Increasing returns, urban unemployment, and international capital mobility: A trade policy analysis

Abstract This paper compares the effects of tariffs, quotas and VER, both with and without international capital mobility, for a small open economy facing urban unemployment of unskilled labor and external increasing returns in the manufacturing sector. Expressions for the shadow price of foreign exchange and capital are derived under each type of trade restriction. It is shown that international capital mobility in such an economy unambiguously lowers the welfare cost of all forms of trade restriction, in contrast to the existing literature on full employment CRS economy, where international capital mobility unambiguously raises the welfare cost of tariff protection.