Introduction

The literature on the nature and the structure of optimal tariffs is an old one in the theory of international trade. There are many arguments for the imposition of tariffs, the most well-known argument being the monopoly power in trade – the terms of trade argument (see Bhagwati and Ramaswamy, 1963): since a large country can affect the international terms of trade by imposing tariffs, it can use tariffs to maximize its own welfare. There are other reasons, such as monopoly power in production (Katrak, 1977), unalterable domestic distortions, the infant industry argument (see Corden, 1974, ch. 9), etc., for a country to impose tariffs in order to raise its welfare.

The above literature ignores one important aspect of real life, viz., the fact that often producers and sellers of a commodity are different entities. For example, Toyota cars are most often sold abroad by dealers that are nationals of the country where the cars are sold. Another example is the clothing industry where items are usually sold by big stores under their own brand names (e.g., St. Michael for Marks and Spencer) but are often produced not by the stores but by other domestic and/or foreign producers.

In deciding on the level of the optimal tariff on a commodity under this circumstance, the importing country clearly has to take into account its effect on the domestic sellers' profits. Can this new consideration change the sign of optimal tariffs?