: faymakantas@aueb.gr

3 . Introducton It s wdely accepted that one of the "pllars" of the WTO (World Trade Organzaton), as well as ts predecessor, the GATT (General Agreement n Tarffs and Trade), s the prncple of non-dscrmnaton (see, for nstance, Horn and Mavrods 00.) The prncple of non-dscrmnaton, or the Most Favored Naton () clause as t s more wdely known, s a norm under whch a member-country (or a customs unon) must adopt the same unfed tarff schedule for mports aganst all ts tradng partners. Gatsos (990) offers a smple explanaton for the need for an nternatonal agreement such as the prncple. In a model wth two exportng countres-frms producng a homogeneous product, subsdzng ther exports and competng for the market of a thrd mportng country, he shows that n the absence of the mportng country s optmal tarff polcy would be to tarff dscrmnate by mposng a hgher tarff on the more cost effcent exporter. Moreover, he shows that although that prncple s well ustfed n terms of world producton effcency by dvertng producton from the less to the more cost effcent country, ncreasng n ths way world welfare, ts dstrbutonal effects favor only the more developed (and more cost-effcent) countres whle they harm the other two countres. Hwang and Ma (99) produce a smlar result. Moreover, they show that f the two exportng frms sell dfferentated products wth lnear technologes, then wth lnear and symmetrc demands, the weaker the degree of product dfferentaton the greater the tarff dfference, under tarff dscrmnaton, compared wth the cost dfference. Sagg (004) extends Gatsos results usng a n 3country olgopoly model of ntrandustry trade n a homogenous good. He confrms that the non-cooperatve tarff equlbrum results nto a preferental tarff regme n whch each country mposes hgher tarffs on low cost producers relatve to hgh cost ones. He also confrms that the adopton of tarffs by each country mproves world welfare by elmnatng the neffcent trade dverson generated by tarff dscrmnaton. Fnally, he shows that hgh cost countres refuse recprocal adopton wth others and that they lose even n the case where others engage between them n recprocal adopton. Cho (995) brngs up the role of the prncple as a commtment mechansm that helps to resolve the tme-nconsstency problem facng the mportng country. In partcular, he allows exportng frms to endogenze ther cost levels by nvestng n some cost reducng actvty, lke R&. He then explores the effects of an actve trade polcy on the choce of technology by the producers, to sow that under a lower margnal cost technology wll

4 be chosen by the exporters, leadng to welfare gans by the mportng country. The source of neffcency stems from the fact that ex post technology choce, the mportng country prefers dscrmnatory tarffs. Bagwell and Stager (999), develop a general equlbrum trade model that takes nto account poltcal-economy consderatons relatng to the possblty of dstrbutonal concerns n the preferences of governments, n addton to those of natonal ncome maxmzaton. They establsh that both the prncple as well as that of recprocty can be vewed as smple rules assstng governments n the mplementaton of effcent trade agreements. As a consequence, they argue that the preferental agreements undermne the WTO s (GATT s) ablty to establsh effcent multlateral outcomes. Another reason for mportng countres wantng to abde by the prncple s provded by To (999). He develops a dynamc model n whch governments lack the ablty to precommt, whle consumers are facng swtchng costs. When these costs are suffcently hgh, then dscrmnatory tarffs, by reducng the value of market share, may lower the mportng country s welfare. That creates an ncentve for mporters to stck by the rule. Sagg and Yldz (005) present a case where tarff dscrmnaton may be preferred to from a world welfare perspectve. In partcular, they develop an olgopoly model of trade between two exportng countres and one mportng country to show that f the two exportng countres are asymmetrc wth respect to both cost and market structure, then when hgh-cost exporters are merged t s possble that tarff dscrmnaton s welfare preferred to. McCalman (00) explores the nteracton between prvate nformaton and the clause n trade negotatons. He shows that the prncple, by aggregatng uncertanty over a number of tradng partners, may offer an mprovement over a set of blateral trade negotatons. Ths mprovement s more pronounced the larger the number of countres nvolved n such negotatons. In a smlar fashon Ozerturk and Sagg (005) examne how the ncomplete nformaton on behalf of the mportng country regardng the costs of the two exportng frms affect the case for tarffs. They show that, despte the lack of complete nformaton, the mportng country stll prefers tarff dscrmnaton to. However, equlbrum tarff dsperson s lower and, as a result, the global welfare gans from, although postve, are smaller under ncomplete nformaton relatve to the case of complete nformaton. Ths paper develops a smple model of two exportng frms/countres each producng a varety of a dfferentated product solely for exports n a thrd mportng country, to focus on 3

