Optimum policies with unemployment and international capital mobility

Abstract

We construct a small open economy model characterized by unemployment, diminishing returns to scale in production, and free international captial mobility. When a sub-optimum labor subsidy exists, the optimal policy is a production or consumption subsidy on the imported good, and it is an import tariff or subsidy according to whether such a policy raises the country's overall employment. When for reasons other than efficiency, a sub-optimal tariff structure exists, the optimal policy towards labor (capital) can be a subsidy or tax when no capital (labor) tax or subsidy exists. When trade is free, the optimal policy towards either factor is always a subsidy. [411, 422]