Trade policy in a model of sequential production

Abstract We develop a two-country trade model with sequential production in which a technologically backward economy exports intermediates in exchange for final goods from a technologically advanced economy. The advanced country can raise welfare by imposing import tariffs on intermediates, whereas export tariffs on intermediates or import tariffs on final goods are ineffective for the backward economy. Instead, the backward economy resorts to a quantitative export constraint, diverting part of its labor force into a less efficient autarkic production process. We show that non-cooperative policy choices reduce trade and lower welfare in both countries, underscoring the need for a trade agreement. To sustain mutually beneficial liberalization after prior tariff reductions, however, an agreement may have to link tariff cuts to the removal of export constraints, particularly when lifting these constraints is costly for the backward economy.