5 the mpact that the degree of product dfferentaton has on dscrmnatory and tarffs, as well as welfare. We show that both under tarff dscrmnaton and tarffs, the equlbrum levels of tarffs, outputs and profts are all postvely related to the degree of product dfferentaton. Ths s because the more dfferentated the two varetes are, then the hgher degree of monopoly power enoyed by the two exportng frms results to hgher profts; the hgher mport tarffs, then, reflect the desre of the mportng country to capture a part of those ncreased profts. However, we also show that under both regmes the dfference between the two frms equlbrum proft levels gets smaller the more dfferentated the two varetes are. As a result, the welfare effects of movng from a regme of dscrmnatory tarffs to tarffs are less pronounced the hgher the degree of product dfferentaton. The mportng country and the less cost effcent exporter are both worse off, whereas the more cost effcent country and the world as a whole are better off when the prncple s appled. However, all those welfare changes are lesser n magntude as the degree of product dfferentaton ncreases. The rest of ths paper s organzed as follows. In secton. we present the model, whle sectons.3 and.4 examne the equlbrum outcomes under, respectvely, dscrmnatory and tarffs. In secton.5 we compare the tarff and the welfare levels under the two regmes and relate them to the degree of the product dfferentaton. Secton.6 concludes.. The model There are two exportng frms, denoted by,, each one of whch s located n a dfferent country. Each frm produces a varety of a dfferentated good and they both compete for the market of a thrd mportng country. For smplcty, we assume that the two varetes are produced solely for exports and that they are not produced n the thrd country. Ths s a facltatng assumpton; t does not affect our man results. We denote by q the amount of the dfferentated products suppled by frm,,. Followng xt (979) and Sngh and Vves (984) we assume the followng (nverse), symmetrc and lnear demand structure for the two varetes: p q q,, and () These demand functons come from a strctly concave, quadratc utlty functon 4

6 U( q, q) a q q ( q q ) qq () Strct concavty of the utlty functon s ensured by assumng that. Moreover, we assume that 0. Therefore, our restrctons on the values of become 0. They mply, n turn, that the own prce effects domnate the cross prce effects,, and that the goods are substtutes n consumpton, 0. The measure for the degree of product dfferentaton s gven by the value of. The two q varetes are hghly dfferentated f s close to zero (so that c 0 ), whereas they p q q are sad to be almost homogeneous f s close to (so that c b). p p The two frms operate under a constant margnal cost, denoted by c, and no fxed costs. Wthout any loss of generalty, we wll be assumng throughout that frm s more costeffcent. Namely, c c. Fnally, we assume that the mportng country leves a specfc tarff, t, on ts mports from country. The game n hand s a two-stage game: n the frst stage, the government of the mportng country chooses ts tarff schedules to maxmze ts own welfare. We wll dstngush two cases here; one n whch t follows a preferental tarff regme and one n whch t follows a non-preferental one accordng to the clause. In the second stage, frms compete n outputs a là Cournot. We are lookng for the sub-game Nash equlbra of the game..3 Preferental tarff regme ( t t ) Startng from the second stage of the game, the exportng frms choose ther output levels so as to maxmze ther profts; that s To see all ths fnd the drect demand functons, by nvertng the system of equatons () to get q a bp cp and q a bp cp, where a, b 0, c 0. Clearly, the own prce effects domnate the cross prce effects f b c or, equvalently,, and the two goods are substtutes (rather than complements) n consumpton f c 0 or, equvalently, 0. Clearly, both c and c must be smaller than the vertcal ntercept of the (symmetrc) nverse demand functons,,.e., c c. In fact, to ensure that quanttes are postve under both tarff regmes we assume that 4c. 5

