Commercial Policy and Dynamic Adjustment Under Monopolistic Competition

We assess some likely consequences of commercial policy in an intertemporal CGE model of an imperfectly competitive, small open economy. Specifically, we combine an overlapping generations model of aggregate savings with capital accumulation by forward-looking investors and production under monopolistic competition and increasing returns to scale. The model replicates Austrian data. We find that unilateral tariff cuts have an expansionary effect resulting both in rationalization of industrial production and in new products supplied by new firms entering the market. Small export subsidies are self financing. The expansionary effects and the welfare increases get magnified under monopolistic competition when compared with a more competitive case. Although all generations are able to participate in the efficiency gains, we note uneven generational gains. Finally, we report large overshooting in the net asset position which we attribute to a life-cycle type savings mechanism.