Tariff reforms with rigid wages (Q834721)

Recently, three major approaches have been used to analyse piecemeal trade policy reform. According to the first approach, the traditional focus on welfare improvements is supplemented as the objective of the reforms with considerations of market access. The second approach expands the range of reforms known to be welfare or market access improving. Finally, the third approach introduces a binding minimum wage into the standard model of a competitive small open economy to consider the welfare effects of trade policy reform in the presence of involuntary unemployment. This paper builds on all three aforementioned contributions and analyses the effects of tariff reforms on welfare and market access in a competitive small open economy, which is characterised by involuntary unemployment due to non-market clearing wages that are fixed either in terms of the numeraire or in real terms. It shows that recent tariff-reform results can be extended to integrated reforms of tariffs and the wage rate, and that the inherent tension between reforms that increase welfare and market access carries over. Welfare increasing tariff-reform strategies, which keep the wage rate constant, are also derived, and it is shown that this tension may be attenuated.