7 max q, q q q q c q t q,, and (3) q One can easly see that the condtons governng the parameters of the model ensure that the proft functon of frm s strctly concave n ts own output, 0,, q and that the usual stablty condton holds, q q q q q q 4 0. Moreover, the two varetes are strategc substtutes, qq 0,,, and. The frst-order necessary condtons yeld the best response functons of the two exportng frms, gven by: ( c t) q q q,, and (4) As expected, the best response functons are downward slopng n the output space (outputs are strategc substtutes.) Moreover, the effect of the mport tarff on frm s to shft ts best response functon nwards: q t. Solvng ontly the best response functons (4) we get the equlbrum outputs of the two exportng frms under tarff dscrmnaton, functon of the mport tarffs q, as a ( c t ) ( c t ) q t, t,, and 4 (5) Ths completes the second stage of the game. The effects of the tarff t on the two exportng frms equlbrum output levels and profts are qute standard: t reduces both output and profts of frm and ncreases those of ts rval. 3 3 p Moreover, there s an ncomplete pass through of the tarff: 0. t 4 6

8 In the frst stage of the game, the government of the mportng country chooses ts tarff polcy to maxmze ts welfare, beng the sum of consumer s surplus plus tarff revenues; that s max W( t, t ) U( q, q ) p q p q t q t q,, and (6) t, t where U( q, q ) pq p q s the consumer s surplus and t q t q s tarff revenues. The frst-order necessary condtons yeld the mportng country s dscrmnatory tarff rule, gven by p p q q q t t t t t,, and q t (7) Substtutng (5) nto (7) and solvng ontly we get, after some routne calculatons, the optmal dscrmnatory tarff levels, ˆt, mposed by the mportng country on ts mports from country, as well as the equlbrum output levels of the two frms, gven by ˆq. Those are 3 3c c tˆ ˆ q,, and 9 (8) Substtutng nto (3) we derve the equlbrum proft levels of the two frms c a c 9 3 ˆ ˆq,, and (9) There are a few nterestng remarks we can make at ths pont. Frst we observe that, n equlbrum, the more cost effcent frm produces more, gans more and ts exports are taxed more: ˆ ˆ t ˆ ˆ q t q and ˆ ˆ. Put dfferently, the mportng country follows a 7

9 polcy of tarff dscrmnaton and mposes a hgher tarff on the exports of the most cost effcent frm. In partcular, c c 3 tˆ tˆ ˆ ˆ q q 0 (0) and snce ˆ ˆ c c t ˆ ˆ t q q 3 we get that ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ t t t t t t c c c c 9 0 () Notce n (0) that tarff dscrmnaton, as an optmal polcy for the mportng country, s entrely drven by cost dfferences, not by product dfferentaton; rrespectve of the value of 0, tarff dscrmnaton wll be followed so long as there s a cost dfference between the two exporters. Moreover, the larger that cost dfference s, the larger the dfference between the optmal dscrmnatory tarffs wll be. The reason behnd ths result s smlar to that n the case of homogenous products as n Gatsos (990): n the absence of mport tarffs, the more cost effcent frm would be producng more and, gven the symmetry of demands, would be earnng more n equlbrum. The greater the cost dfference s, the greater the dfference n profts, as () testfes. Hence, as mport tarffs are used to extract rent from the exportng frms, not only the tarff mposed on the more cost effcent exporter wll be hgher than the one mposed on the less cost effcent one, but ther dfference would get larger as ther cost dfferences (and, hence, ther proft dfferences) get more pronounced. Second, we observe that, the optmal tarffs gven by (8) are decreasng n, ˆt 0. (See, Appendx A.) Clearly, the same apples for outputs and proft levels. Therefore, the more dfferentated the two varetes are,.e., the smaller the value of s, the hgher the mport taxes and the larger the frms outputs and profts wll be. At the same tme, however, one observes from (0) and () that those dfferences are all ncreasng n. Thertefore, the more dfferentated the two varetes are, the less pronounced the dfferences between the dscrmnatory tarffs, the output levels and the profts become. We summarze our results n the followng proposton. 8

