The Internationalisation of Economic Activity and Tariff Policy

Optimal tariffs in the presence of foreign factor ownership are derived and interpreted. Three types of optimal tariffs are considered: the analogue (with foreign factor ownership) of the standard optimal tariff (terms of trade improvement), the second best optimal tariff (distortion reducing) and the general optimal tariff. The general optimal tariff is equal to the analogue of the standard optimal tariff if foreigners do not own factors in the home country. In this case the optimal tariff is negative if and only if trade pattern reversals occur. The general optimal tariff may be positive in the presence of foreign factor ownership in the home country even if trade pattern reversals occur. Foreign factor ownership may explain the existence of import or export subsidies in many countries. This explanation is an alternative to rent shifting or the existence of a foreign monopoly which supplies the domestic market.