10 Proposton. Under mport tarff dscrmnaton, the mportng country sets a hgher mport tarff on the varety produced by the more cost effcent frm. Although the equlbrum values of tarffs, outputs and profts are all postvely related to the degree of product dfferentaton, ther respectve dfferences become smaller the more dfferentated the two varetes are..4 Non-Preferental () tarff regme ( t t t ) We now turn to the case of tarffs. Proceedng n an analogous manner to that of the prevous secton, n the second stage of the game the equlbrum output levels of the two frms under, q, are gven by (5) where we set t t t ; that s c c t( ) q t,,, 4 () We mmedately observe that, as expected, for any tarff level, the equlbrum output of the most cost effcent frm wll be larger than that of the less cost effcent one, q q. Ths wll be useful below. In the frst stage of the game, the mportng country chooses ts tarff schedule to maxmze ts welfare,.e., max W( t) U( q, q ) p q p q t q q t The frst order necessary condton yelds the optmal non-dscrmnatory tarff rule, gven by t p q t q t 0 4 (3) 4 The expresson s postve snce p t 0, that s, there s an ncomplete pass through q t 0. of the tarff, and snce the tarff exerts a negatve effect on output levels,.e., 9

11 Substtutng () nto (3) and solvng ontly we derve. after some routne calculatons the optmal tarff, partcular, ˆt, and the output levels of the two exportng frms, ˆq. In ˆq c c 3 5 (4) and ˆ a cc t qˆ ˆ q 0 (3 ) (5) Substtutng (4) and (5) nto (3) we derve the equlbrum proft levels of the two exportng frms. It turns out that ˆ c c 43 5 ˆq (6) As expected, snce both frms face the same mport tarff, the most cost effcent of them wll be exportng more and wll be makng hgher profts, n equlbrum: qˆ ˆ q and ˆ ˆ. In partcular, c qˆ ˆ c q (7) and snce c qˆ c ˆ q 3 we get that 5 5 Observe that the sum of equlbrum outputs are the same under both regmes; namely c c qˆ ˆ ˆ ˆ q q q 3 0

12 q q q q q q ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ c c c c 3 0 (8) Moreover, we observe from (5) that the tarff s decreasng n ; the more dfferentated the two varetes are (.e., the smaller the value of ) the hgher the mport tarff wll be: ˆt 0. The same apples to outputs and profts; they both ncrease as product dfferentaton becomes more promnent: ˆq 0 and ˆ 0. At the same tme, however, (7) and (8) suggest that the dfferences between the outputs produced and the profts ganed by the two exporters are ncreasng wth ; they become smaller the more dfferentated the two varetes are. We summarze these fndngs n the followng proposton Proposton. Under tarffs, the more dfferentated the two varetes are, the hgher the equlbrum levels of the tarff, the outputs and the profts are. However, the respectve dfferences between the two exporters output and proft levels become less pronounced the more dfferentated the two varetes are..5 Comparng the two regmes: tarffs, welfare and product dfferentaton Comparng the two tarff regmes, the dscrmnatory and the, we can derve a number of nterestng results. Frst, the optmal tarff les between the two dscrmnatory ones: ˆt ˆ ˆ t t. That s, the orgnal result by Gatsos (990) for the case of homogeneous products carres through n the case of product dfferentaton as well: n the absence of the clause n the WTO, the mportng country would have an ncentve to dscrmnate ts mport tarffs by settng a hgher tarff on ts mports comng from the more cost effcent country. To show ths, smply dfferentate the welfare functon of the mportng country gven by (6) wth respect to t and evaluate the dervatve at the optmal value of the tarff gven by (5). If that dervatve s postve (respectvely, negatve) then t would mply that the optmal dscrmnatory tarff ˆt. Indeed, t s easy to see that ˆt s larger (respectvely, smaller) that the optmal tarff

13 W qˆ ˆ q t 4 ˆ t t (9) Hence, snce qˆ ˆ q, t mmedately follows that turn confrms our clam, namely, ˆt ˆt ˆt. W t W 0 t ˆ ˆ tt tt, whch n In fact, we can clam somethng more than that. The value of the optmal tarff les. To n the mddle between the values of the dscrmnatory ones; namely, ˆ t ˆt ˆ t see ths, recall that tˆ qˆ,, (eq. 5). At the (eq. 8) and that tˆ qˆ ˆ q same tme, as we have already noted and as one can easly confrm from (8) and (4), the total amount of mports remans unchanged under the two regmes, qˆ qˆ. The applcaton of tarffs has smply dverted producton from the less to the more cost effcent frm. In partcular, c c qˆ qˆ (0) 3 Ths, mmedately, establshes our clam. We now turn to examnng the welfare effects of movng from a regme of tarff dscrmnaton to that of tarffs on the exportng countres, the mportng country and the world as a whole. Moreover, we are nterested n examnng n whch way the degree of product dfferentaton affects those welfare changes. We start from the two exportng countres. Snce we have assumed that the two exportng frms produce solely for exports, the comparson of welfare levels amounts to comparng the proft levels under the two regmes. But, snce ˆ ˆq and ˆ ˆq, what s needed s to compare output levels. To do so, we recall that from (0) and (7) we know that c c 3 qˆ ˆ q 0

14 and c qˆ ˆ c q c c Consequently, qˆ qˆ qˆ qˆ qˆ qˆ qˆ ˆ q 3 () But we also know from (0) that qˆ qˆ ˆ ˆ q q. Or, equvalently, that qˆ qˆ qˆ qˆ () Combnng () and (), we get c c qˆ qˆ qˆ qˆ 3 0 () That s, qˆ ˆ q and qˆ ˆ q conclude that ˆ ˆ and ˆ ˆ. Therefore, snce ˆ ˆq and ˆ ˆq, we. Moreover, t s mmedate from () that the more dfferentated the two varetes are,.e. the smaller the value of s, the smaller these dfferences n welfare are. At ths pont, t wll be useful for future purposes to see what the dfference s n the total welfare (profts) of the two exportng countres under the two regmes. enotng by ˆ,, the sum of the two frms profts under the two regmes and recallng that ˆ ˆq,,, we get qˆ qˆ qˆ qˆ qˆ ˆ q qˆ ˆ q qˆ ˆ q qˆ ˆ q ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ Snce qˆ qˆ ˆ ˆ q q (eq. ) we get q q q q q q ˆ ˆ q q q q q q 3

15 Fnally, usng (0), (7) and () we conclude that 5 3 c c 0 () We observe that the total welfare (profts) of the exportng countres (frms) ncreases under. That would mply that the welfare gans enoyed by the more cost effcent country under tarffs outwegh the correspondng welfare losses ncurred by the less cost effcent one. Moreover, we observe, agan, that that dfference n the total welfare of the two exporters s decreasng wth the degree of product dfferentaton. We now turn to the mportng country. As t does not produce the dfferentated good domestcally, ts welfare s composed of tarff revenues, TR,, and consumer surplus, CS,,. Regardng tarff revenues, these are hgher under tarff and dscrmnaton rather than under. In partcular, recallng that ˆ t ˆt ˆ t ˆ ˆ ˆ ˆ, we get that q q q q TR TR ˆt qˆ ˆt qˆ ˆt qˆ qˆ ˆt qˆ ˆt qˆ ˆt qˆ ˆt qˆ qˆ qˆ ˆt ˆt qˆ ˆ q qˆ ˆ q snce ˆ t q ˆ,,. Usng (0) we fnally get that TR TR c c 3 0 (3) Therefore, movng from tarff dscrmnaton to tarffs, the mportng country experences a reducton n ts tarff revenue. That reducton, however, s smaller the more dfferentated the two varetes are (.e., the smaller the value of.) Although tarff revenues decrease under tarffs, consumer surplus ncreases. To see ths recall that CS U q, q p q p q and use () and () to get, after some 4

16 manpulatons, that surplus between the two regmes s CS a q q qq. Therefore, the dfference n consumer CS CS q q q q q q q q ˆ ˆ 0 ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ where the last equalty s derved by recallng that observng that qˆ qˆ qˆ qˆ ˆ ˆ. 6 Usng (), the above expresson becomes ˆ ˆq,,, and by 5 3 c c CS CS 0 (4) Interestngly, controllng for the cost dfferental, we observe that the change n consumer surplus s due entrely to product dfferentaton. As the two varetes become more alke (.e., as ) the dfference n consumer surplus under the two regmes tends to zero. Combnng (3) and (4) and after some routne calculatons we get that the welfare of the mportng country s reduced under tarffs. That s, the ensung loss s tarff revenue overtakes the gans n consumer surplus. In partcular, t turns out that c c W W3 0 (5) We observe, however, that the more dfferentated the two varetes are, the less s the welfare loss experenced by the mportng country under tarffs. Ths s because, as we notced 6 The latter holds because q q q q q q q q q q ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ ˆ qˆ qˆ qˆ qˆ 5

17 above, under tarffs the losses n tarff revenues get smaller the more dfferentated the two varetes are and, at the same tme, the gans n consumer surplus partly offset those losses. In the opposte case, as the two varetes become more smlar the losses n tarff revenue ncrease whle the gans n consumer surplus evaporate. We have seen, up to ths pont, that movng from dscrmnatory tarffs to tarffs s welfare mprovng for the more cost effcent exporter and welfare deteroratng both for the less cost effcent exporter and the mporter of the dfferentated products. Moreover, we have notced that these welfare losses and gans are less pronounced the more dfferentated the two varetes are. We now turn to examnng the correspondng effects on world welfare. World welfare, beng the sum of the welfare levels of the three countres, s composed of consumer surplus, tarff revenue and total profts. Therefore, denotng world welfare under the two regmes by WW,, we get ˆ ˆ WW WW CS CS TR TR ˆ ˆ TR TR 3. where the last equalty follows from the fact that CS CS ˆ ˆ Usng () and (3) and after some routne calculatons the above expresson becomes c c WW WW 0 (6) Therefore, world welfare ncreases under. Although both the less cost effcent country and the mportng country loose under, the welfare gans of the most cost effcent one overtake those losses. Ths s due to the mprovement n world producton effcency: the applcaton of the tarffs dverts, as we have seen, producton from the less to the more cost effcent country. However, these welfare gans are less sgnfcant as the varetes become more dfferentated. We summarze our results n the followng proposton 6

18 Proposton 3. In the absence of the clause, the mportng country would have an ncentve to dscrmnate ts mport tarffs by settng a hgher tarff on ts mports from the more cost effcent country. Compared to tarff dscrmnaton, the applcaton of tarffs s welfare mprovng for the more cost effcent exporter, whle t s welfare deteroratng for both the less cost effcent and the mportng country. At the same tme, tarffs are welfare mprovng for the world as a whole, as they result n the mprovement of world producton effcency. However, all these gans and losses are less pronounced the more dfferentated the two exported varetes are..6 Concludng Comments In a smple model wth two exportng countres/frms each producng a varety of a dfferentated product and one mportng country, we have seen that, n the absence of the clause, the mportng country would have an ncentve to dscrmnate ts mport tarffs by mposng a hgher tarff on ts mports from the more cost effcent producer. The applcaton of the clause leads to a (unform) tarff level lyng n between the two dscrmnatory ones. However, under both regmes, the optmal tarff levels are postvely related to the degree of product dfferentaton. So are output and proft levels. Swtchng from a regme of tarff dscrmnaton to one of tarffs results to an mprovement of world producton effcency, as producton s dverted from the less to the more cost effcent producer. But t also has dstrbutonal effects. Although world welfare s ncreasng, due to the mproved producton effcency, the dstrbuton of those welfare gans s pretty asymmetrc. It s only the more cost effcent exporter who benefts; both the less cost effcent exporter and the mporter stand to lose. So, one can understand the tensons exstng between more and less developed countres regardng the applcaton of the prncple. However, we have also shown that the welfare mplcatons, postve or negatve, are less acute the more dfferentated the two varetes are. As the bulk of trade s n dfferentated products, that would mply that the tensons between the more and the less developed countres we were referrng to before may not be or should not be as severe. At the same tme, one also must note that, for precsely the same reasons the welfare gans for the world as a whole may also be not as great as one mght thnk. 7

19 APPENIX ˆq A. To show that 0,,. We know that c qˆ ˆ c q 3 0). qˆ qˆ So, 0 (see, eq. 0) and that c qˆ c ˆ q 3 (see, eq. qˆ qˆ and 0. The latter nequalty mples that at least one of the two dervatves s negatve and ths must be the smaller of the two; accordng to ˆq the frst nequalty ths must be. So we only need to show that ˆq 6 c 9 c 9 0. It suffces that the numerator s negatve, whch can be wrtten as c c 0. It suffces that c 0 or 9 3 c always less than 4c. 3 9 c 0 or. However, the fnal nequalty always holds as 4c and the RHS s ˆq A. To show that 0,,. We know that c qˆ ˆ c q eq. 0). (see, eq. 7) and that c qˆ c ˆ q 3 Followng the same reasonng as above, we only need to show that c 3 ˆq qˆ for becomes 0 or, smply, that ˆq (eq. 4) and notcng that 3 (see, ˆq c. Substtutng the latter nequalty 8

20 c c c Hence t suffces to show that c c or, after some routne calculatons, that 3 for all 0, 3 c. Snce t suffces to show that 3 c or, smply, that 3 c. However, the fnal nequalty always holds as 4c and the RHS s always less than 4c. 9

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22 ATHENS UNIVERSITY OF ECONOMICS AN BUSINESS EPARTMENT OF ECONOMICS I S C U S S I O N P A P E R S (An electronc verson of the paper may be downloaded from: ) 93. George C. Btros, AUEB. AGGREGATION OF PROUCER URABLES WITH EXOGENOUS TECHNICAL CHANGE AN ENOGENOUS USEFUL LIVES. Publshed n: Journal of Economc and Socal Measurement, 34 (009), Efthymos Tsonas, AUEB, Ncholas C. Baltas, AUEB and onysos P. Chons, emocrtus Unv. of Thrace. COST STRUCTURE, EFFICIENCY AN PROUCTIVITY IN HELLENIC RAILWAYS. Publshed n: Journal of Economc Asymmetres, Vol. 5, No., pp. 39-5, George C. Btros, AUEB. THE THEOREM OF PROPORTIONALITY IN MAINSTREAM CAPITAL THEORY: AN ASSESSMENT OF ITS CONCEPTUAL FOUNATIONS. (Ths paper has evolved from scusson Paper No.9 under the ttle The Hypothess of Proportonalty n Captal Theory: An Assessment of the Lterature. The present covers only the theoretcal lterature and t wll be supplemented by another paper coverng the emprcal lterature.) [Sept. 009]. 96. George C. Btros, AUEB. THE THEOREM OF PROPORTIONALITY IN MAINSTREAM CAPITAL THEORY: AN ASSESSMENT OF ITS APPLICABILITY. (Ths paper has evolved from scusson Paper No.9 under the ttle The Hypothess of Proportonalty n Captal Theory: An Assessment of the Lterature. It surveys the emprcal lterature and accompanes scusson Paper No. 95 under the ttle The theorem of Proportonalty n Manstream Captal theory: An Assessment of ts Conceptual Foundatons.) Forthcomng n a slghtly revsed verson n the Journal of Economc and Socal Measurement. 97. George. emopoulos, European Char Jean Monnet and AUEB, Ncholas A. Yannacopoulos, Unversty of Praeus, and Athanassos N. Yannacopoulos, AUEB. THEORY AN POLICY IN MONETARY UNIONS: INETERMINACY AN OPTIMAL CONTROL. (Feb. 00). 98. Stelos Arvants and Antons emos, AUEB. STOCHASTIC EXPANSIONS AN MOMENT APPROXIMATIONS FOR THREE INIRECT ESTIMATORS. (June 00). 99. Yanns Katsoulacos, AUEB and avd Ulph, Unv. of St. Andrews. THE WELFARE EFFECTS OF LEGAL UNCERTAINTY AN ITS IMPLICATIONS FOR ENFORCEMENT PROCEURES. (June 00). 00. Ioanna Sapfo Pepelass, AUEB. ENTREPRENEURIAL TYPOLOGIES IN A YOUNG NATION STATE: EVIENCE FROM THE FOUNING CHARTERS OF GREEK SOCIETE ANONYMES, (June 00). 0. George C. Btros, AUEB. TWO PUZZLES REGARING THE REPLACEMENT RATIO IN THE CONTEXT OF RENEWAL THEORY. Forthcomng n the Journal of Economc Methodology. 0. Konstantne Gatsos, AUEB and Evmorfa Makantas, AUEB. ISCRIMINATORY TARIFFS AN THE MOST FAVORE NATION CLAUSE. (July 00).